Forecasting1

10B11PD311 Economics
• Process of predicting a future event

on the basis of past as well as
present knowledge and experience Sales will
• Underlying basis of be $200
all business decisions Million!
– Production
– Inventory
– Personnel
– Facilities
•To reduce risk and uncertainty
•To take business decisions
•For planning
 Setting the objective

 Selection and classification of goods
 Selection of method
 Interpreting the results
 Purpose of Short- term Forecasting

 Scheduling of production
 Inventory management
 Price strategy
 Sales strategy
 Financial requirements
 Purpose of Long- term Forecasting
 Planning a new Project
 Financial requirements
 Manpower
NATURE OF
PRODUCT
Durable Non durable

Capital Goods
Consumer goods consumer goods
 Capital Goods (Producer goods)- goods

which help in further production of goods
 Replacement Demand
 New Demand
 Information required
 Growth possibilities of industry demanding such
goods
 Life expectancy
 The norm of consumption
 Durable consumer goods - consumer goods which

can be used repeatedly
 Replacement demand
 New demand
 Life expectancy tables
 Purchasing power
 Number of households/firms
 Existence and growth of cooperating facilities
 Non durable consumer goods - goods which can

be used once
 Disposable income of consumer
 Price of the product
 Price of related products
 Demography
 Time horizon
 Stability
 Data Availability
 Cost
 Accuracy
 Ease of Application
Forecasting Methods
Qualitative
Quantitative
Methods
Methods
Qualitative Forecasts & Sources of Data
Expert Opinion Consumer Survey Composite Market

Method method Opinion Method Experiments
Complete Sample
enumeration survey
 Iterative group
process
Decision Makers
 3 types of people
(Sales?)
 Decision makers
 Staff Staff (Sales will be
(What will 50!)
 Experts
sales be?
 Proposes to reduce
survey)
‘group-think’
 Demerits
 Expensive
 Time consuming Experts
 Biased opinion (Sales will be 45, 50,
55)
• Ask customers How many hours will

about purchasing you use the Internet
plans next week?
• What consumers
say, and what they
actually do are
often different
• Sometimes difficult
to answer
 Directmethod of assessing information

from primary sources
 Simple method
 Insufficient Information
 Lack of time
 Biased information
 Utility limited to very short
period
 There may be sampling error, if sample is
not properly chosen
• Each salesperson projects their sales

• Combined at district & national levels
• Sales rep’s know customers’ wants
• Tends to be overly optimistic
• Involves small group of high-level

managers
– Group estimates demand by working
together
• Combines managerial experience with
statistical models
• Relatively quick
• ‘Group-think’
disadvantage
 Simple
 Based on first-hand knowledge of salesman
 Biased opinion
 Restricted to short-term forecasting
Can help in determining the demand function
Expensive
Time consuming
Risky
Difficult to satisfy the condition of homogeneity
Quantitative Forecasting
Methods Quantitative
Forecasting
Time Series Associative

Models Models
Trend Exponential Moving Linear

Projection Smoothing Average Regression
 Time -Series data - values of a variable

arranged chronologically by days, weeks,
months, quarters or years
 Past Values plotted on y- axis
 Time plotted on x- axis
 Time Series analysis- attempts to forecast

future values of the time series by examining
past observations of the data
 Assumption - past pattern will continue
unchanged in the future
Time Series Sales Data

Period
Year Quarter (t) Sales (S) S *
1996 I 1 300 300
1996 II 2 305 610
1996 III 3 315 945
1996 IV 4 340 1360
1997 I 5 346 1730
1997 II 6 352 2112
1997 III 7 364 2548
1997 IV 8 390 3120
1998 I 9 397 3573
1998 II 10 404 4040
1998 III 11 418 4598
1998 IV 12 445 5340
n = 12 78 4376 30276
 Secular Trend - long run increase or decrease

in data series
 Cyclical fluctuations - changes that recur over
years
 Seasonal variation - regularly recurring
fluctuation
 Irregular or random influences - variations
resulting from unique events
 Persistent,overall upward or downward pattern

 Due to population, technology etc
 Several years duration
Response
Mo., Qtr., Yr.

 Repeating up & down movements

 Due to interactions of factors influencing economy
 Usually 2-10 years duration
Cycle
Response
Mo., Qtr., Yr.

 Regular pattern of up & down fluctuations

 Due to weather, customs etc
 Occurs within 1 year
Summer
Response
Mo., Qtr.
 Erratic,unsystematic, ‘residual’ fluctuations

 Due to random variation or unforeseen events
 Union strike
 Cyclone
 Short duration &
nonrepeating
Trend Projection – Graphic
Values of Dependent Variable
Curve Fitting
Random Influences
Cyclical Fluctuatio
Secular Trend
Time
Curve Fitting
Actual
observati
on
Time
Curve Fitting
Deviation
Deviation Deviation
Actual
Deviation
Deviation observati
on
Deviation Point on
Deviation
the line
Time
Trend Projection – Graphic Curve Fitting
Deviation
Deviation
Deviation
Actual
Deviation observation
Deviation
Deviation Point on
Deviation the line
Yˆ  a  bx
Time

Curve Fitting
Assumptions
 Relationship is assumed to be linear
 Relationship is assumed to hold only within or

slightly outside data range
 Deviations around least squares line are assumed to

be random
 Projecting the past trend by fitting a straight

line to the data
 Constant Rate of Change
St = So + bt
 Where:
 St = value of time series to be forecasted for period t
 So = estimated value of time series in the base period
 b = absolute amount of growth per period
 t = time period for which series is to be forecasted

Period
Year Quarter (t) Sales (S) S*t
1996 I 1 300 300
1996 II 2 305 610
1996 III 3 315 945
1996 IV 4 340 1360
1997 I 5 346 1730
1997 II 6 352 2112
1997 III 7 364 2548
1997 IV 8 390 3120
1998 I 9 397 3573
1998 II 10 404 4040
1998 III 11 418 4598
1998 IV 12 445 5340
n = 12 78 4376 30276

Period
Year Quarter (t) Sales (S) S*t t^2
1996 I 1 300 300 S = S1 + bt
t o
1996 II 2 305 610 4
1996 III 3 315 945 9
1996 IV 4 340 1360 16
1997 I 5 346  S1730
= nSo + b25 t
1997 II 6 352  S*t
2112= So t36 + b  t
2
1997 III 7 364 2548 49

1997 IV 8 390 3120 64
1998 I 9 397 3573 81
1998 II 10 404 4040 100
1998 III 11 418 4598 121
1998 IV 12 445 5340 144
n = 12 78 4376 30276 650
So   S  t    t  S * t / d

2

b  n S * t   t  S  / d 
Where: d  n  
t 2
 ( t ) 2

Period
Year Quarter (t) Sales (S) S*t t^2
1996 I 1 300 300 1
1996 II 2 305 610 4
1996 III 3 315 945 9
1996 IV 4 340 1360 16
1997 I 5 346 1730 25
1997 II 6 352 2112 36
1997 III 7 364 2548 49
1997 IV 8 390 3120 64
1998 I 9 397 3573 81
1998 II 10 404 4040 100
1998 III 11 418 4598 121
1998 IV 12 445 5340 144
n = 12 78 4376 30276 650
St = So + bt St = 281.39 + 12.81t
 S = nSo + b  t
 S*t = So t + b  t2
Sales per Quarter

500
450
400
350
300
250
200
0 2 4 6 8 10 12 14
1996 1997 1998 Quarter
Seasonal Variation
Ratio to Trend Method
Actual
Ratio =
Trend Forecast
Seasonal Average of Ratios for

=
Adjustment Each Seasonal Period
Adjusted Trend Seasonal

Forecast = Forecast Adjustment
Seasonal Adjustment using Ratio-

Trend method
Forecasted IV Actual IV Adjusted

Year quarter sales quarter sales Ratio quarter sales
1996 332.64 340 1.022 339.29

1997 383.88 390 1.016 391.56
1998 435.13 445 1.023 443.83
Seasonal Adjustment 1.02
(Average)
 Limited to short term predictions
 Fluctuation in economic growth are not

considered
 Assumes that historical relationships will not

change
 Predictingvalues of a time series on the basis

of some average of its past values
 Used when time series exhibit irregular or
random variation
 Moving Averages
 Exponential Smoothing
Moving Average
Quarter Actual Market 3 Quarter Moving
Share (A) Average(F)
1 20
2 22
3 23
4 24 21.67
5 18 23.00
6 23 21.67
7 19 21.67
8 17 20.00
9 22 19.67
10 23 19.33
11 18 20.67
12 23 21.00
13 21.33
Moving
Average
Quarter Actual Market 3 Quarter Moving A - F (A - F)^
Share (A) Average(F)
1 20
2 22
3 23
4 24 21.67 2.33 5
5 18 23.00 -5.00 25
6 23 21.67 1.33 1
7 19 21.67 -2.67 7
8 17 20.00 -3.00 9
Moving Average
Quarter Actual Market 3 Quarter Moving A-F (A - F)^2 5 Quarter Moving
Share (A) Average(F) Average(F)
1 20
2 22
3 23
4 24 21.67 2.33 5.44
5 18 23.00 -5.00 25.00
6 23 21.67 1.33 1.78 21.40
7 19 21.67 -2.67 7.11 22.00
8 17 20.00 -3.00 9.00 21.40
9 22 19.67 2.33 5.44 20.20
10 23 19.33 3.67 13.44 19.80
11 18 20.67 -2.67 7.11 20.80
12 23 21.00 2.00 4.00 19.80
78.33
13 21.33 20.60 (Forecas
RMSE 2.95 2.99

Moving Average
Quarter Actual Market 3 Quarter Moving A-F (A - F)^2 5 Quarter Moving
A-F (A - F)^2
1 20
2 22
3 23
4 24 21.67 2.33 5.44
5 18 23.00 -5.00 25.00
6 23 21.67 1.33 1.78 21.40 1.60 2.56
7 19 21.67 -2.67 7.11 22.00 -3.00 9.00
8 17 20.00 -3.00 9.00 21.40 -4.40 19.36
9 22 19.67 2.33 5.44 20.20 1.80 3.24
10 23 19.33 3.67 13.44 19.80 3.20 10.24
11 18 20.67 -2.67 7.11 20.80 -2.80 7.84
12 23 21.00 2.00 4.00 19.80 3.20 10.24
78.33 62.48
13 21.33 (Forecast) 20.60

To decide on the better moving average forecast calculate the

root-mean-square error(RMSE) of each forecast and use the
moving average which results in the smallest RMSE
RMSE =  ( A F )
t t
2
n
Moving Average
Quarter Actual Market 3 Quarter Moving A-F (A - F)^2 5 Quarter Moving A-F (A - F)^2
1 20
2 22
3 23
4 24 21.67 2.33 5.44
5 18 23.00 -5.00 25.00
6 23 21.67 1.33 1.78 21.40 1.60 2.56
7 19 21.67 -2.67 7.11 22.00 -3.00 9.00
8 17 20.00 -3.00 9.00 21.40 -4.40 19.36
9 22 19.67 2.33 5.44 20.20 1.80 3.24
10 23 19.33 3.67 13.44 19.80 3.20 10.24
11 18 20.67 -2.67 7.11 20.80 -2.80 7.84
12 23 21.00 2.00 4.00 19.80 3.20 10.24
78.33 62.48
13 21.33 20.60 (Forecast)
RMSE 2.95 2.99

 Gives equal weightage to all observations in

computing the average.
 Forecast for next period (ie, t + 1) is a

weighted average of the actual and
forecasted values of the time series in
period t
Ft 1  wAt  (1  w) Ft
0  w 1
Exponential Forecasting
Quarter Actual Market Forecast with A-F (A
Share (A) w= 0.3
1 20 21.0 -1.0
2 22 20.7 1.3
3 23 21.1 1.9
4 24 21.7 2.3
5 18 22.4 -4.4
6 23 21.1 1.9
7 19 21.6 -2.6
8 17 20.8 -3.8
9 22 19.7 2.3
10 23 20.4 2.6
11 18 21.2 -3.2
12 23 20.2 2.8
252
13 21.1
RMSE =
Ft 1  wAt  (1  w) Ft
Quarter Actual Market Forecast with A-F (A - F)^2 Forecast wi
Share (A) w= 0.3 w= 0.
Mean
1 20 of A 21.0 -1.0 1.0 21.0
2 22 20.7 1.3 1.7 20.5
3 23 21.1 1.9 3.6 21.3
4 24 21.7 2.3 5.5 22.1
5 18 22.4 -4.4 19.0 23.1
6 23 21.1 1.9 3.8 20.5
7 19 21.6 -2.6 7.0 21.8
8 17 20.8 -3.8 14.8 20.4
9 22 19.7 2.3 5.3 18.7
10 23 20.4 2.6 6.8 20.3
11 18 21.2 -3.2 10.0 21.7
12 23 20.2 2.8 7.7 19.8
252 86.3
13 21.1 21.4
RMSE = 2.68
Quarter Actual Market Forecast with A-F (A - F)^2 Forecast with A-F (A - F)^2
Share (A) w= 0.3 w= 0.5
1 20 21.0 -1.0 1.0 21.0 -1.0 1.0
2 22 20.7 1.3 1.7 20.5 1.5 2.3
3 23 21.1 1.9 3.6 21.3 1.8 3.1
4 24 21.7 2.3 5.5 22.1 1.9 3.5
5 18 22.4 -4.4 19.0 23.1 -5.1 25.6
6 23 21.1 1.9 3.8 20.5 2.5 6.1
7 19 21.6 -2.6 7.0 21.8 -2.8 7.6
8 17 20.8 -3.8 14.8 20.4 -3.4 11.4
9 22 19.7 2.3 5.3 18.7 3.3 10.9
10 23 20.4 2.6 6.8 20.3 2.7 7.0
11 18 21.2 -3.2 10.0 21.7 -3.7 13.5
12 23 20.2 2.8 7.7 19.8 3.2 10.0
252 86.3 102.1
13 21.1 21.4
RMSE = 2.68 2.92

 Gives greater weight to recent data

 It is easy to update the forecasts
 No need to re-estimate the equations
 When time trend is positive, forecasts are
likely to be too low
 When time time trend is negative, forecasts
are likely to be too high
A time series that is correlated with another

time series is called an indicator
 Coincident indicators two series change at

the same time
 Leading indicators one series consistently

occurs prior to changes in another series
Economic Indicators
Value Leading indicator A
B
Indicator level
Coincident indicator
C
Business Cycle Time

 Must be accurate
 Provide adequate lead time
 Lead time should be constant
 Logical explanation why it is a leading
indicator
 Cost and time necessary for data collection
Construction of an Index
 Indices represent a single time series made up
of a number of individual leading indicators.
 Purpose is to smooth out the random fluctuations in
each individual series.
 Composite index- weighted average of

individual indicators in each group. Good
indicators are given more weightage.
 Index is interpreted in terms of percentage
change from period to period.
 Diffusion Index- gives the percentage of

the leading indicators that increase from
one time period to the next.
Month Leading Leading Leading

Indicator I Indicator II Indicator
II
1 400 30 100
2 425 29 110
3 460 33 135
The 1 month represents the base period

All series to be given equal weight
Construct a composite & diffusion index
Month Leading Leading Leading
Indicator I Indicator II Indicator II
1 400 30 100
2 425 29 110
3 460 33 135
Composite Index:
[ 25/400 + (-1)/30 + 10/100] / 3 = 4.31
[ 60/400 + 3/30 +35/100] / 3 = 20
Month Diffusion Index Composite Index

1 - 100.00
2 66.7 104.31
3 100.00 120.00
 Forecast turning points in the business cycles

 Prediction record not perfect
 Variability in lead time
 Difficult to identify accurate indicators
 Provides only qualitative forecast of turning point

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10B11PD311 Economics

• Process of predicting a future event

•To take business decisions

 Setting the objective

 Purpose of Short- term Forecasting

Durable Non durable

 Capital Goods (Producer goods)- goods

 Durable consumer goods - consumer goods which

 Non durable consumer goods - goods which can

Qualitative Forecasts & Sources of Data

Expert Opinion Consumer Survey Composite Market

• Ask customers How many hours will

 Directmethod of assessing information

• Each salesperson projects their sales

• Involves small group of high-level

Can help in determining the demand function

Time Series Associative

Trend Exponential Moving Linear

 Time -Series data - values of a variable

 Time Series analysis- attempts to forecast

Time Series Sales Data

 Secular Trend - long run increase or decrease

 Persistent,overall upward or downward pattern

Mo., Qtr., Yr.

 Repeating up & down movements

Mo., Qtr., Yr.

 Regular pattern of up & down fluctuations

 Erratic,unsystematic, ‘residual’ fluctuations

Trend Projection – Graphic

 Relationship is assumed to be linear

 Relationship is assumed to hold only within or

 Deviations around least squares line are assumed to

 Projecting the past trend by fitting a straight

Time Series Sales Data

Time Series Sales Data

1997 III 7 364 2548 49

So   S  t    t  S * t / d

Time Series Sales Data

Sales per Quarter

Ratio to Trend Method

Seasonal Average of Ratios for

Adjusted Trend Seasonal

Seasonal Adjustment using Ratio-

Forecasted IV Actual IV Adjusted

1996 332.64 340 1.022 339.29

 Limited to short term predictions

 Fluctuation in economic growth are not

 Assumes that historical relationships will not

 Predictingvalues of a time series on the basis

13 21.33 20.60 (Forecas

RMSE 2.95 2.99

13 21.33 (Forecast) 20.60

To decide on the better moving average forecast calculate the

13 21.33 20.60 (Forecast)

RMSE 2.95 2.99

 Gives equal weightage to all observations in

 Forecast for next period (ie, t + 1) is a

RMSE = 2.68 2.92

 Gives greater weight to recent data

A time series that is correlated with another

 Coincident indicators two series change at

 Leading indicators one series consistently

Business Cycle Time