Forecasting

Introduction

“We have two classes of forecasters: Those who don’t know — and those who don’t
know they don’t know.”

- *John Kenneth Galbraith

Experienced economists know that economic forecasting is fraught with uncertainty.

Predicting trends in macroeconomic conditions and their impact on costs or demand for company
goods and services is one of the most difficult responsibilities facing management. Predicting the
effects of changes in the competitive microeconomic environment can also be daunting.
However, forecasting is a necessary task because for better or for worse, all the decisions are
made on the basis of future expectations.

*John Kenneth Galbraith was a Canadian-American economist. His books on economic topics
were bestsellers in the 1950s and 1960s. A prolific author, he produced four dozen books & over
a 1000 articles on many subjects. Among his most famous works was his economics trilogy:
American Capitalism (1952), The Affluent Society (1958) & The New Industrial State (1967).
He taught at Harvard University for many years. He was active in politics, serving in the
administrations of Franklin Roosevelt, Harry Truman, John Kennedy, and Lyndon Johnson. He
served as US Ambassador to India under John F. Kennedy.

Etymological Definition
• The word “forecast” originated from the root word “fore” or “before” and “casten” in the
sense of contrive plan, or prepare. In its most sense the word “forecast” means an act to
“predict events” (15th c) and “to perceive or notice”(late 14th c).

• Forecasting is the process of making predictions of the future based on past and present
data most commonly by analysis of trends. (Wikipedia)
 “fore”
or
“before”
“Predict
events” (15th c)
“To perceive or
notice”(late
14th c)
“casten”

Forecasting Applications

Macroeconomic Applications

It involves predicting aggregate measures of economic activity at the international,

national, regional or state levels.

 GDP – is the value at final point of sale of all goods and services produced in the
domestic economy

 GNP – is the value at final point of sale of all goods and services produced by
domestic firms

Macroeconomic forecasts commonly reported in the press include the predictions of

consumer spending, business investment, home building, exports, imports, federal purchases,
state and local government spending and so on.

Microeconomic Applications

It involves the prediction of economic data at the industry, firm, plant or product levels. It
is the prediction of partial economic data. Unlike predictions of GDP growth, which are widely
followed in the press, the general public often ignores microeconomic forecasts of scrap prices
for aluminum, the demand for new cars, or production cost for Crest toothpaste.
Forecast Techniques

Accurate forecasts require pertinent data that are current, complete, and free from error
and bias. To overcome forecasting problems caused by errors and bias, a variety of forecast can
be employed:

a. Qualitative Analysis
b. Trend analysis and projection
c. Exponential smoothing
d. Econometric methods

A. Qualitative Analysis
- Is an intuitive approach to forecasting that can be useful if it allows for the systematic
collection of data from unbiased and informed opinion.

Expert Opinion

▫ Personal Insight

- the most basic form

- uses personal or company experience as a basis

▫ Panel Consensus

- informed opinion of several individuals is relied on

- superior to those that individuals generate

▫ Delphi Method

- - members of a panel experts individually receive a series of questions

Survey Techniques

- Generally use interviews or mailed questionnaires that ask firms, government agencies,
and individuals about their future plans. Businesses plan and budget virtually all their
expenditures in advance of actual purchase or production decisions.
 B. Trend Analysis and Projection
Trend Analysis - based on the premise that future economic performance follows an established
historical pattern.

Trends in Economic Data

Trend Projection is simply the prediction on the assumption that historical relationships
will continue into the future. All such method uses time-series data.

A time series depicts the relationship between two variables. Time is one of those variables and the
second is any quantitative variable. It is not necessary that the relationship always shows increment
in the change of the variable with reference to time. The relation is not always decreasing too.

The arrangement of data in accordance with their time of occurrence is a time series. It is the
chronological arrangement of data. Here, time is just a way in which one can relate the entire
phenomenon to suitable reference points. Time can be hours, days, months or years. It may be
increasing for some and decreasing for some points in time.

▫ Secular trend – the long-run pattern of increase or decrease in a series of economic data
▫ Cyclical fluctuation – describes the rhythmic variation in economic series that is due to a
pattern of expansion or contraction in the overall economy.
▫ Seasonal variation or Seasonality – a rhythmic annual pattern in sales or profit caused by
weather, habit or social customs.
▫ Irregular or Random influences – are unpredictable shocks to the economic system and the
pace of economic activity

*Seasonal and Cyclic Variations are the

periodic changes or short-term
fluctuations.