Beruflich Dokumente
Kultur Dokumente
Learning outcomes
Introduction
CONCEPTS OF FORECASTING
3) Determinants of demand: Once you have identified the nature of product for
which you are to build a forecast, your next task is to locate clearly the
determinants of demand for the product. Depending on the nature of product and
nature of forecasts, different determinants will assume different degree of
importance in different demand functions. In the preceding unit, you have been
exposed to a number of price-income factors or determinants-own price, related
price, own income-disposable and discretionary, related income, advertisement,
price expectation etc. In addition, it is important to consider socio-psychological
determinants, specially demographic, sociological and psychological factors
affecting demand. Without considering these factors, long-run demand
forecasting is not possible.
Such factors are particularly important for long-run active forecasts.
The size of population, the age-composition, the location of household unit, the
sex-composition-all these exercise influence on demand in. varying degrees. If
more babies are born, more will be the demand for toys; if more youngsters
marry, more will be the demand for furniture; if more old people survive, more will
be the demand for sticks. In the same way buyers’ psychology-his need, social
status, ego, demonstration effect etc. –also effect demand. While forecasting,
you cannot neglect these factors.
4) Analysis of factors &determinants: Identifying the determinants alone would
not do, their analysis is also important for demand forecasting. In an analysis of
statistical demand function, it is customary to classify the explanatory factors into
(a) trend factors, which affect demand over long-run, (b) cyclical factors whose
effects on demand are periodic in nature, (c) seasonal factors, which are a little
more certain compared to cyclical factors, because there is some regularly with
regard to their occurrence, and (d) random factors which create disturbance
because they are erratic in nature; their operation and effects are not very
orderly.
An analysis of factors is specially important depending upon whether it is the
aggregate demand in the economy or the industry’s demand or the company’s
demand or the consumers; demand which is being predicted. Also, for a long-run
demand forecast, trend factors are important; but for a short-run demand
forecast, cyclical and seasonal factors are important.
6) Testing accuracy : This is the final step in demand forecasting. There are
various methods for testing statistical accuracy in a given forecast. Some of them
are simple and inexpensive, others quite complex and difficult. This stating is
needed to avoid/reduce the margin of error and thereby improve its validity for
practical decision-making purpose. Subsequently you will be exposed briefly to
some of these methods and their uses.
a set of series of some variables which exhibit a close association in their movement over
a period or time.
It shows the movement of agricultural income (AY series) and the sale of tractors
(ST series). The movement of AY is similar to that of ST, but the movement in ST
takes place after a year’s time lag compared to the movement in AY. Thus if one
knows the direction of the movement in agriculture income (AY), one can predict
the direction of movement of tractors’ sale (ST) for the next year. Thus
agricultural income (AY) may be used as a barometer (a leading indicator) to
help the short-term forecast for the sale of tractors.
Generally, this barometric method has been used in some of the developed
countries for predicting business cycles situation. For this purpose, some
countries construct what are known as ‘diffusion indices’ by combining the
movement of a number of leading series in the economy so that turning points in
business activity could be discovered well in advance. Some of the limitations of
this method may be noted however. The leading indicator method does not tell
you anything about the magnitude of the change that can be expected in the
lagging series, but only the direction of change. Also, the lead period itself may
change overtime. Through our estimation we may find out the best-fitted lag
period on the past data, but the same may not be true for the future. Finally, it
may not be always possible to find out the leading, lagging or coincident
indicators of the variable for which a demand forecast is being attempted.
DX = a + b1 A + b2PX + b3Py
You know that the regression coefficients b1, b2, b3 and b4 are the components of
relevant elasticity of demand. For example, b1 is a component of price elasticity
of demand. The reflect the direction as well as proportion of change in demand
for x as a result of a change in any of its explanatory variables. For example, b2<
0 suggest that DX and PX are inversely related; b4 > 0 suggest that x and y are
substitutes; b3 > 0 suggest that x is a normal commodity with commodity with
positive income-effect.
Given the estimated value of and bi, you may forecast the expected sales (DX), if
you know the future values of explanatory variables like own price (PX), related
price (Py), income (B) and advertisement (A). Lastly, you may also recall that the
statistics R2 (Co-efficient of determination) gives the measure of goodness of fit.
The closer it is to unity, the better is the fit, and that way you get a more reliable
forecast.
The principle advantage of this method is that it is prescriptive as well
descriptive. That is, besides generating demand forecast, it explains why the
demand is what it is. In other words, this technique has got both explanatory and
predictive value. The regression method is neither mechanistic like the trend
method nor subjective like the opinion poll method. In this method of forecasting,
you may use not only time-series data but also cross-section data. The only
precaution you need to take is that data analysis should be based on the logic of
economic theory.
Simultaneous Equations Method: Here is a very sophisticated method of
forecasting. It is also known as the ‘complete system approach’ or ‘econometric
model building’. In your earlier units, we have made reference to such
econometric models. Presently we do not intend to get into the details of this
method because it is a subject by itself. Moreover, this method is normally used
in macro-level forecasting for the economy as a whole; in this course, our focus
is limited to micro elements only. Of course, you, as corporate managers, should
know the basic elements in such an approach.
The method is indeed very complicated. However, in the days of computer, when
package programmes are available, this method can be used easily to derive
meaningful forecasts. The principle advantage in this method is that the
forecaster needs to estimate the future values of only the exogenous variables
unlike the regression method where he has to predict the future values of all,
endogenous and exogenous variables affecting the variable under forecast. The
values of exogenous variables are easier to predict than those of the
endogenous variables. However, such econometric models have limitations,
similar to that of regression method.
Thus we may conclude that each and every method has its own merits and
demerits and we need to bare in mind this when we select a particular tool.
Exercises
How is the slope of demand curve different from price elasticity of demand?
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
---------------------------------------
You can verify in the above numerical that the elasticity will have the same value
whether you consider a price fall from Rs. 3 or prices rise from Rs. 3 to Rs. 4.
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
..............................................................................
Given the following table on price and quantity, determine whether demand is
elastic, unitary
elastic, or less elastic when price rises from Rs. 7 to Rs. 8.
Why does the Government prefer to levy an excise tax on commodities which
are less elastic in demand (like gasoline)?
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
..............................................................................
eij
er
ea
E
What is the role of time element in the context of demand forecasting? What
factors would you normally consider in choosing a forecasting technique?
Joel Dean has suggested the following set of approaches with regard to
techniques of forecasting the demand for new products:
v) Evolutionary Approach
vi) Substitute Approach
vii) Growth Curve Approach
viii) Opinion Poll Approach
ix) Sales Experience Approach
x) Vicarious Approach
Note: Some of these terms may be new; but if you get back to recommended
reading No. 3 by Joel Dean and run down those few pages, you should be
able to discover all these approaches in this unit itself. And then you can
attempt integration.
Compare and contrast briefly the simultaneous equation and the regression
methods of demand forecasting.
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
.................................................................................................................................
As a manager, you should predict the event, project the course of variables and
forecast the data. Keeping this in mind, fill in the blanks in the table below. Note
the suggested guideline.
ADDITIONAL READINGS
Adhikary, M. (1987) Managerial Economics, Khosla Publishing House: N. Delhi
(Ch. VIII).
Gupta, G.S. (1974) ‘Forecasting Techniques’, Management Annual, Vol. IV, Nov.
1974, pp. 8-21.
Appendix
i) Linear trend : D = a + dT where D is the demand for the product under
forecast, T is the trend variable which may be normalized to take the value of 1 in
the first period, 2 in the second period and so on a (intercept) and b (slope) are
parametric information which can be estimated. The trend line assumes that
there will be a constant absolute amount of change (=b) every period.
ii) Exponential trend : D = aebT or logeD = loge a + bT. This semi-log function-
assumes a constant growth rate = b each period.
In this case, the slope of the parabola is given by the term dD and it changes
dT
direction only once, either from positive to negative or vice-versa. The shape and
location with respect to axis will vary according to the values of constant a, b and
c.
POINTS TO PONDER
Slide 1 ___________________________________
Demand forecasting
___________________________________
Meaning of forecasting:
Forecasting is the ___________________________________
forward projection of data variables.
Also known as sales forecasting ___________________________________
___________________________________
___________________________________
___________________________________
Slide 2 ___________________________________
Need for demand forecasting
___________________________________
Demand forecasting is need because the
concepts and the techniques of demand ___________________________________
forecasting can be applied anywhere.
___________________________________
___________________________________
___________________________________
___________________________________
Slide 3 ___________________________________
Types of forecast
___________________________________
Economic and Non-
Non-economic forecast
Micro and Macro forecast ___________________________________
Active and passive forecast
Conditional and non-
non-conditional forecast ___________________________________
Short run and long run forecast
___________________________________
___________________________________
___________________________________