Tarun Das Page 1 11/26/2009

Demand Projections
Prof. Tarun Das, IILM, New Delhi-110003.

1. Purpose and Use of Demand Projections

1.1. Demand projections form the basic foundations of corporate planning.
1.2. These are essential for production, pricing and employment planning.
1.3. Every big corporate house employs statisticians and econometricians for
analyzing and forecasting market demand.
1.4. Basic building block of demand analysis is the empirical demand functions.
1.5. However, these are subject to identification and specification problems.

2. Dimensions of Demand Projections

2.1. Macro models (National level)
2.2. Meso (Middle level- States)
2.3. Spatial (over space)
2.4. Regional (over regions)
2.5. Industrial (over industries)
2.6. Sectoral (sectors- rural, urban)
2.7. Micro (at unit/firm levels)
2.8. Inter temporal (over time)
2.9. Intergenerational (over generations)

3. Factors Influencing Demand Projections

3.1. Overall objective and purpose- a part of corporate plan
3.2. Planning horizon
3.3. Product disaggregation
3.4. Regional disaggregation
3.5. Quantifiable variables influencing demand and their perspectives in the short
and medium term
3.6. Constraints in the system
3.7. Expected change in environment

4. Forecasting techniques
4.1 Opinion polls- collecting opinions of those who are knowledgeable about
the markets such as sales representatives, sales executives, professional
marketing experts and consultants. The opinion poll methods include:
(a) Expert opinions- although the method is simple and less expensive, it
has limitations due to subjective judgments and may lead to either
over-estimation or under-estimation.
(b) Delhi method- Similar to expert opinion, but here experts are
provided with alternative forecasts and asked to give their expert
opinions and revisions, with explanations, if any. These unstructured
opinions of experts can be used to cross check results obtained from
more sophisticated and statistical techniques.
(c) Market surveys- widely used to estimate and forecast demand.

1
Tarun Das Page 2 11/26/2009

4.2 Barometer method and Economic indicators- Barometer method is

generally used for forecasting weather. The essence of the technique can be
used to forecast demand. The basic approach is to use a set of economic
indicators to project demand. These indicators can be classified as the
following:
(a) Leading indicators- those indicators which move up or down
ahead of some other series such as net investments, new
constructions and transport links, prices of materials, contracts
and orders, change of inventories, net corporate profits etc.
(b) Coincidental indicators- those which move up or down
simultaneously with the level of economic activity such as
employees and payrolls, rate of unemployment, gross national
product, sales by manufacturing, trading and retail sectors,
personal incomes etc.
(c) Lagging indicators- those which follow after some time lag such
as wage rates and inflation, consumer credits, lending rates,
outstanding loans etc.
4.3 Projections techniques
4.4 Econometric models

5. Methods of demand Projection

5.1. Average growth approach
5.2. Demand Intensity approach
5.3. Per capita demand approach
5.4. Elasticity approach
5.5. End-Use/ Input-output approach
5.6. Material balance approach
5.7. Time Trend Method
5.8. Engel curves
5.9. Econometric approach- multiple regression approach

5.0 An Example- Trends of Sales, Income and Population

Income
Sales (S) (Y) Population (P)
Year Time (Rs.bln) (Rs.bln) (mln)
2000 1 1200 21043 1019
2001 2 1300 22960 1037
2002 3 1400 24510 1055
2003 4 1550 26900 1072
2004 5 1680 29514 1088
2005 6 1800 32465 1104
Total 6 8930 157392 6375
Average 1488.3 26232 1062.5

2
Tarun Das Page 3 11/26/2009

Fig-5.1: Trends of Sales, Income and Population

4000

3000

2000
1000

0
1 2 3 4 5 6

S (Rs.bln) Y (Rs.10bln) P (mln)

5.1 Average growth method:

Year S (Rs.bln) Y (Rs.bln) P (mln) GR (S)
2000 1200 21043 1019 8.5
2001 1300 22960 1037 8.3
2002 1400 24510 1055 7.7
2003 1550 26900 1072 10.7
2004 1680 29514 1088 8.4
2005 1800 32465 1104 7.1
Total 8930 157392 6375 50.8
Average 1488.3 26232 1062.5 8.5
Average growth rate of sales= 8.5%
Projection of sales for 2006 = 1800 x (1+8.5/100)
= 1800 x 1.085 = 1953

5.2 Demand Intensity Approach

Year S (Rs.bln) Y (Rs.bln) Intensity
2000 1200 21043 0.0570
2001 1300 22960 0.0566
2002 1400 24510 0.0571
2003 1550 26900 0.0576
2004 1680 29514 0.0569 Ave. Sales Intensity w.r.t. GDP = 0.0567
2005 1800 32465 0.0554 Assumption: GR of GDP in 2006=10%
Total 8930 157392 0.0567 GDP in 2006 = 32465 x 1.10 =35712
Average 1488.3 26232 0.0567 Proj. for 2006 =35712 x0.0567= 2026
5.3 Percapita Demand Approach
Year S (Rs.bln) Y (Rs.bln) P (mln) PC Sales=S/P
2000 1200 21043 1019 1.18
2001 1300 22960 1037 1.25
2002 1400 24510 1055 1.33
2003 1550 26900 1072 1.45
2004 1680 29514 1088 1.54
2005 1800 32465 1104 1.63
Assumption: Population GR in 2006 = 1.5%, Percapita sales = 1.75
Sales Proj. for 2006 = 2005 Pop x Pop Growth factor x PC sales = 1104 x 1.015 x 1.75
= 1961

3
 Tarun Das Page 4 11/26/2009

5.4 Demand elasticity approach

Year S (Rs.bln) Y (Rs.bln) P (mln) GR (S) GR (Y) GR (P)
2000 1200 21043 1019 8.5 9.2 1.9
2001 1300 22960 1037 8.3 9.1 1.8
2002 1400 24510 1055 7.7 6.8 1.7
2003 1550 26900 1072 10.7 9.8 1.6
2004 1680 29514 1088 8.4 9.7 1.5
2005 1800 32465 1104 7.1 10.0 1.5
Total 8930 157392 6375 50.8 54.5 10.0
Average 1488.3 26232 1062.5 8.5 9.1 1.7
Sales elasticity w.r.t. Y & P = GR (S)/GR (Y) or GR (P) 0.93 5.0
Sales proj.for 2006: Assume GR (Y)=10%, GR (P)=1.5%
(1) Sales GR= 10 x 0.93 = 9.3% Projection of sales for 2006 = 1967
(2) Sales GR= 1.5 x 5 = 7.5% Projection of sales for 2006 = 1935

5.5 End-Use Method- Planning Commission (PC) Model for Five-Year Plans
Demand = Intermediate + Final Demand = Σ aij Xj +Fi,
Intermediate Demand = Use by other industries in the process of production
= Σ aij Xj, where aij is the amount of ith good used per unit of jth good,
Final Demand (Fi) = Private consumption (Ci) + Public consumption (Gi) +
Investment (Ii) +Stocks (Sti) +Exports (EXPi) – Imports (IMPi)
Fi = Ci + Gi + Ii + STi + EXPi - IMPi

5.6 PC Macroeconomic Model in Leontief Input-Output Framework

Di= Xi = Σ aij Xj +Fi
Fi = Ci + Gi + Ii + STi + EXPi - IMPi
Xi = Supply of ith good
Di = demand for ith good
Ci estimated by Engel curves
Ii is estimated by a distributed lag model on investment.
Gi is estimated by minimum needs program and other public distribution and
welfare programs of the government.
Sti is estimated by fixed coefficients.
EXPi are exogenous.
IMPi = Σ mj Xj + ki Ci + bi Gi + hi Ii

5.7 Time Trend Method

Year Time (T) S (Rs.bln) Log (S)

2000 1 1200 7.09
2001 2 1300 7.17
2002 3 1400 7.24
2003 4 1550 7.35
2004 5 1680 7.43
2005 6 1800 7.50

4
Tarun Das Page 5 11/26/2009

Fitted Time Trends

Type α β R-SQ
Linear S = α + β T 1059.3 122.6 0.996
Exponential Log S = α + β T 7.006 0.083 0.998
Projection for 2006 (Time=7)
Linear S = α + β T 1917
Exponential Log S = α + β T 1969

5.8 Engel Curves

• Engel curves show the relationship between per capita consumption demand and
per capita income.
• There are various forms of Engel curves.
Linear C = α + β Y
Loglinear Log C = α + β Log Y
Semi log Log C = α + β Y
Log Inverse Log C = α + β / Y
Log Log Inverse Log C = α + β 1 Log Y+ β 2 / Y
• These are estimated on the basis of consumption data obtained from the
household expenditure surveys.
Year Time S (Rs.bln) Y (Rs.bln) log(s) log(Y) 1/ Y
2000 1 1200 21043 7.09 9.95 4.75217E-05
2001 2 1300 22960 7.17 10.04 4.3554E-05
2002 3 1400 24510 7.24 10.11 4.07997E-05
2003 4 1550 26900 7.35 10.20 3.71747E-05
2004 5 1680 29514 7.43 10.29 3.38822E-05
2005 6 1800 32465 7.50 10.39 3.08024E-05
Assumption: GR of income =10%, Income (Y) in 2006 = 1.10 x 32465 = 35712
Sales Projections for 2006
Linear 1998
Log-linear 2001
Semi log 2075
Log-inverse 1936
Type Linear Log linear Semi log Log-inverse
α 77.17 -2.45 6.35 8.27
β 0.05 0.96 3.6E-05 -24916
R-SQ 0.994 0.995 0.984 0.998

5
Tarun Das Page 6 11/26/2009

6.1 Econometric Demand Functions

a.Econometric Demand Functions help to establish statistical relations
between demand and major factors that influence demand.
b. Demand functions can be specified, calibrated,
tested, monitored, updated, simulated and predicted with certain degree of
confidence.
c.Identify potential variables

6.2 Steps in econometric demand analysis

i. Have a sound theoretical basis

ii. Specify equations
iii. Identify equations
iv. Calibration of parameters
v. Testing- Various goodness of fit statistics- R-sq, ξ -sq, Theil index etc.
vi. Simulation, projections and planning
vii. Monitoring, review and updating

Typical Empirical Demand equations

D = a + b P + c Y+ d Pr + e N
Where D = demand of a good or service
P = Price of the good or service
Y = Consumer’s income
Pr = Price of a related good or service
N = A catch-all variable to take care of omitted variables (could be time)
b<0 for normal, b>0 for inferior good
c>0 for normal, b<0 for Giffen good
d>0 for substitute d<0 for complement

6.3 Types of econometric models

(a) Static (at a particular time period) and dynamic (takes care of change of time
and business environment)
(b) Consistent (consistency among the systems equations), behavioral (on the basis
of consumers, producers and traders behavior) and optimizing (maximizing
revenue, market share, profits or minimizing costs etc.)
(c) Partial equilibrium (deals with specific good) or general equilibrium (considers
equilibrium in the whole system)
(d) sectoral model (deals with a sector) or the economy-wide model (all sectors)

6.4 Types of data for econometric analysis

(a) Time series (over time- inter-temporal)

(b) Cross section (across consumers, regions, countries etc. at a particular time)
(c) Pooled- Pooling of consumers and sectors (All consumers in urban, rural)

6
Tarun Das Page 7 11/26/2009

(d) Panel - Combination of time series and cross section data

6.5 Types of variables

Ct = α + β Yt + χ Wt + δ Ct-1 + ε Dt+λ T
Dt = 1 if t is 1991 to 2003, 0 otherwise
• Endogenous variables (determined within the model) Ct, Yt
• Exogenous/ predetermined variable Wt
• Parameters α , β , χ , δ , ε , λ
• Lagged variable Ct-1
• Instrumental variable Wt
• Dummy (binary, categorical, indicative, qualitative, dichotomous) variable Dt
• Catch all variable (Time T to take care of all omitted variables)

7. Concluding Observations- General Agreements by Modelers

a. State your biases, intuitive arguments and limitations of the model.

b. Equations provide guideposts and are not expected to produce precise
results.
c. Econometric results should be supplemented by qualitative judgments for
useful policy formulation and corporate planning.
d. Social environment and political economy may be treated as given in the
model.
e. Models should be tested rigorously for the real world with full range of
policies.
f. Sufficient resources should be used for full documentation of the model,
so that any other group can test, calibrate and run the model.
g. Documentation should be clear and free from jargons for general
understanding by the non-technical audience.
h. Modelers should specify data sources and share their data.
i. It is needed to continually review, monitor, update, upgrade, and simulate
the model.
j. However, limited purpose model is better than general-purpose model.
k. Descriptive model is better than normative and subjective model.
l. Policy oriented model is better than general understanding model.
m. Short run and medium term models are better than long-term models.
n. Sectoral model is better than economy wide model.
o. To guess crucial missing data rather than leaving out.
p. Try to deal with future economic agents, technology change, prices and
population.

7
Tarun Das Page 8 11/26/2009

Review Questions

1. Why is demand forecasting essential for corporate planning? Discuss critically

the different opinion poll methods for demand forecasting.

2. Define leading indicators, coincidental indicators and lagging indicators for

demand projections. What would be the appropriate leading indicators,
coincidental indicators and lagging indicators for forecasting demands for
steel?

3. What is meant by an Engel curve? Distinguish between time series, cross

section, pooled and panel data and their uses for estimation of Engel curves.

4. You are given the following data:

Year Sales of Cars GDP Population

(Million) (Rs. billion) (Million)
2004 10 100 1000
2005 11.5 110 1016
Further assume that GDP is expected to grow at the rare of 10% and population at 1.5%
in 2006. Forecast demand for cars in 2006 under the following methods:
(a) Elasticity of demand with respect to GDP,
(b) Average demand intensity in GDP,
(c) Average per capita demand for cars and
(d) Past growth rate of cars.