Forecasting Problems

LEAST SQUARE METHOD OF FORECASTING (Regression Analysis)

This is the mathematical method of obtaining "the line of best fit between the dependent
variable (usually demand) and an independent variable. This method is called least square
method as the sum of the square of the deviations of the various points from the line of best
fit is minimum or least. It gives the equation of the line for which the sum of the squares of
vertical distances between the actual values and the line values are at minimum". In a simple
regression analysis, the relationship between the dependent variable .y and some independent
variable x can be represented by a straight line.

These two equations are called normal equations.

To compute the values of a and b
(i) Calculate the deviation (x) for each period and also the sum of deviations.
(ii) Find the value of ΣX²
(iii) Find the value of ΣXY
(iv) Calculate the values of a and b
(v) Make the sum of deviations ΣX = 0
Substituting the value of ΣX= 0 in equations (1) and (2)

Note: (i) If the Time Series consists of odd number of years to make ΣX = 0, the middle
value of the time series is taken as the Origin.

(ii) If the time series consists of even number of years, the midway period between two middle
periods is taken as origin to make ΣX = 0.

Problem 1: The following data gives the sales of the company for various years. Fit the straight
line. Forecast the sales for the year 1998 and 1999.
Problem 2: The past data regarding the sales of SPMS for the last five years is given. Using the least
square method, fit a straight line, estimate the sales for the year 1996 and 1997.
Problem 3: The sales for the domestic water pumps manufactured by Ajit Manufacturing
Company is given forecast the demand for the pumps for the next three years using least square
method.
Least square method when the sum of the deviations is not zero (ΣX = 0)
Problem 4: A company manufacturing washing machines establishes a fact that there is a
relationship between sale of washing machines and population of the city. The market research
carried out reveals the following information:
MOVING AVERAGE (MA) FORECASTING
The past data of sales of a company can have fluctuations (high or low) because of the
seasonal variations and random variations. Simple averaging of demand for previous
periods is going to hide the trend and it is meaningless since trend is an important factor.
Moving Average (MA) consists of series of arithmetic means calculated from overlapping
groups of successive elements of time series.
Moving average is a simple statistical method to extrapolate and establish trend of past sales.
This method uses a past data and calculates a rolling average for a constant period. At
each period, fresh average is computed at the end of each period by adding the demand of the
most recent period and deleting the data of the old-period since the data in this method
changes from period to period, it is called moving average method. A simple moving average
is calculated as follows:
Problem 6: The data given below represents sales figures of ABC company for the 12 months of
the year 1996.
1. Compute 3 months moving average (ignoring decimal values)
2. Forecast the demand for the month of Jan. 1997
3. If the actual demand for the month of Jan. 1997 is 905 units. what should be the forecast for the
month of Feb. 97.

(ii) Forecast for the month of January is 907.

(As the secular trend for Jan. 97 is not available, the forecast equals last moving average)
(iii) Forecast for Feb. 97
CAUSAL FORECASTING METHOD
Casual methods try to identify the factors which causes the variation of demand and try to
establish a relationship between the demand and these factors.
In the method, the analyst tries to identify those factors that best explain the level of sales of
the product. This process is called econometric forecasting.
The objective of this method is to establish a cause and effect relationship between the
changes in the sales level of the product and set of relevant explanatory variable.
Some of the, casual methods are,
1. Regression and Correlation analysis.
2. Input-output analysis.
3. End use analysis.

Regression and Correlation

Regression analysis is a forecasting technique that establishes the relationshipbetween
variables. Historical data establishes a functional relationship between the two
variables.Correlation analysis is determining the degree of closeness of the
relationship between two variables.
In general, the sales of any product is influenced by external or internal factors. Sales
is thus a dependent variable and is a function of one or more independent variable. A
regression models (simple or multiple) establish the relationship between the
independent and dependent variable.

Types of Correlation
(i) Positive and Negative Correlation: The direction of variation of variables
determine whether the relationship is positive (direct) or negative (inverse or
indirect). If the increase in value of one is accompanied by increase in value of the
other it is called positive correlation, i.e., both variables vary in the same direction.
Correlation is said to be negative if increase (or decrease) in one variable results in
decrease (or increase) in another variable.
(ii) Simple and Multiple Correlation: Correlation is said to be simple when only two
variables are involved e.g., price and demand for a product. If more than two
variables are studied at the same time, the correlation is said to be multiple. e.g.,.
Price, demand and supply of a product.
(iii) Linear and Non-linear Correlation:
Co-efficient of correlation
The degree of relationship is called correlation. It is a single figure which expresses
the degree and direction of correlation is called co-efficient of correlation.

Karl pearsons co-efficient of correlation

Problem 10: The following data relates the cost of production and sales prices.

FORECAST ERROR
The demand for the product is forecasted using many forecasting methods. It is
essential to have a good measure of effectiveness of the methods. Forecast error is
the numerical difference between the forecasted demand and the actual demand. The
error should be minimum as far as possible.

Mean Absolute Deviation (MAD)

It is a measure of forecast error and it measures the average forecast error without
direction. It is calculated all the sum of the absolute value of the forecast error for all
periods divided by the total number of periods.

Problem : A dealer for electrical appliances forecasts the demand for the Geyser at
the rate of 500 per month for the next three months. The actual demands turned out
to be 400,560 and 700. Calculate the forecast error and bias, comment on the same.