Chapter VI

Time Series and Forecasting

Time Series

Definition: A time series is a set of numerical measurements on a time-dependent variable of

interest arranged over a regular interval of time.
Suppose, y1, y2, ……………….., yk be the values of variable for k different times periods t1, t2, …
tk respectively, thus y is a function of t. Symbolically, y = (t).

Time series data typically possess special characteristics that necessitate statistical methods for their
analysis.

Objectives of Time Series Analysis

The main objective of analyzing the time series is to get a concrete idea about the past behavior of
data so that appropriate course of action for future can be taken. However, the objective can be
pointed out as follows:
i. To identify the pattern and trends and isolate the, influencing factors or effects
ii. To apply the idea obtained from analyzing the pattern of time series data for future planning
and control.

Importance of Time Series Analysis in Business Decision-Making

Time series analysis is of great importance to business executives. It is extremely useful for him/her
in decision-making due to the following reasons:
i. This is the most popular and so far the effective method for business forecasting.
ii. It helps in understanding the past behavior of economic process and in predicting the future
behavior.
iii. It helps in planning future operations.
iv. It helps in evaluating current achievement.
v. It facilities comparison of some phenomenon over two or more periods.

Measurement of trend Component

Of the four components of time series, secular trend represents the long-term direction of the time
series. The following are the methods used to eliminate linear trend component from a given time
series data:
A. Graphic or free hand curve method
B. Semi-average method
C. Least squares method
D. Moving average method.
A. Graphic or free hand curve method: The given data are plotted on a graph paper and a free
hand trend line fitted to the data is obtained just by inspection. A freehand curve drawn through
the data values is often an easy and perhaps, adequate representation of data. Forecasts can be
obtained simply by extending the line.
B. Semi-average method: In this method the given data are divided into two equal parts
preferably with equal number of periods. If there is odd number of years or period like 7,9 etc.
the middle year is ignored and the two equal parts are formed. An average of each part is

1
 computed and the two points thus obtained are centered corresponding to the middle period and
shown on the graph. A straight line is drawn through these two points. The values lying on this
describe the trends. By projecting the line it is possible to forecast the future values.
Example: Apply the method of semi-average of measuring the trend of sales of a commodity
from the following data:
Year: 1985 1986 1987 1988 1989 1990
Sales (in Tk.): 20 24 22 30 28 32
Solution:

C. The method of least squares: One of the important methods for determining trend is the
method of least squares. This method has been elaborately discussed in connection with
correlation and regression analysis. The basic principle of fitting trend line is the same as the
fitting of regression lines under the method of least squares. The only difference is that the X-
axis represents the year or any other time period and the Y-axis represents the values. The trend
line fitted by the method of least squares may be linear or curvilinear. We shall concentrate on
linear trends.
The equation for straight line given by ŷ = a + bx . Here represents the time which is the

independent variable and y represents the values of the variable which is dependent upon time
and a and b are the two constants. The least squares estimates of a and b are respectively-
u v
 uv  n
a  yˆ  bx and b 
 u 2
u 2

n
The estimated trend lines becomes-
ŷ = a + bx
On the basis of this trend line, values of y can be obtained for different values x and prediction
on future value of y can be done.
D. Moving average method: A mathematical method of determining non-linear trend of a time
series data is the moving average method. A moving average or a time period is the simple
arithmetic mean of the values in that time period. The effect of averaging is to give a smoother
curve, lessening the influence of the fluctuations that pull the annual figures away from the
general trend. The moving average method is also used for smoothing the irregularity present in
a time series data.
The simplest technique of moving average is called a simple centered n= (2m+1)-period moving
average. The data here is to replace each actual observation Yt by the average of itself and its m
neighbors on either side that means, replace Yt by
1 m
Y Y  .....  Yt  ....  Yt m1  Yt m
MAt (2m  1)  Yt  
2m  1 j   m
Yt  j  t m t m1
2m  1
It is to be noted that here t= m +1

2
 Forecasting

Due to increasing competition and complexity in business activities in almost all sectors of business
worldwide together with rapid change in demands, expectations and trend towards automation,
there is a necessity for every organization to know the key decision variable to be occurred in
advance. Forecasting in the term, which refers to projecting the occurrence of uncertain events for a
future period analyzing the past and present history of data. This may help the organizations to
assess the future plans of actions or strategies. Ex-
Forecasting is concerned with two main tasks, first the determination of the best basis available for
the formulation of efficient managerial expectations and second, the handling of uncertainty about
the future, so that the implication of decisions become very comprehensible.

Objectives of Forecasting
Although forecasts are commonly applied to capital investment decisions, strategic planning,
product and market planning etc. with an expectation of certain levels of returns and help in
decision making, the main objectives or functions of forecasting can be summarizes as below.
Since, it is impossible to evolve a worthwhile system of business control without acceptable system
of forecasting, so no plan of action in business can be created without making forecasts of desired
factor.
Monitoring the continuing progress of action of plans depends on forecasting. The forecast provides
a warning system of the critical factors to be monitored regularly because they might drastically
affect the future course of action and performance in the plan as well.

Steps in Forecasting
Broadly speaking, the forecasting of business fluctuations consists of the following steps:
1. Understanding why changes in the past have occurred. One of the basic principles of
statistical forecasting—indeed of all forecasting when historical data are available—is that
the forecaster should use the data on past performance to get a ―speedometer reading‖ of the
current rate (of sales, say) and of how fast that rate is increasing or decreasing. The current
rate of changes in the rate—―acceleration‖ and ―declaration‖—constitute the basis of
forecasting. Once they are known, various mathematical techniques can develop projections
from them. If an attempt is made to forecast business fluctuations without understanding
why past changes have taken place, the forecast will be purely mechanical, based solely
upon the application of mathematical formulae and subject to serious error.
2. Determining which phases of business activity must be measured. After it is known why
business fluctuations have occurred, or if there is a reasonable supposition it is necessary to
measure certain phases of business activity in order to predict what changes will probably
follow the present level of activity.
3. Selecting and compiling data to be use as measuring devices. There is an interdependent
relationship between the selection of statistical data and determination of why business
fluctuations occur. Statistical data cannot be selected and complied in an intelligent manner
unless there is a sufficient understanding of business fluctuations; likewise, it is important
that reasons for business fluctuations be stated in such a manner that it is possible to secure
data that are related to the reasons.
4. Analysis of data. In this last step, the data are analyzed in the light of one’s understanding of
the reason why changes occur. For example, if it is reasoned that a certain combination of
forces will result in a given change, the statistical art of the problem is it measure these
forces and from the data available, to draw conclusions on the future course of action.

3
Requirements of a good forecasting system
A forecasting system to be instrumental in contributing to better management decision-making,
needs certain conditions:
i. It must involve the manager whose decision are affected.
ii. Individual forecasts and group of forecasts have to be specifically relevant to the decisions
being taken.
iii. The forecasts must not claim too much validity or authority.
iv. Implications of the various probable errors in the predictions for the organizations need to
be thoroughly worked through so that management can evaluate the consequences of the
probable range of likely outcomes.
v. Management must at least know how badly things could go wrong if all the guesses turned
out wrong.

--o—

4
 Problems and Solutions

Least Squares Method

(even)
Problem 1
Determine of trend of the following time series by least square method.
Year 2001 2002 2003 2004 2005 2006
Production in ton 27 28 35 34 37 36
a) Calculate the trend values.
b) What would be predicted production for the year of 2010?
Solution:
a) Here, the number of years, n = 6(even). Hence we want to shift the origin to the arithmetic mean
of the two middle years.
Let the time indicator, x  2 year  2003  2004   2 year  2003.5 and Production  y
 2 
Calculation of straight-line trend
Production Estimate trend values
Year x=2(year-2003.5) x2 xy
(in tons), y ŷ = 32.83+1.014 x
2001 27 -5 25 -135 27.76
2002 28 -3 9 -84 29.79
2003 35 -1 1 -35 31.82
2004 34 1 1 34 33.85
2005 37 3 9 111 35.87
2006 36 5 25 180 37.90
y=197 x=0  x =70 xy=71
2

Let, the equation of the straight line is ŷ = a + bx

 x y 0
 xy  n
71 
6  71  1.014
b 
Here,  x  70  0 70
2

 x2  n 6

and a  yˆ  bx 
 y  b  x  197  1.014  0  32.83
n n 6 6
So, the estimated straight line trend equation, ŷ = 32.83+1.014 x (Answer)
a) Calculated the trend values:
When
x = -5, then ŷ 2001 =32.83+1.014 (-5) =27.75
x = -3, then ŷ 2002 =32.83+1.014 (-3) =29.788
x = -1, then ŷ 2003 =32.83+1.014 (-1) =31.816
x = 1, then ŷ 2004 =32.83+1.014 (1) =33.844
x = 3, then ŷ 2005 =32.83+1.014 (3) =35.872
x = 5, then ŷ 2006 =32.83+1.014 (5) =37.90
b) If assume the same rate of change continue, what would be predicted production for the year 2010.
For the year 2010, the time indicator, x = 2 (year – 2003.5) =2(2010-3003.5) = 13
The estimated predicted production for the year 2010 is
yˆ 2010  32.83  (1,014  13)  32.83  13.18  45.91 tons ( Answer )

5
 (even)
Problem 2
The numbers of units produced in a factory during the period 1999-2006 are as follows:
Year 1999 2000 2001 2002 2003 2004 2005 2006
Production (in m. tons) 56 55 51 47 42 38 35 32
a) Fit a straight-line trend and obtain the trend values.
b) What is monthly increase in the number of units produced?
c) Estimate the expected units produced in 2008.
Solution:
Here, the number of years, n = 8(even). Hence we want to shift the origin to the arithmetic mean
of the two middle years.
Let the time indicator, x  2 year  2002  2003   2 year  2002.5 and Production  y
 2 
Calculation of straight-line trend
Production x= Estimate trend values
Year x2 xy
(units) y 2(year-2002.5) ŷ = 32.83+1.014 x
1999 56 -7 49 -392 57.499
2000 55 -5 25 -275 53.785
2001 51 -3 9 -153 50.071
2002 47 -1 1 -47 46.357
2003 42 1 1 42 42.643
2004 38 3 9 114 38.929
2005 35 5 25 175 35.215
2006 32 7 49 224 31.501
y=356 x=0 x =168 xy=-312
2

a) Let, the equation of the straight line is ŷ = a + bx

 x y
 xy  n  312
b    1.857
Here,  x 2
168
x 2

n

and a  yˆ  bx 
 y b x 
356
 0  44.5
n n 8
So, the estimated straight line trend equation, yˆ  44.5  1.857 x (Answer)
Calculated the trend values:
When
x = -7, then ŷ1999 =44.5+1.857 (-7) =44.5-12.999 =57.499
x = -5, then ŷ 2000 =44.5+1.857 (-5) =44.5-9.285 =53.785
x = -3, then ŷ 2001 =44.5+1.857 (-3) =44.5-5.571 =50.071
x = -1, then ŷ 2002 =44.5+1.857 (-1) =44.5-1.857 =46.357
x = 1, then ŷ 2003 =44.5+1.857 (1) =44.5+1.857 =42.643
x = 3, then ŷ 2004 =44.5+1.857 (3) =44.5+5.571 =38.929
x = 5, then ŷ 2005 =44.5+1.857 (5) =44.5+9.285=35.215
x = 7, then ŷ 2006 =44.5+1.857 (7) =44.5+12.999=31.501

b) Here, trend values are decreasing, 57.999-53.785=3.714

6
 So, the yearly decreased is 3.714
 The monthly decreased units is = 3.714 = 0.3095
12

c) For the year 2008, x would be 2(2008 – 2002.5) =25.5=+11, putting x=11 in the equation,
yˆ 2008  44.5  (1.857  11)  44.5  20.427  24.073
Hence the likely production for the year 2008 is 24.073 units (Answer)

Problem 3 (odd)
Below are given the figures of production (in matric tons) of a sugar factory:
Year 1998 1999 2000 2001 2002 2003 2004
Production (in m. tons) 80 90 92 83 94 99 92
a) Fit a straight-line trend to these figures.
b) Estimate the likely production of the company during 1995 and 2005.

Solution
a) Here, the number of years, n = 7(odd). Hence we want to shift the origin to the arithmetic mean
of the middle year.
Let the time indicator, x = (X -2001) and Production = y

Fitting the straight-line trend

Deviation from Trend values
Production (in
Year middle year, xy x2
metric tons), y ŷ = a + bx
x=(X-2001)
1998 80 -3 -240 9 84
1999 90 -2 -180 4 86
2000 92 -1 -92 1 88
2001 83 0 0 0 90
2002 94 1 94 1 92
2003 99 2 198 4 94
2004 92 3 276 9 96
N=7 y=630 x=0 xy= 56 x =28
2

Let, the equation of the straight line is ŷ = a + bx

Since, x=0
a
 y  630  90; b
 yx  56  2
n 7 x2 28

Hence, the equation of straight line trend is, ŷ = 90 + 2 x (Answer)

7
Calculated the trend values:
When
x = -3, then ŷ1998 =90+2 (-3) =84
x = -2, then ŷ1999 =90+2 (-2) =86
x = -1, then ŷ 2000 =90+2 (-1) =88
x = 0, then ŷ 2001 =90+2 (0) =90
x = 1, then ŷ 2002 =90+2 (1) =92
x = 3, then ŷ 2003 =90+2 (2) =94
x = 5, then ŷ 2004 =90+2 (3) =96

Similarly, by putting x = 0,1,2,3, we can obtain other trend values. However, since the value of b is
constant, only first trend value need be obtained and then if the value of b is possible we may continue
adding the value of b to every preceding value. For example, in the above case for 1998 the calculated
value of y is 84. For 1998 if will be 84+2 = 86, for 2000 it will be 86+2 = 88 and so on. If b is negative
then instead of adding we will deduct.
b) The graph of the above data is given below:

c) For the year 1995, x would be (1995 – 2001) = -6, putting x =-6 in the equation
yˆ1995  90  2(6)  90  12  78
Hence the likely production for 1995 is 78 metric tons (Answer)

And for the year 2005, x would be (2005 – 2001) = +4, putting x =4 in the equation
ŷ 2005 = 90 + 2(4) = 98
Hence the likely production for 2005 is 98 metric tons (Answer)

(even)
Problem (for Class test)
The numbers of workers (in thousand) in a large industry at different times are given below:
Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Sold 3.1 3.8 4.2 4.6 5.3 5.7 6.4 7 7.9 9.6
a) Fit linear trend line for number of workers.
b) Estimate the number of workers would be employed by the industry in 2012.