Chapter 3: Forecasting

Forecasting; Chapter3

MGMT 405, POM, 2010/11. Lec Notes

Department of Business Administration

FALL 2010-2011I see that you willget an A this semester.

Forecasting; Chapter 3

Outline: What You Will Learn . . .

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

What is meant by Forecasting and Why?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.

The aim of forecastingThe aim of forecasting

The aim of forecasting is to reduce the risk or uncertainty that the firm faces in its short-term operational decision making and in planning for its long term growth.

Forecasting the demand and sales of the firm’s product usually begins with macroeconomic forecast of general level of economic activity for the economy as a whole or GNP.

The aim of forecastingThe aim of forecasting

The firm uses the macro-forecasts of general economic activity as inputs for their micro-forecasts of the industry’s and firm’s demand and sales.

The firm’s 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 MapForecasting Process Map

MarketingMarketingSalesSalesProductProduct

Management Management & Finance& Finance

Executive Executive ManagementManagement

Production &Production & Inventory Inventory

ControlControl

Causal Causal FactorsFactors

Statistical Statistical ModelModel

Demand Demand HistoryHistory

Consensus Consensus ProcessProcess

Consensus Consensus ForecastForecast

Accounting Cost/profit estimates

Finance Cash flow and funding

Human Resources Hiring/recruiting/training

Marketing Pricing, promotion, strategy

MIS IT/IS systems, services

Operations Schedules, MRP, workloads

Product/service design New products and services

Uses of ForecastsUses of Forecasts

Assumes causal systempast ==> future

Forecasts rarely perfect because of randomness

Forecasts more accurate forgroups vs. individuals

Forecast accuracy decreases as time horizon increases

I see that you willget an A this semester.

Features of ForecastsFeatures of Forecasts

Elements of a Good Forecast

Timely

AccurateReliable

ningfu

Written

Steps in the Forecasting Process

Step 1 Determine purpose of forecast

Step 2 Establish a time horizon

Step 3 Select a forecasting technique

Step 4 Obtain, clean and analyze data

Step 5 Make the forecast

Step 6 Monitor the forecast

“The forecast”

Forecasting Techniques

A wide variety of forecasting methods are available to management. These range from the most naïve methodsnaïve methods that require little effort to highly complex approacheshighly 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: QQualitative approachesualitative approaches (Judgmental (Judgmental forecasts)forecasts) and QQuantitative approachesuantitative approaches (Time- (Time-series forecasts) and Associative model forecasts)series forecasts) and Associative model forecasts)..

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

Forecasting TechniquesForecasting Techniques

Survey TechniquesSome of the best-know surveys

Planned Plant and Equipment SpendingExpected Sales and Inventory ChangesConsumers’ Expenditure Plans

Opinion PollsBusiness ExecutivesSales ForceConsumer Intentions

Qualitative ForecastsQualitative Forecasts or or Judgmental ForecastsJudgmental Forecasts

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 product’s life cycle stage

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: Consumer’s decisions to purchase houses, automobiles, TV sets, furniture, vocation, education etc. are made months or years in advance of actual purchases)

Opinion Polls– The firm’s 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.

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 polling-Consumers intentions polling- Firms 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 consumer’s future income.

Sales force polling –Sales force polling – Forecast of the firm’s sales in each region and

for each product line, it is based on the opinion of the firm’s sales force in the field (people working closer to the market and their opinion about future sales can provide essential information to top management).

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.

Quantitative Forecasting Approaches

Time Series AnalysisA 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 patternsOnce the patterns are identified, they can be used to

develop a forecast

Forecast Horizon

Short term Up to a year

Medium term One to five years

Long term More than five years

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 year’s 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)

Forecast Variations

Irregularvariation

Seasonal variations

908988

Cycles

Stable time series dataF(t) = A(t-1)

Seasonal variationsF(t) = A(t-n)

Data with trendsF(t) = A(t-1) + (A(t-1) – A(t-2))

Uses for Naïve ForecastsUses for Naïve Forecasts

Techniques for Averaging

Moving averageWeighted moving averageExponential smoothing

Moving Averages

Moving average – A technique that averages a number of recent actual values, updated as new values become available.

Ft = MAn= n

At-n + … At-2 + At-1

Ft = WMAn=

wnAt-n + … wn-1At-2 + w1At-1

Weighted moving average – More recent values in a series are given more weight in computing the forecast.

nn=total amount of number of weights

n= number of period

Simple Moving Average

1 2 3 4 5 6 7 8 9 10 11 12

Actual

Ft = MAn= n

At-n + … At-2 + At-1

Simple Moving AverageAn averaging period (AP) is given or selectedThe 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 usedBy 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 SmoothingExponential Smoothing

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

Ft = Ft-1 + (At-1 - Ft-1)Ft = forecast for period tFt-1 = forecast for the previous period smoothing constant At-1 = actual data for the previous period

Exponential SmoothingExponential Smoothing ForecastsForecasts

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.

Example-Moving AverageExample-Moving AverageCentral 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.

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 compute a three-period average forecast given scenario above:scenario above:

F13 = (168 + 198 + 159)/3 = 175.0 calls

Example-Moving AverageExample-Moving Average

Example-Weighted Moving AverageExample-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 compute a weighted average forecast given scenario above:above:

F13 = .1(168) + .3(198) + .6(159) = 171.6 calls

Note: The WMA forecast is lower than the MA forecast because Day 13’s relatively low call volume carries almost twice as much weight in the WMA (.60) as it does in the MA (.33).

Example-Example-Exponential SmoothingExponential Smoothing

Exponential Smoothing Exponential Smoothing ((Central Call Center) SupposeSuppose a smoothing constant value of .25 is used and a smoothing constant value of .25 is used and

the exponential smoothing forecast for Day 11 was the exponential smoothing forecast for Day 11 was 180.76 calls180.76 calls..

what is the exponential smoothing forecast for Day 13?what is the exponential smoothing forecast for Day 13?

F12 = 180.76 + .25(198 – 180.76) = 185.07F12 = 180.76 + .25(198 – 180.76) = 185.07 F13 = 185.07 + .25(159 – 185.07) = 178.55F13 = 185.07 + .25(159 – 185.07) = 178.55

Example 2-Example 2-Exponential SmoothingExponential SmoothingPeriod Actual Alpha = 0.1 Error Alpha = 0.4 Error

1 422 40 42 -2.00 42 -23 43 41.8 1.20 41.2 1.84 40 41.92 -1.92 41.92 -1.925 41 41.73 -0.73 41.15 -0.156 39 41.66 -2.66 41.09 -2.097 46 41.39 4.61 40.25 5.758 44 41.85 2.15 42.55 1.459 45 42.07 2.93 43.13 1.87

10 38 42.36 -4.36 43.88 -5.8811 40 41.92 -1.92 41.53 -1.5312 41.73 40.92

Exponential Smoothing Exponential Smoothing (Actual (Actual Demand forecasting ) SupposeSuppose a smoothing constant value of . a smoothing constant value of .1010 is used and the exponential is used and the exponential

smoothing forecast for smoothing forecast for the previous periodthe previous period was was 42 units (actual demand 42 units (actual demand was 40 units).was 40 units).

what is the exponential smoothing forecast for what is the exponential smoothing forecast for the nextthe next periodsperiods?? FF33 = = 4242 + . + .1010((4040 – – 4242) = ) = 4141..88 FF44 = = 41.841.8 + . + .1010((4343 – – 41.841.8) = ) = 41.9241.92

1 2 3 4 5 6 7 8 9 10 11 12

Period

and .1

Actual

Example 2-Example 2-Exponential SmoothingExponential SmoothingGraphical presentationGraphical presentation

Trend ProjectionThe 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 = Forecast for period t t = Specified number of time periods a = Value of Ft at t = 0b = Slope of the line

Ft = a + bt

0 1 2 3 4 5 t

Trend Projection

Linear Trend:St = S0 + b t

b = Growth per time periodConstant Growth Rate

St = S0 (1 + g)t

g = Growth rateEstimation 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)

Trend Projection- Calculating a and b

Constants a a and bb The constants aa and bb are

computed using the equations given:

Once the a a and b 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 xya =

n x -( x)

xy- x yb =

n x -( x)

Trend Projection- Calculating a and b

Or If formula b is used first, it may be used formula a in the following format:

xy- x yb =

n x -( x)

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 next four quarters.quarters.

Do not forget to use the formulae a and b

Example1 for Trend Projection

xy- x yb =

n x -( x)

x y- x xya =

n x -( x)

TP T Q sq ( T ) Q x T1997Q1 1 11 1 111997Q2 2 15 4 301997Q3 3 12 9 361997Q4 4 14 16 561998Q1 5 12 25 601998Q2 6 17 36 1021998Q3 7 13 49 911998Q4 8 16 64 1281999Q1 9 14 81 1261999Q2 10 18 100 1801999Q3 11 15 121 1651999Q4 12 17 144 2042000Q1 13 15 169 1952000Q2 14 20 196 2802000Q3 15 16 225 2402000Q4 16 19 256 304

x y sq x xy sq sum xsum 136 244 1496 2208 18496

a 11.9b 0.394118

Example1 for Trend Projection

Y = 11.90 + 0.394XY = 11.90 + 0.394X

Y17 = 11.90 + 0.394(17) = 18.60 in the first quarter of 2001Y17 = 11.90 + 0.394(17) = 18.60 in the first quarter of 2001Y18 = 11.90 + 0.394(18) = 18.99 in the second quarter of 2001Y18 = 11.90 + 0.394(18) = 18.99 in the second quarter of 2001Y19 = 11.90 + 0.394(19) = 19.39 in the third quarter of 2001Y19 = 11.90 + 0.394(19) = 19.39 in the third quarter of 2001Y20 = 11.90 + 0.394(20) = 19.78 in the fourth quarter of 2001Y20 = 11.90 + 0.394(20) = 19.78 in the fourth quarter of 2001

Note:Note: Electricity sales are expected to increase Electricity sales are expected to increase by 0.394 mn kilowatt-hours per quarter.by 0.394 mn kilowatt-hours per quarter.

Example 2 for Trend Projection

Estimate a trend line using regression analysis

Time Period

(t)Sales (y)

tbby 10

Use time (t) as the independent variable:

The linear trend model is:

Sales trend

01020304050607080

0 1 2 3 4 5 6 7

Time Period

(t)Sales (y)

t 5714.9333.12y

(continued)

Forecast for time period 7:

01020304050607080

0 1 2 3 4 5 6 7

Time Period

(t)Sales (y)

(continued)

(7) 5714.9333.12y

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.

CoefficientsStandard Error t StatIntercept 2.486914 0.062793 39.60489T 0.026371 0.006494 4.060874

St = 12.06(1.026)t

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

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 waysStandard error of the forecast (SEF)Mean absolute deviation (MAD)Mean squared error (MSE) Mean absolute percent error (MAPE)Root mean squared error (RMSE)

Forecast AccuracyError - difference between actual value and

predicted valueMean Absolute Deviation (MAD)

Average absolute errorMean Squared Error (MSE)

Average of squared errorMean Absolute Percent Error (MAPE)

Average absolute percent errorRoot Mean Squared Error (RMSE)

Root Average of squared error

MAD, MSE, and MAPE

MAD = Actual forecast

MSE = Actual forecast)

MAPE = Actual forecas

/ Actual*100)

2( )t tA FRMSE

MAD, MSE and MAPE MAD

Easy to computeWeights errors linearly

MSESquares errorMore weight to large errors

MAPEPuts errors in perspective

RMSERoot of Squares errorMore weight to large errors

Example-MAD, MSE, and MAPECompute MAD, MSE and MAP for the following data showing actual and the predicted numbers of account serviced.

Period Actual Forecast (A-F) |A-F| (A-F)^2 (|A-F|/Actual)*1001 217 215 2 2 4 0.922 213 216 -3 3 9 1.413 216 215 1 1 1 0.464 210 214 -4 4 16 1.905 213 211 2 2 4 0.946 219 214 5 5 25 2.287 216 217 -1 1 1 0.468 212 216 -4 4 16 1.89

-2 22 76 10.26

MAD= 2.75MSE= 10.86

MAPE= 1.28

22/8=2.75

76/8-1=10.86

10.26/8=1.28 %

Example: Central Call Center-Forecast Accuracy - MAD

Which forecasting method (the AP = 3 moving average or the a = .25 exponential smoothing) is preferred, based on the MAD over the most recent 9 days? (Assume that the exponential smoothing forecast for Day 3 is the same as the actual call volume.)

MADMADMAMA = = 20.520.5//99 = = 2.272.27

Example: Central Call Center-Forecast Accuracy - MAD

MADMADEXPEXP = = 18.0/918.0/9= = 2.02.0

E E AP4AP4 = = 161-187.3=26.3161-187.3=26.3 EEEXP4EXP4 = = 161-186=25.0161-186=25.0

FF44MAMA = ( = (186186 + + 217217 + 159)/3 = + 159)/3 = 187187..3333 calls calls

FF44EXPEXP = 18 = 1866 + .25( + .25(186186 – 18 – 1866) = ) = 186186..00 00 callscalls

Example-For MA TechniquesElectricity sales data from 2000.1 to 2002.4 (t=12)-Forecast Accuracy - RMSE

1 2 3 4 5 6 7 8Quarter Firm's ams (A) Tqmaf (F) A-F sq(A-F) Fqmaf (F) A-F sq(A-F)

1 202 223 234 24 21.6666667 2.333333 5.4444445 18 23 -5 256 23 21.6666667 1.333333 1.777778 21.4 1.6 2.567 19 21.6666667 -2.66667 7.111111 22 -3 98 17 20 -3 9 21.4 -4.4 19.369 22 19.6666667 2.333333 5.444444 20.2 1.8 3.2410 23 19.3333333 3.666667 13.44444 19.8 3.2 10.2411 18 20.6666667 -2.66667 7.111111 20.8 -2.8 7.8412 23 21 2 4 19.8 3.2 10.24

total 78.33333 total 62.4813 21.3333333 20.6

AP = 3 moving average AP = 5 moving average

Example-For MA TechniquesElectricity sales data from 2000.1 to 2002.4 (t=12)-Forecast Accuracy - RMSE

2( )t tA FRMSE

RMSE for 3-qma=2.95

RMSE for 5-qma=2.99

Thus three-quarter moving average forecast is marginally better than the corresponding five- moving average forecast.

Sqroot of 78.33/9=2.95

Sqroot of 62.48/7=2.98

Example-Exponential Smoothing Example-Exponential Smoothing Forecast Accuracy - Forecast Accuracy - RMSERMSE1 2 3 4 5 6 7 8

QuarterFirm's ams (A) (F) w=0.3 A-F sq(A-F) (F) w=0.5 A-F sq(A-F)1 20 21 -1 1 21 -1 12 22 20.7 1.3 1.69 20.5 1.5 2.253 23 21.09 1.91 3.6481 21.25 1.75 3.06254 24 21.663 2.337 5.461569 22.125 1.875 3.5156255 18 22.3641 -4.3641 19.04537 23.0625 -5.0625 25.628916 23 21.05487 1.94513 3.783531 20.53125 2.46875 6.0947277 19 21.63841 -2.63841 6.961202 21.76563 -2.76563 7.6486828 17 20.84689 -3.84689 14.79853 20.38281 -3.38281 11.443429 22 19.69282 2.30718 5.323078 18.69141 3.308594 10.9467910 23 20.38497 2.615026 6.838359 20.3457 2.654297 7.04529211 18 21.16948 -3.16948 10.04562 21.67285 -3.67285 13.4898412 23 20.21864 2.781363 7.735978 19.83643 3.163574 10.0082

total 87.19 total 101.513 21 21.5

F2= 0.3 (20)+(1-0.3) 21=20.7 with w=0.3F2= 0.5 (20)+(1-0.5) 21=20.5 with w=0.5

(20+22+...23)/12=21=F1

1 (1 )t t tF wA w F

Example-Exponential Smoothing Example-Exponential Smoothing Forecast Accuracy - Forecast Accuracy - RMSERMSE

F2= 0.3 (20)+(1-0.3) 21=20.7 with w=0.3

F2= 0.5 (20)+(1-0.5) 21=20.5 with w=0.5

RMSE with w=0.3 is 2.70 RMSE with w=0.5 is 2.91

Both exponential forecasts are better than the previous techniques in terms of average values.

2( )t tA FRMSE

Seasonal Variation

Ratio to Trend Method

ActualTrend Forecast

Ratio =

SeasonalAdjustment =

Average of Ratios forEach Seasonal Period

AdjustedForecast =

TrendForecast

SeasonalAdjustment

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 Actual Act/Forec1997Q1 12.29 11 0.8950371998Q1 13.87 12 0.8651771999Q1 15.45 14 0.9061492000Q1 17.02 15 0.881316

AV 0.886920.887

Deseasonalize data=actual sales/seasonal relative (index)

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.

Example: Computer Products Corp. Seasonalized Times Series Regression Analysis An analyst at CPC wants to develop next year’s quarterly

forecasts of sales revenue for CPC’s line of Epsilon Computers. The analyst believes that the most recent 8 quarters of sales (shown on the next slide) are representative of next year’s sales. Calculate the seasonal indexes

Example: Computer Products Corp.

Unseasonalized vs. Seasonalized

QuarterSeasonalized

SalesSeasonal

IndexDeseasonalized

2327.88

Sales: Unseasonalized vs. Seasonalized

1 2 3 4 5 6 7 8 9 10 11Quarter

Sales Deseasonalized Sales

Deflating a Time Series

Observed values can be adjusted to base year equivalent

Allows uniform comparison over timeDeflation formula:

)100(I

= adjusted time series value at time t

yt = value of the time series at time t

It = index value at time t

Deflating a Time Series: Example

Which movie made more money (in real terms)?

YearMovieTitle

Total Gross $

1939Gone With the

Wind199

1977 Star Wars 461

1997 Titanic 601

(Total Gross $ = Total domestic gross ticket receipts in $millions)

Deflating a Time Series: Example

Total Gross

CPI (base year = 1984)

Gross adjusted to 1984 dollars

1939Gone With the Wind

199 13.9 1431.7

1977 Star Wars 461 60.6 760.7

1997 Titanic 601 160.5 374.5

7.1431)100(9.13

199GWTW 1984adj

GWTW made about twice as much as Star Wars, and about 4 times as much as Titanic when measured in equivalent dollars

Thanks

Chapter 3: Forecasting

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