UNIT- I DEMAND FORECASTING AND ELEMENTS OF COST
What you will know? Macro and Micro economics Factors influencing demand Demand forecasting – time series, exponential smoothing, casual, Delphi method, correlation and regression, Barometric method, long and short run forecast Elements of cost – Material cost, labour cost
Expenses- types of cost, cost of production, overhead expenses, problems
Macro and Micro Economics The study of economics is divided into two parts. - Micro Economics and Macro Economics Micro economics : Microeconomics is the study of the small part or component of the whole economy that we are analyzing. For example we may be studying an individual firm or in any particular industry. In Microeconomics we study the price of a particular product or particular factor of the production.
The Micro Economics theory studies the behavior of individual decision-making units such as consumers, business owners and business firms.
Macro economics is the study of behavior of the economy as a whole. It examines the overall level of nations out put, employment, price and foreign trade. Macroeconomics is concerned with aggregate and average of entire economy. e.g. In Macro economics we study about forest not about tree.
In other words in macro economics study how these aggregates and averages of economy as whole are determined and what causes fluctuation in them. For making of useful economic policies for the nation macroeconomics is necessary.
We can summarize the objects of macroeconomics as : 1 . A high and rising level of real output. 2. High employment and low unemployment, providing good jobs with high salary to those who 3. A stable or gently rising price level, with process and wages determined by free markets.
4. Foreign economic relations marked by stable foreign exchange rate and exports more or less balancing imports.
Macro economics involves choice among alternative central objectives. A nation can’t always have high consumption and rapid growth.
High inflation rate has either a period of high unemployment and low output, or interference with free markets through wage-price policies. These difficult choices are among those that must be faced by macroeconomic policy makers in any nation.
Demand and Supply What is the salary of a school teacher? How much does a management guru like Arindham Chaudhry charge per hour? What salary does a bus driver get? How much does a pilot flying an aircraft get? How much do sportsmen like Sachin or Dhoni make? How much do actors and actresses make?
Why this difference in earnings?
Have you ever awakened at 3 AM with a bad headache and had to rush to the pharmacy to buy some aspirin? How did the store know to have aspirin in stock? Who coordinates this production to make sure there is enough? What price should be charged for aspirin? Government officials don't tell businesses how much aspirin to produce nor the price to charge. Private producers figure out production levels and prices on their own. The producer supplies the product if she can make a profit by doing so.
The forces of supply and demand coordinate all this activity.
The Market System Consumers - create a demand for a product the amount consumers desire to purchase at various prices Not what they will buy, but what they would like to buy!
Effective demand – must be willing AND able to pay
Individual and Market Demand Market demand – consists of the sum of all individual demand schedules in the market Represented by a demand curve At higher prices, consumers generally willing to purchase less than at lower prices
Demand curve – negative slope, downward sloping from left to right
Demand Curve Demand 100 150 Rs.50 Rs.100 Price Quantity The demand curve slopes downwards from left to right (a negative slope) indicating an inverse relationship between price and the quantity demanded. Demand will be higher at lower prices than at higher prices. As price falls, demand rises. As price rises, demand falls.
Factors influencing demand D = f (P n, P n …P n-1 , Y, T, P, A, E) P n …P n-1 = Prices of other goods – substitutes Y = Incomes – the level and distribution of income T = Tastes, Trends and fashions P = The level and structure of the population, A = Advertising, Attitude
E = Expectations of consumers
Elasticity of demand (EOD) The law of demand tells us that as the price of a commodity falls, the quantity demanded increases, and vice versa.( Eg. Gold) But it does not state by how much the quantity demanded increases as a result of a certain fall in the price or by how much the quantity demanded decreases as a result of the rise in the price.
In other words it only tells us only direction of change but not the rate of change.
Definition and formula of EOD The degree of responsiveness of the quantity demanded to a change in price Change in quantity demanded Change in quantity demanded / Quantity demanded
ep = (Q2-Q1) / Q1 ( where ,ep= price elasticity of demand)
Contd.. Q1 = Quantity demanded before price change Q2 = Quantity demanded after price change P1 = Price charged before price change P2 = Price charged after price change If Q1= 2000, Q2 = 2500, P1 = 10 and P2 = 9, then
This implies that a 1% reduction in price will increase
Types of elasticity of demand Perfectly elastic demand (At a given price or less than the given price, infinite qty will be bought) Perfectly inelastic demand ( Same qty will be bought at any price) Demand with unity elasticity (Equally proportionate demand for proportionate change ) Relatively elastic demand ( More than proportionate demand due to price change) steep Less than one Relatively inelastic Flat More than one Relatively elastic Rectangular hyperbola One unity elasticity Vertical Zero Perfectly inelastic Horizontal Infinite Perfectly elastic Curve shape Description Type
Relatively inelastic demand (less than proportionate demand due to price change )
Price Price Price Price Perfectly elastic demand Perfectly inelastic demand Quantity demanded Quantity demanded Quantity demanded Quantity demanded Relatively elastic demand Relatively inelastic demand
Factors affecting EOD Type of goods- elastic for luxuries and inelastic for necessities Existence of substitutes: Inelastic if substitutes exist No. of uses of goods: Elastic if commodity has variety of uses Time element: Elastic if use can be postponed
Customer’s income: Inelastic if expenditure is only a small part of income
Demand Forecasting Correlation and regression,
Long and short run forecast
Delphi Method The most primitive method of forecasting is guessing . Delphi is used for long-range forecast. technological forecast for new technology, effect of scientific advances, changes in competitive environment, etc.
For example, the effect of internet/intranet or information-highway in the educational system of India in next 25 years may be forecasted through this approach.
The result may be rated acceptable if the person making the guess is an expert in the matter. In this method, a panel of outside experts is identified. They are given a series of structured questionnaires. The answers of each questionnaire are used as input for the design of the next questionnaire.
The identity of experts is not disclosed. This is for the purpose that nobody should influence the opinion of others.
In the next step, the researcher coordinator makes a summary of all the replies he has received. He then sends the summary to the respondents and asks if any of them wants to revise his original response. The Delphi procedure is normally repeated until the respondents are no longer willing to adjust their responses. The opinions are compared for similarity or variation If the variation is too much, the expert is asked to justify for the opinion
Based on the replies a final consensus will be arrived about the product demand
Disadvantages The Delphi method is not very reliable. Results of Delphi questionnaires are often later found to have predicted the real course of events remarkably badly.
Wrong guesses are often made by renowned specialists and sometimes even by a majority of them, and the odd person who is later found to have predicted right would perhaps never have been elected to the Delphi group of experts
Elements of cost
Classification of costs
Association with products
According to nature or elements The three main elements of costs are
Material cost Direct Materials
Direct materials Also known as Productive materials, it is the cost of the material that enter into and forms a part of the product it is essential for the completion of the product Timber in furniture making and clay in brick making, HSS bit for making turning tool Ni, Fe, Cr etc for making alloy steels Essentially needed to convert the raw materials into final products but not used directly in the product itself. Eg. coolants, grease, cotton waste , thread, nail, gum, fuel, etc
The cost associated with indirect material is called indirect cost
Cost of remuneration of the employees of an organization. Such as wages, salaries, bonus, commissions etc.
Direct labour cost The cost of labour that can be directly associated with the manufacture of the product and can be allocated to cost centers and cost units. A direct labour is one who converts the direct material into a saleable product and the expenses incurred on such labour is called direct labour cost
The direct labour cost may be apportioned to the unit of the cost or on the basis of the time spent by the worker or as the price for some physical measurement of the product
Indirect labour cost The cost of the labour that does not alter the construction, composition, conformation, or the condition of the direct material but is necessary for the progressive movement and handling of the product to the point of dispatch. This cost is absorbed by the cost centers and cost units.
Eg. Maintenance men, helpers, machine setters, supervisors, foremen etc.
It’s a collective title which refers to all charges other than those incurred as a direct result of employing workers or obtaining material.
Direct expense Expenses that can be identified with and allocated to cost centers /cost units Eg: Costs of special layouts, designs, drawings, for a special job Hiring special purpose machines or equipments for a particular production order Expenses absorbed by cost centers or cost units
Eg: building rent, Insurance, phone bills etc.
Fixed expense Costs that remain fixed independent of the volume of production Eg: land tax, water tax, building tax, depreciation, rent , insurance, salary etc. Costs that vary directly with volume of production.
Eg: electricity, wages for contract labour, consumables, raw material cost etc..
Prime cost Direct labour cost + Direct expenses
Note: Prime cost is limited in its use to manufacturing division of a business concern
Overheads All expenses other than direct expenses Defn.: cost of indirect material, indirect labour and other indirect expenses including services.
Overheads are subdivided into
i) Manufacturing overhead All direct expenses incurred by the company from the receipt of production order to its completion for despatch to the customer Typical mfg overheads are 1. Building expenses rent, insurance, repairs, heating and lighting, depreciation etc.
2. Indirect labour supervisors, foremen, machine setters, general workers, maintenance men, shop clerks, shop inspectors etc.
4. Consumables like cotton waste, grease etc. 5. Plant maintenance and depreciation
6. Sundry expenses such as security, employment office, welfare measures, recreation facilities, restrooms etc.
ii) Administrative overhead Expenses incurred in direction, control, administration of an enterprise It is the expense of providing a general management and clerical service
Eg: rent, salaries of clerks, salaries of directors, GM etc, insurance, legal costs, taxes, postage, telephone, audit fees, bank charges, etc.
iii) Selling overhead Expenses required to maintain and increase volume of sales All expenses direct or indirect necessary to persuade consumers to buy Salaries and commissions for sales people
After sales service cost etc.
iv) Distribution overhead Expenses connected with storing and transportation to customers Loading and unloading charges Maintenance of delivery vehicles
Depreciation of vehicles etc…
R & D overhead Expenses on product development = Prime cost + factory overhead
= direct material cost + direct labour cost + direct expenses + factory overhead
Total cost = Factory cost + administrative overhead
Selling Price = total cost + profit or loss
Problem From the data below find the following Selling and distribution overheads Total cost or cost of sales
Assume a net profit of Rs. 10,000/=
Material in hand: 60,000 As on 01 April 2009 New material purchased: 2,50,000 Depreciation on car: 1,200 Printing and stationery: 300 Plant depreciation: 5,000 Wages of direct workers:70,000 Wages of indirect workers: 10,000
Factory building rent: 5,000
Salesmen commission: 2,500 Expenses on sales dept car:1,500 Material in hand as on 31 March 2010: 50,000 Variable direct expenses: 750 Plant repair and maintenance: 3,000
Heating and lighting for office; 2,500
Solution Material cost: = cost of material as on 01 April 2009 – cost of material as on 31 March 2010 + cost of new material purchased = 60,000 - 50,000 + 2,50,000 Prime cost: Direct material cost + direct labour cost + Variable direct expenses
= 2,60,000 + 70,000 + 750 = 3,30,750
Direct cost = same as prime cost = 3,30,750 Factory cost: Prime cost + production overhead where production overhead=Plant depreciation: 5,000 + Wages of indirect workers:10,000+ Factory building rent: 5,000+ Electricity: 1000 + Plant repair and maintenance: 3,000
= 3,30,750 + [ 5,000 +10,000 + 5000 +1000 +3000 ] = 3,54,750
Administrative overheads:= director fee;3,500 +Printing charges:300+ postage:200+ office salaries:2000+office rent: 500 + distribution cost:2000 = 3500 + 300 + 200 + 2,000 + 500 + 2,500 Cost of production: = Factory cost + Admin overheads= 3,54,750 + 9,000
Selling and Distribution overheads: = advertising: 12,000+ Depreciation on car: 1,200+showroom rent:1,500+ salesmen commission: 2,500 +Expenses on sales dept car:1,500+Distribution cost: 2,000
Total cost or cost of sales:= cost of production + sales and distribution overheads = 3,63,750 + 20,700
Selling price = Cost of sales + profit