Chapter 6

Forecasting
Forecasting Application- managers must make informed forecast when it comes to
deciding on new product introduction, pricing products or making hiring decision.
Macroeconomics Application
Macroeconomics forecast- involves predicting aggregate measures of economic activity
at the international, national, regional, or state of levels.
- It involves also the prediction of economic data at the industry firm, plant or
products levels.
GDP- is the value at final point of sale of all goods and services product in the domestic
economy during a given period by both domestic and foreign-owned enterprises.
GNP- is the value at final point of sale of all goods and services produced by domestics
firms.
Forecast Technique- accurate forecast require pertinent data that are current,
complete, and free from error and bias.
Qualitative Analysis-is an intuitive approach to forecasting that can be useful if it
allows for the systematic collection of data from unbiased and informed opinion.
Expert Opinion- the most basic form of qualitative analysis, forecasting is personal
right, in which an informed individual user or company experience as a basis for
developing future expectation.
Survey Techniques- generally use interviews or mailed questionnaires that ask firms,
government agencies, and individuals about their future and plans.
Trend Analysis and Projection-is based on the premise that future economic
performance follows an established historical pattern.
TRENDS IN ECONOMIC DATA
Trends Projection- is prediction on the assumption that historical relationships will
continue into the future.
Secular Trend- is the long-run pattern of increase or decrease in a series of economic
data.
Cyclical Fluctuation- describes the rhythmic variation in economic series that is due to
pattern of expansion or contradiction in the overall economy.
Seasonality-is a rhythmic annual pattern in sales or profits caused by weather, habit or
social custom.
Irregular of random influences- are unpredictable shocks to the economic system and
place of economic activity caused by wars, strikes, natural catastrophes, and so on.
Linear Trend Analysis- a constant period by period unit changes in an important
economic variable over time.
𝑠𝑡 = 𝑎 + b x t
Growth Trend Analysis- a constant period by period percentage change in an
important economic variable over time.
Sales in t years = current sales x (1+𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒)t
𝑠𝑡 = 𝑠0 (1 + 𝑔) t
Linear and Growth Comparison - the importance of selecting the correct structural
form for a trend model can be demonstrated by comparing the sales projections that
result from the two basic approaches that have been considered.

Business Cycle – rhythmic pattern of contraction and expansion observed in the

overall economy.
Economic Indicator- that describe projected, current or past economic activity.
Composite Index- weighted average of leading, coincident or lagging economic
indicators.
Economic Recession- period of declining economic activity.
Economic Expansion- period of rising economic activity.

Exponential Smoothing
 A method for forecasting trends in unit sales, unit costs, wage expenses and so
on.
 Averaging method for forecasting time series of data.

One-Parameter(Simple) Exponential Smoothing- method for forecasting slowly

changing levels.
Two- Parameter (Hot) Exponential Smoothing -method for forecasting stable growth.
Three – Parameter (Winter) Exponential Smoothing-method for forecasting
seasonally adjusted growth.

Econometric Methods
- Combine economic theory with statistical tool to predict relations.
Single- Equation Models
- The first step in developing an econometric model is to express relevant
economic relations in the form of equation.
C= Ao + A1P + A2I + A3 Pop + A4i + A5 A
Computer Demand (C) is determined by price (P), disposable income (I), population
(Pop), interest sales (i) and an advertising expenditure.

Multiple-equation System
Endogenous- variables whose values are determined within.
Exogenous-determined external to the system.

Multi-equation Econometric Models 2 Basic Kinds

1. Identities- economic relations that are true by definition.
Example of identity: 𝜋 = TR − TC
Profits (𝜋) equal total revenue (TR) minus total cost (TC)
2. Behavioral Equations-economic relations that are hypothesized to be true.
 Three equations are: 2.1] St = b1 + b2TR + 𝑢1
2.2] Pt = Co+ C1Ct-1 + 𝑢2
2.3] TRt= St + Pt + Ct

S is software sales, TR is total revenue, P is peripheral sales, C is computer sales, t is

the current time period, t-1 is the previous time period and 𝑢1 and 𝑢2, are error, or
residual terms.
Substituting Equation:
TRt= bo + b1 + TRt + Pt + Ct
Collecting terms and isolating TR in equation
(1-b1)TRt= b0+ C1Ct-1 + Ct
Or alternatively: TRt= b0+ C1Ct-1 + Ct
(1-b1)

Forecast Reliability
 predictive consistency
 must be adequately assessed prior to the implementation of any successful
forecasting program.
Test Predictive Capability
 a forecast model generated over one sample or period is used to forecast data
for some alternative sample or period.
Correlation analysis
 the correlation between forecast and actual values is on substantial interest.
Forecast group and test group
 a given forecast model is often estimated by using a test group of data and
evaluated by forecast group data.
Sample mean Forecast error
 useful estimate of the average forecast error of model.
 called the root mean squared forecast error and is denoted by the symbol U.
1 𝑛
𝑈 = 𝑛 ∑𝑡=1(fi − xi)2

n is the number of sample observations f is the forecast value and x is the

corresponding actual values.