Prof. Babar Hussain
What Is Demand Estimation?
When running a small business, it is important to have an idea of what you should expect in the way of sales. To estimate how many sales a company will make, demand estimation is a process that is commonly used. With demand estimation, a company can gauge how much to produce and make other important decisions.
Demand estimation is a process that involves coming up with an estimate of the amount of demand for a product or service. The estimate of demand is typically confined to a particular period of time, such as a month, quarter or year. While this is definitely not a way to predict the future for your business, it can be used to come up with fairly accurate estimates if the assumptions made are correct. Methods of Demand Estimation:
There are a variety of ways that can be used to estimate demand, each of which has certain advantages and disadvantages. They are divided into Qualitative and Quantitative Methods. Qualitative Methods:
Qualitative methods consists of following points. Consumer surveys:
Firms can obtain information regarding their demand functions by using interviews and questionnaires, asking questions about buying habits, motives and intentions. These can be quick on-the-street interviews, or in-depth ones. They might ask, for example, how much more petrol respondents would buy if its price were reduced by Rs.15 per liter, or which brand of several possibilities they prefer. These methods have certain drawbacks. Market experiments:
As with consumer surveys these can be performed in many ways. Laboratory experiments or consumer clinics seek to test consumer reactionsto changes invariables in the demand function in a controlled environment.Consumers are normally given small amounts of money and allowed to choose how to spend this on different goods at prices that are varied by the investigator. However, such experiments have to be set up very carefully to obtain valid andreliable results; the knowledge of being in an artificial environment can affect consumer behavior other types of market study involve using real markets in different geographic locations and varying the controllable factors affecting demand.
While the above methods are useful, they often do not provide management with the kind of detailed information necessary to estimate a useful demand function,and thereby test the relevant hypotheses and make forecasts. Statisticaltechniques, especially regression analysis, provide the most powerful means of estimating demand functions. Regression techniques do have various limitations: 1)They require a lot of data in order to be performed.
2) They necessitate a large amount of computation.
3) They suffer from a number of technical problems.
In spite of these limitations, regression techniques have become the most popular method of demand estimation, since the widespread availability of powerful desktop PCs and software packages have made at least the first two problems easy to overcome.
There are two major aspects of this stage. In order to understand this we must first distinguish a statistical relationship from a deterministic relationship. The latter are relationships known with certainty, for example the relationship among revenue ,price and quantity :R=P*Q; if P and Q are known R can be determined exactly. Statistical relationships are much more common in economics and involve an element of uncertainty. The deterministic relationship is considered first. Mathematical models:
It is assumed to begin with that the relationship is deterministic. With a simple demand curve the relationship would therefore be Q=f (P)
If we are also interested in how sales are affected by the past price, the model might in...