CH 5 Defor 13

Department of Business Administration
FALL 2012-2013
I see that you will get an A this semester.
Chapter 5: Demand Forecasting
Outline: What You Will Learn . . .

Ch 5 : Demand Forecasting
List the elements of a good forecast. Outline the steps in the forecasting process. Describe at least three qualitative forecasting techniques and the advantages and disadvantages of each. Compare and contrast qualitative and quantitative approaches to forecasting. Briefly describe averaging techniques, trend and seasonal techniques, and regression analysis, and solve typical problems. Describe two measures of forecast accuracy. Describe two ways of evaluating and controlling forecasts. Identify the major factors to consider when choosing a forecasting technique
2 Dominick Salvatore; ed. 2007;2011, 2012/13, Sami Fethi, EMU, All Right Reserved.
Managerial Economics in a Global Economy
What is meant by Forecasting and Why?
Forecasting is the process of estimating a variable, such as the sale of the firm at some future date. Forecasting is important to business firm, government, and non-profit organization as a method of reducing the risk and uncertainty inherent in most managerial decisions. A firm must decide how much of each product to produce, what price to charge, and how much to spend on advertising, and planning for the growth of the firm.
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Dominick Salvatore; ed. 2007;2011, 2012/13, Sami Fethi, EMU, All Right Reserved.
The aim of forecasting

The aim of forecasting is to reduce the risk or uncertainty that the firm faces in its shortterm operational decision making and in planning for its long term growth. Forecasting the demand and sales of the firms product usually begins with macroeconomic forecast of general level of economic activity for the economy as a whole or GNP.
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The aim of forecasting

The firm uses the macro-forecasts of general economic activity as inputs for their microforecasts of the industrys and firms demand and sales. The firms demand and sales are usually forecasted on the basis of its historical market share and its planned marketing strategy (i.e., forecasting by product line and region). The firm uses long-term forecasts for the economy and the industry to forecast expenditure on plant and equipment to meet its long-term growth plan and strategy.
Forecasting Process Map

Demand History Statistical Model
Causal Factors
Sales
Marketing
Product Production & Executive Management Inventory Management & Finance Control
Consensus Process Consensus Forecast

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Uses of Forecasts
Accounting Finance Human Resources Marketing MIS Operations Product/service design
Cost/profit estimates Cash flow and funding Hiring/recruiting/training Pricing, promotion, strategy IT/IS systems, services Schedules, MRP, workloads New products and services
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Features of Forecasts
Assumes causal system past ==> future Forecasts rarely perfect because of randomness Forecasts more accurate for groups vs. individuals Forecast accuracy decreases as time horizon increases or may otherway around
I see that you will get an A this semester.
Elements of a Good Forecast
Timely
Reliable
Accurate
Written
Steps in the Forecasting Process
The forecast
Step 6 Monitor the forecast Step 5 Make the forecast Step 4 Obtain, clean and analyze data Step 3 Select a forecasting technique Step 2 Establish a time horizon Step 1 Determine purpose of forecast
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Forecasting Techniques
A wide variety of forecasting methods are available to management. These range from the most nave methods that require little effort to highly complex approaches that are very costly in terms of time and effort such as econometric systems of simultaneous equations. Mainly these techniques can break down into three parts: Qualitative approaches (Judgmental forecasts) and Quantitative approaches (Timeseries forecasts) and Associative model forecasts).
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Forecasting Techniques
Judgmental - uses subjective inputs such as opinion from consumer surveys, sales staff etc.. Time series - uses historical data assuming the future will be like the past Associative models - uses explanatory variables to predict the future
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Qualitative Forecasts or Judgmental Forecasts
Survey Techniques Some of the best-know surveys Planned Plant and Equipment Spending Expected Sales and Inventory Changes Consumers Expenditure Plans Opinion Polls Business Executives Sales Force Consumer Intentions
What are qualitative forecast ?
Qualitative forecast estimate variables at some future date using the results of surveys and opinion polls of business and consumer spending intentions. The rational is that many economic decisions are made well in advance of actual expenditures. For example, businesses usually plan to add to plant and equipment long before expenditures are actually incurred.
Surveys and opinion pools are often used to make short-term forecasts when quantitative data are not available. Usually based on judgments about causal factors that underlie the demand of particular products or services. Do not require a demand history for the product or service, therefore are useful for new products/services. Approaches vary in sophistication from scientifically conducted surveys to intuitive hunches about future events. The approach/method that is appropriate depends on a products life cycle stage.
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Polls can also be very useful in supplementing quantitative forecasts, anticipating changes in consumer tastes or business expectations about future economic conditions, and forecasting the demand for a new product. Firms conduct opinion polls for economic activities based on the results of published surveys of expenditure plans of businesses, consumers and governments.
Survey Techniques The rationale for forecasting based on surveys of economic intentions is that many economic decisions are made in advance of actual expenditures (Ex: Consumers decisions to purchase houses, automobiles, TV sets, furniture, vocation, education etc. are made months or years in advance of actual purchases) Opinion Polls The firms sales are strongly dependent on the level of economic activity and sales for the industry as a whole, but also on the policies adopted by the firm. The firm can forecast its sales by pooling experts within and outside the firm.
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Executive Polling- Firm can poll its top management from its sales, production, finance for the firm during the next quarter or year. Bandwagon effect (opinions of some experts might be overshadowed by some dominant personality in their midst). Delphi Method experts are polled separately, and then feedback is provided without identifying the expert responsible for a particular opinion.

Consumers intentions pollingFirms selling automobiles, furniture, etc. can pool a sample of potential buyers on their purchasing intentions. By using results of the poll a firm can forecast its sales for different levels of consumers future income. Sales force polling Forecast of the firms sales in each region and for each product line, it is based on the opinion of the firms sales force in the field (people working closer to the market and their opinion about future sales can provide essential information to top management).
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Quantitative Forecasting Approaches
Based on the assumption, the forces that generated the past demand will generate the future demand, i.e., history will tend to repeat itself. Analysis of the past demand pattern provides a good basis for forecasting future demand. Majority of quantitative approaches fall in the category of time series analysis.
Time Series Analysis
A time series (naive forecasting) is a set of
numbers where the order or sequence of the numbers is important, i.e., historical demand Attempts to forecasts future values of the time series by examining past observations of the data only. The assumption is that the time series will continue to move as in the past Analysis of the time series identifies patterns Once the patterns are identified, they can be used to develop a forecast
Forecast Horizon
Short term
Up to a year One to five years More than five years
Medium term
Long term
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Reasons for Fluctuations in Time Series Data
Secular Trend are noted by an upward or downward sloping line- long-term movement in data (e.g. Population shift, changing income and cultural changes). Cycle fluctuations is a data pattern that may cover several years before it repeats itself- wavelike variations of more than one years duration (e.g. Economic, political and agricultural conditions). Seasonality is a data pattern that repeats itself over the period of one year or less- short-term regular variations in data (e.g. Weekly or daily restaurant and supermarket experiences). Irregular variations caused by unusual circumstances (e.g. Severe weather conditions, strikes or major changes in a product or service). Random influences (noise) or variations results from random variation or unexplained causes. (e.g. residuals)
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Forecast Variations
Irregular variatio n
Trend
Cycles
90 89 88 Seasonal variations
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Uses for Nave Forecasts

Stable
time series data F(t) = A(t-1) Seasonal variations F(t) = A(t-n) Data with trends F(t) = A(t-1) + (A(t-1) A(t-2))
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Techniques for Averaging

Moving
average Weighted moving average Exponential smoothing
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Moving Averages
Moving average A technique that averages a number of recent actual values, updated as new values become available.
Ft = MAn=
At-n + At-2 + At-1 n
Weighted moving average More recent values in a series are given more weight in computing the forecast. wnAt-n + wn-1At-2 + w1At-1 Ft = WMAn=
n=total amount of number of weights
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Simple Moving Average

Actual
MA5
47 45 43 41 39 37 35 1 2 3 4 5 6 7 8 9 10 11 12
MA3
At-n + At-2 + At-1

Ft = MAn=
n
Simple Moving Average

An averaging period (AP) is given or selected The forecast for the next period is the arithmetic average of the AP most recent actual demands It is called a simple average because each period used to compute the average is equally weighted It is called moving because as new demand data becomes available, the oldest data is not used By increasing the AP, the forecast is less responsive to fluctuations in demand (low impulse response and high noise dampening) By decreasing the AP, the forecast is more responsive to fluctuations in demand (high impulse response and low noise dampening)
Exponential Smoothing
Ft = Ft-1 + (At-1 - Ft-1)

Ft = forecast for period t Ft-1 = forecast for the previous period = smoothing constant At-1 = actual data for the previous period
Premise--The most recent observations might have the highest predictive value. Therefore, we should give more weight to the more recent time periods when forecasting. Weighted averaging method based on previous forecast plus a percentage of the forecast error A-F is the error term, is the % feedback 30
Exponential Smoothing Forecasts
The weights used to compute the forecast (moving average) are exponentially distributed. The forecast is the sum of the old forecast and a portion (a) of the forecast error (A t-1 - Ft-1). The smoothing constant, , must be between 0.0 and 1.0. A large provides a high impulse response forecast. A small provides a low impulse response forecast. 31
Example-Moving Average
Central Call Center (CCC) wishes to forecast the number of incoming calls it receives in a day from the customers of one of its clients, BMI. CCC schedules the appropriate number of telephone operators based on projected call volumes.
CCC believes that the most recent 12 days of call volumes (shown on the next slide) are representative of the near future call volumes.
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Example-Moving Average
Moving Average Use the moving average method with an AP = 3 days to develop a forecast of the call volume in Day 13 (The 3 most recent demands) compute a three-period average forecast given scenario above: F13 = (168 + 198 + 159)/3 = 175.0 calls
Example-Weighted Moving Average

Weighted Moving Average (Central Call Center ) Use the weighted moving average method with an AP = 3 days and weights of .1 (for oldest datum), .3, and .6 to develop a forecast of the call volume in Day 13. compute a weighted average forecast given scenario above: F13 = .1(168) + .3(198) + .6(159) = 171.6 calls Note: The WMA forecast is lower than the MA forecast because Day 13s relatively low call volume carries almost twice as much weight in the WMA (.60) as it does in the MA (.33).
Example-Exponential Smoothing

Exponential Smoothing (Central Call Center) Suppose a smoothing constant value of .25 is used and the exponential smoothing forecast for Day 11 was 180.76 calls. what is the exponential smoothing forecast for Day 13?
Ft = Ft-1 + (At-1 - Ft-1)

F12 = 180.76 + .25(198 180.76) = 185.07 F13 = 185.07 + .25(159 185.07) = 178.55
Example 2-Exponential Smoothing

Period 1 2 3 4 5 6 7 8 9 10 11 12 Actual 42 40 43 40 41 39 46 44 45 38 40 Alpha = 0.1 Error 42 41.8 41.92 41.73 41.66 41.39 41.85 42.07 42.36 41.92 41.73 -2.00 1.20 -1.92 -0.73 -2.66 4.61 2.15 2.93 -4.36 -1.92 Alpha = 0.4 Error 42 41.2 41.92 41.15 41.09 40.25 42.55 43.13 43.88 41.53 40.92 -2 1.8 -1.92 -0.15 -2.09 5.75 1.45 1.87 -5.88 -1.53
Exponential Smoothing (Actual Demand forecasting ) Suppose a smoothing constant value of .10 is used and the exponential smoothing forecast for the previous period was 42 units (actual demand was 40 units). what is the exponential smoothing forecast for the next periods?
F3 = 42 + .10(40 42) = 41.8 F4 = 41.8 + .10(43 41.8) = 41.92
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Example 2-Exponential Smoothing Graphical presentation

Actual
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Demand
= .4
45 40 35 1 2 3 4 5 6 7 8
= .1
9 10 11 12
Period
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Trend Projection
The simplest form of time series is projecting the past trend by fitting a straight line to the data either visually or more precisely by regression analysis. Linear regression analysis establishes a relationship between a dependent variable and one or more independent variables. In simple linear regression analysis there is only one independent variable. If the data is a time series, the independent variable is the time period. The dependent variable is whatever we wish to forecast.
Linear Trend Equation

Ft
Ft = a + bt
Ft = Forecast for period t t = Specified number of time periods a = Value of Ft at t = 0 b = Slope of the line
0 1 2 3 4 5 t
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Trend Projection
Linear Trend: St = S0 + b t b = Growth per time period Constant Growth Rate(Non-linear) St = S0 (1 + g)t g = Growth rate Estimation of Growth Rate ln St = ln S0 + t ln (1 + g)
Trend Projection- Simple Linear Regression

Regression Equation This model is of the form: Y = a + bX
Y = dependent variable (the value of time series to be forecasted for period t) X = independent variable ( time period in which the time series is to be forecasted) a = y-axis intercept (estimated value of the time series, the constant of the regression) b = slope of regression line (absolute amount of growth per period)
The correlation coefficient, determination of coefficient and standard deviation

Standard deviation
Correlation Coefficient Determination of coefficient
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Trend Projection- Calculating a and b
Constants a and b The constants a and b are computed using the equations given: Once the a and b values are computed, a future value of X can be entered into the regression equation and a corresponding value of Y (the forecast) can be calculated.
x y- x xy a= n x -( x)
2 2 2
b=
n xy- x y n x -( x)
2 2
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Trend Projection- Calculating a and b

Or If formula b is used first, it may be used formula a in the following format:
b=
n xy- x y n x -( x)
2 2
Y b X a=
n
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Example 1 for Trend Projection-Electricity sales
Suppose we have the data show electricity sales in a city between 1997.1 and 2000.4. The data are shown in the following table. Use time series regression to forecast the electricity consumption (mn kilowatt) for the next four quarters.
Do not forget to use the formulae a and b
Example1 for Trend Projection

Year Trent (t) 1997Q1 1 1997Q2 2 1997Q3 3 1997Q4 4 1998Q1 5 1998Q2 6 1998Q3 7 1998Q4 8 1999Q1 9 1999Q2 10 1999Q3 11 1999Q4 12 2000Q1 13 2000Q2 14 2000Q3 15 2000Q4 16 (SUM) 136 a 11.9 b 0.394 Av 15.25 ELECSALE (Y) 11 15 12 14 12 17 13 16 14 18 15 17 15 20 16 19 244 (t )SQ 1 4 9 16 25 36 49 64 81 100 121 144 169 196 225 256 1496 Y*t 11 30 36 56 60 102 91 128 126 180 165 204 195 280 240 304 2208 (y) SQ 121 225 144 196 144 289 169 256 196 324 225 289 225 400 256 361 3820 (t) SQ (Y) SQ
a=
x 2 y- x xy n x 2 -( x) 2
b=
n xy- x y n x 2 -( x) 2
18496
59536

Y = 11.90 + 0.394X
Y17 = 11.90 + 0.394(17) = 18.60 in the first quarter of 2001 Y18 = 11.90 + 0.394(18) = 18.99 in the second quarter of 2001 Y19 = 11.90 + 0.394(19) = 19.39 in the third quarter of 2001 Y20 = 11.90 + 0.394(20) = 19.78 in the fourth quarter of 2001
Note: Electricity sales are expected to increase by 0.394 mn kilowatt-hours per quarter.
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Std.de v
Sxy = SQRT( [3820-(11.9) (244)- (0.394) (2208)]/(16-2))=1.82 Sxy is a measure of how historical data points have been dispersed about the trend line. If it is large (reference point in mean of the data) , the historical data points have been spread widely about the trend line and if otherway around, the data points have been grouped tightly about the trend.

Corr. Coeff.
r= ((16) (2208)- (136) (244))/SQRT( [(16) (1496)(18496)*((16)(3820-59536)]=0.73
r lies between -1 and 1, -1 is strong negative whereas 1 is strong positive. 0 means that there is no relationship between the two variables (x and y). In this case, there is a strong positive relationship between the two variables and if an increase in independent variable, it will be a rise in dependent variable.

Determination of coefficient R2=0.533. It varies between 0 and 1. 0 means that there is no relationship between the two variables whereas 1 indicates that there is a perfect relationship. 53.3% variation in dependent variable can be explained by the variation happened in the independent variable. It is worth to emphasize that 46.7% shows unexplained part of the relationship.
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Example 2 for Trend Projection
Estimate a trend line using regression analysis

Time Period (t) 1 2 3 4 5 6
Year
Sales (y)
Use time (t) as the independent variable:
2003 2004 2005 2006 2007 2008
20 40 30 50 70 65
y = b 0 b1t
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(continued)
The linear trend model is:
Year 2003 2004 2005 2006 2007 2008
Time Period (t)

1 2 3 4 5 6
Sales (y) 20 40 30 50 70 65
y = 12 .333 9.5714 t
Sales trend
80 70 60 50 40 30 20 10 0 0 1 2 3 4 5 6 7
sales
Year

(continued)
Forecast for time period 7:
Year 2003 2004 2005 2006 2007 2008 2009
Time Period (t) 1 2 3 4 5 6 7
Sales (y) 20 40 30 50 70 65 ??
80 70 60 50 40 30 20 10 0 0
y = 12.333 9.5714 (7) = 79.33 Sales
sales
Year
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Example for Trend Projection using-Non linear form
St = S0 (1 + g)t
Running the regression above in the form of logarithms: ln St = ln S0 + t ln (1 + g) to construct the equation which has coefficients a and b. Antilog of 2.49 is 12.06 and Antilog of 0.026 is 1.026.
Coefficients Standard Error t Stat Intercept 2.486914 0.062793 39.60489 T 0.026371 0.006494 4.060874
St = 12.06(1.026)t
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Example for Trend Projection using St = S0 (1 + g)t
S17= 12.06(1.026)17 = 18.66 in the first quarter of 2001 S18= 12.06(1.026)18 = 19.14 in the second quarter of 2001 S19= 12.06(1.026)19 = 19.64 in the third quarter of 2001 S20= 12.06(1.026)20= 20.15 in the fourth quarter of 2001
These forecasts are similar to those obtained by fitting a linear trend

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Evaluating Forecast-Model Performance
Accuracy Accuracy is the typical criterion for judging the performance of a forecasting approach Accuracy is how well the forecasted values match the actual values Accuracy of a forecasting approach needs to be monitored to assess the confidence you can have in its forecasts and changes in the market may require reevaluation of the approach Accuracy can be measured in several ways Standard error of the forecast (SEF) Mean absolute deviation (MAD) Mean squared error (MSE) Mean absolute percent error (MAPE) Root mean squared error (RMSE)
Forecast Accuracy
Error - difference between actual value and predicted value Mean Absolute Deviation (MAD) Average absolute error Mean Squared Error (MSE) Average of squared error Mean Absolute Percent Error (MAPE) Average absolute percent error Root Mean Squared Error (RMSE) Root Average of squared error
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MAD, MSE, and MAPE

MAD = Actual ( Actual forecast
n MSE =
forecast)
2
n -1 MAPE =
( Actual forecast / Actual)*100) n
RMSE =
( At Ft )2 n
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MAD, MSE and MAPE
MAD Easy to compute Weights errors linearly MSE Squares error More weight to large errors MAPE Puts errors in perspective RMSE Root of Squares error More weight to large errors
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Ch 5 : Demand Forecasting Example-MAD, MSE, and MAPE Compute MAD, MSE and MAP for the following data showing actual and the predicted numbers of account serviced.
Period 1 2 3 4 5 6 7 8
Actual 217 213 216 210 213 219 216 212
Forecast 215 216 215 214 211 214 217 216
(A-F) 2 -3 1 -4 2 5 -1 -4 -2
|A-F| 2 3 1 4 2 5 1 4 22
(A-F)^2 (|A-F|/Actual)*100 4 0.92 9 1.41 1 0.46 16 1.90 4 0.94 25 2.28 1 0.46 16 1.89 76 10.26
MAD= MSE= MAPE=
2.75 10.86 1.28
22/8=2.75 76/8-1=10.86 10.26/8=1.28 %

Example-For MA Techniques Electricity sales data from 2000.1 to 2002.4 (t=12)-Forecast Accuracy - RMSE
1 2 Quarter Firm's ams (A) 1 20 2 22 3 23 4 24 5 18 6 23 7 19 8 17 9 22 10 23 11 18 12 23 13
3 Tqmaf (F)
4 A-F
5 6 sq(A-F) Fqmaf (F)
7 A-F
8 sq(A-F)
21.6666667 23 21.6666667 21.6666667 20 19.6666667 19.3333333 20.6666667 21 21.3333333
2.333333 -5 1.333333 -2.66667 -3 2.333333 3.666667 -2.66667 2 total
5.444444 25 1.777778 7.111111 9 5.444444 13.44444 7.111111 4 78.33333
21.4 22 21.4 20.2 19.8 20.8 19.8 20.6
1.6 -3 -4.4 1.8 3.2 -2.8 3.2 total
2.56 9 19.36 3.24 10.24 7.84 10.24 62.48

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AP = 3 moving average
AP = 5 moving average
Example-For MA Techniques
Electricity sales data from 2000.1 to 2002.4 (t=12)-Forecast Accuracy - RMSE
RMSE =
(A F )
t t
n
Sqroot of 62.48/7=2.98
RMSE for 3-qma=2.95 Sqroot of 78.33/9=2.95 RMSE for 5-qma=2.99
Thus three-quarter moving average forecast is marginally better than the corresponding five- moving average forecast.
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(20+22+...23)/12 =21=F1
Ft = Ft-1 + (At-1 - Ft- Ch 5 : Demand Forecasting Example-Exponential Smoothing Forecast Accuracy 1)

RMSE 1
4 A-F -1 1.3 1.91 2.337 -4.3641 1.94513 -2.63841 -3.84689 2.30718 2.615026 -3.16948 2.781363 total 5 sq(A-F) 1 1.69 3.6481 5.461569 19.04537 3.783531 6.961202 14.79853 5.323078 6.838359 10.04562 7.735978 87.19 6 (F) w=0.5 21 20.5 21.25 22.125 23.0625 20.53125 21.76563 20.38281 18.69141 20.3457 21.67285 19.83643 21.5 7 A-F -1 1.5 1.75 1.875 -5.0625 2.46875 -2.76563 -3.38281 3.308594 2.654297 -3.67285 3.163574 total 8 sq(A-F) 1 2.25 3.0625 3.515625 25.62891 6.094727 7.648682 11.44342 10.94679 7.045292 13.48984 10.0082 101.5
2 3 QuarterFirm's ams (A)(F) w=0.3 1 20 21 2 22 20.7 3 23 21.09 4 24 21.663 5 18 22.3641 6 23 21.05487 7 19 21.63841 8 17 20.84689 9 22 19.69282 10 23 20.38497 11 18 21.16948 12 23 20.21864 13 21
F2= 21+(0.3) (20-21)=20.7 with w==0.3 F2= 21+(0.5) (20-21)=20.5 with w==0.5
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Example-Exponential Smoothing Forecast Accuracy RMSE

RMSE =
(A
Ft ) 2
RMSE= SQRT(87.19/12)= 2.6955 RMSE= SQRT(101.5/12)=2.908
RMSE with =0.3 is 2.6955
RMSE with =0.5 is 2.908
Both exponential forecasts are better than the previous techniques in terms of average values.
Example for Trend Projection- Petrol sales
Suppose we have the data show petrol sales in a city between 2004 and 2011. The data are shown in the following table. Use time series regression to forecast the petrol consumption (mn gallons) for the next four year. Do not forget to use the formulae a and b

Year 2004 2005 2006 2007 2008 2009 Trent (t) PETROLSALE (Y) (t )SQ 1 2 3 4 5 6 1 3 4 2 1 3 1 4 9 16 25 36 Y*t (y) SQ (t) SQ (Y) SQ 1 6 12 8 5 18 1 9 16 4 1 9
a=
x 2 y- x xy n x 2 -( x) 2
b=
n xy- x y n x 2 -( x) 2
2010 2011
(SUM) a b
7 8
36 1.678 0.238
5 3
22
49 64
204
35 24
109
25 9
74 1296 484

Y = 1.678 + 0.238X
Y9 = 1.678 + 0.238(9) = 3.83 in 2012 Y10 = 1.678 + 0.238(10) = 4.06 in 2013 Y11 = 1.678 + 0.238(11) = 4.30 in 2014 Y12 = 1.678 + 0.238(12) = 4.54 in 2015
Note: Petrol sales are expected to increase by 0.238 mn gallons per year.
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Std.dev
Sxy =
1.36
Sxy is a measure of how historical data points have been dispersed about the trend line. If it is large (reference point in mean of the data) , the historical data points have been spread widely about the trend line and if otherway around, the data points have been grouped tightly about the trend.
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Corr. coef
r=0.42
r lies between -1 and 1, -1 is strong negative whereas 1 is strong positive. 0 means that there is no relationship between the two variables (x and y). In this case, there is a strong positive relationship between the two variables and if an increase in independent variable, it will be a rise in dependent variable.
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Determination of coefficient R2=0.18. It varies between 0 and 1. 0 means that there is no relationship between the two variables whereas 1 indicates that there is a perfect relationship. 18.0% variation in dependent variable can be explained by the variation happened in the independent variable. It is worth to emphasize that 82% shows unexplained part of the relationship.
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Example for MA, WMA and ES

period No of law case 1 2 3 4 5 60 64 55 58 64 (a) Use a simple three-month moving average to find the next period (b) Use a weight average method conducting 0.50 (for most recent datum), 0.30 , and 0.20 to find the next period. (c) Use single exponential smoothing technique to find the next period employing smoothing constant and 5. period forecast value are 0.4 and 58.60 respectively. (d) Use RMSE error model and decide which technique is better explain the data (MA and ES). (e) Plot the monthly data, three-month moving average estimates as as well as exponential smoothing estimates. Briefly explain the patterns. 71
Example for MA, WMA and ES a-b-c

period No of law case MA3 WMA3 1 2 3 60 64 55 59.66 667 59 59 60.4 ES 0.4 60.2 60.12 61.672
4
5
58
64 next period
59.0032
58.60192 60.761152
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Example for MA, WMA and ES -dErrorMA3 sq(ErrorMA3) ErrorES0.4 sq(ErrorES0.4) -0.2 3.88 -6.672 -1.666666667 5 sum 2.777777778 25 27.77777778 -1.0032 5.39808 0.04 15.0544 44.515584 1.00641024 29.13926769 30.14567793
RMSE
3.726779962
2.455429817
Exponential smoothing technique is better than three-quarter moving average forecast technique because the former one gives less error than the latter one..
Example for MA, WMA and ES -e66

64
62
60 No of law case MA3 ES 0.4 56
58
54
52
50 1 2 3 4 5 6
Seasonal Variation
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Seasonal Variation
Ratio to Trend Method Ratio = Seasonal Adjustment = Actual Trend Forecast Average of Ratios for Each Seasonal Period
Adjusted Forecast
Trend Forecast
Seasonal Adjustment
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Seasonal Variation
Ratio to Trend Method: Example Calculation for Quarter 1
Trend Forecast for 2001.1 = 11.90 + (0.394)(17) = 18.60 Seasonally Adjusted Forecast for 2001.1 = (18.60)(0.887) = 16.50
YEAR Forecasted 1997Q1 12.29 1998Q1 13.87 1999Q1 15.45 2000Q1 17.02
Actual 11 12 14 15 AV
Act/Forec 0.895037 0.865177 0.906149 0.881316 0.88692 0.887
Deseasonalize data=actual sales/seasonal relative (index) 77

Seasonal Variation
Select a representative historical data set. Develop a seasonal index for each season. Use the seasonal indexes to deseasonalize the data. Perform linear regression analysis on the deseasonalized data. Use the regression equation to compute the forecasts. Use the seasonal indexes to reapply the seasonal patterns to the forecasts.
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Example: Computer Products Corp.

Seasonalized Times Series Regression Analysis An analyst at CPC wants to develop next years quarterly forecasts of sales revenue for CPCs line of Epsilon Computers. The analyst believes that the most recent 8 quarters of sales (shown on the next slide) are representative of next years sales. Calculate the seasonal indexes
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80
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Unseasonalized vs. Seasonalized

Quarter
Seasonalized Sales
Seasonal Index
Deseasonalized Sales
1 2 3 4 5 6 7 8 9 10 11
23 40 25 27 32 48 33 37 37 50 40
0.825 1.310 0.920 0.945 0.825 1.310 0.920 0.945 0.825 1.310 0.920
27.88 30.53 27.17 28.57 38.79 36.64 35.87 39.15 44.85 38.17 43.48
27.88 =
23 0.825
Sales: Unseasonalized vs. Seasonalized

60 50 40 30 20 10 0 1 2 3 4 5 6 7 8 9 10 11
Sales
Quarter
Sales Deseasonalized Sales
82
Deflating a Time Series
Observed values can be adjusted to base year equivalent Allows uniform comparison over time Deflation formula:
y adj t
where
yt = (100 ) It
y adj t
= adjusted time series value at time t
yt = value of the time series at time t It = index value at time t

83
Deflating a Time Series: Example
Which movie made more money (in real terms)?
Year 1939 1977
Movie Title Gone With the Wind Star Wars
Total Gross $ 199 461
1997
Titanic
601
(Total Gross $ = Total domestic gross ticket receipts in $millions)

84
Deflating a Time Series: Example

Year Movie Title Total Gross CPI
(base year = 1984)
Gross adjusted to 1984 dollars
Gone 1939 With the Wind Star 1977 Wars
199 461
13.9 60.6
1431.7 760.7
1997
Titanic
601
160.5
374.5
GWTWadj 1984
199 = (100) = 1431.7 13.9
GWTW made about twice as much as Star Wars, and about 4 times as much as Titanic when measured in equivalent dollars.
85
Thanks
86

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Department of Business Administration

Chapter 5: Demand Forecasting

Outline: What You Will Learn . . .

Managerial Economics in a Global Economy

What is meant by Forecasting and Why?

Managerial Economics in a Global Economy

The aim of forecasting

Managerial Economics in a Global Economy

The aim of forecasting

Managerial Economics in a Global Economy

Forecasting Process Map

Consensus Process Consensus Forecast

Managerial Economics in a Global Economy

Managerial Economics in a Global Economy

Managerial Economics in a Global Economy

Elements of a Good Forecast

Managerial Economics in a Global Economy

Steps in the Forecasting Process

Managerial Economics in a Global Economy

Managerial Economics in a Global Economy

Managerial Economics in a Global Economy

Qualitative Forecasts or Judgmental Forecasts

Managerial Economics in a Global Economy

What are qualitative forecast ?

Managerial Economics in a Global Economy

Qualitative Forecasts or Judgmental Forecasts

Managerial Economics in a Global Economy

Qualitative Forecasts or Judgmental Forecasts

Managerial Economics in a Global Economy

Qualitative Forecasts or Judgmental Forecasts

Managerial Economics in a Global Economy

Qualitative Forecasts or Judgmental Forecasts

Managerial Economics in a Global Economy

Qualitative Forecasts or Judgmental Forecasts

Managerial Economics in a Global Economy

Quantitative Forecasting Approaches

Managerial Economics in a Global Economy

Time Series Analysis

A time series (naive forecasting) is a set of

Managerial Economics in a Global Economy

Up to a year One to five years More than five years

Managerial Economics in a Global Economy

Reasons for Fluctuations in Time Series Data

Managerial Economics in a Global Economy

Managerial Economics in a Global Economy

Uses for Nave Forecasts

Managerial Economics in a Global Economy

Techniques for Averaging

average Weighted moving average Exponential smoothing

Managerial Economics in a Global Economy

At-n + At-2 + At-1 n

Simple Moving Average

At-n + At-2 + At-1

Simple Moving Average

Managerial Economics in a Global Economy

Ft = Ft-1 + (At-1 - Ft-1)

Managerial Economics in a Global Economy

Exponential Smoothing Forecasts

Managerial Economics in a Global Economy

Managerial Economics in a Global Economy

Managerial Economics in a Global Economy

Example-Weighted Moving Average