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Demand Forecasting - Lecture 5

The document discusses various techniques for demand estimation and forecasting using regression analysis. It explains how to build a regression model equation to relate a dependent variable like quantity demanded to independent variables that influence demand. The document also discusses challenges with regression models like identification problems and multicollinearity. It emphasizes the importance of forecasting for businesses and outlines different forecasting techniques including qualitative and quantitative approaches.

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Umair Muhammad Haroon
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38 views

Demand Forecasting - Lecture 5

The document discusses various techniques for demand estimation and forecasting using regression analysis. It explains how to build a regression model equation to relate a dependent variable like quantity demanded to independent variables that influence demand. The document also discusses challenges with regression models like identification problems and multicollinearity. It emphasizes the importance of forecasting for businesses and outlines different forecasting techniques including qualitative and quantitative approaches.

Uploaded by

Umair Muhammad Haroon
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Demand Estimation and

Forecasting

Naheed Memon
EMBA
Fall 2021
12/15/2022 Managerial Economics 1
Regression Model to Explain Demand
Equation
• In estimating the demand for a particular good or service, first determine all the factors that might influence
this demand.
• Ideally, all variables that are believed to have an impact on demand should be included in the regression
analysis. The variables used in regression analysis are based on the availability of data and the cost of
generating new data.
• The two types of data used in regression analysis are cross-sectional and time series. Cross-sectional data
provide information on variables for a given period. Time series data give information about the variables
over a number of periods of time.

12/15/2022 Managerial Economics 2


Regression Model Equation

Y, or the quantity demanded, is called the dependent variable. The X variables


are referred to as the independent or explanatory variables

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Interpretation of Regression Result
• Step 1 – Check Signs and Magnitudes
• The negative sign for the P variable indicates an inverse relationship
between price and the quantity demanded for the product.
• The positive sign for the Pr variable indicates a direct relationship
between the price of a related product and the quantity demanded.
• The positive sign of I variable indicates that the product is normal or
perhaps superior, depending on the magnitude of the income
elasticity coefficient.
• Step 2 – Compute Elasticity Coefficients
• Step 3 – Determine Statistical Significance

12/15/2022 Managerial Economics 4


Interpretation of Regression Result

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R^2
• Another important statistical indicator used to evaluate the regression results is the
coefficient of determination or R2.
• This measure shows the percentage of the variation in a dependent variable
accounted for by the variation in all the explanatory variables in the regression
equation.
• R2 increases as more independent variables are added to a regression equation.
• most analysts prefer to use a measure that adjusts for the number of independent
variables used so equations with different numbers of independent variables can
be more fairly compared. This alternative measure is called the adjusted R2,

12/15/2022 Managerial Economics 6


Challenges of Regression Model
Some key problems pertaining to regression analysis are highlighted below:
1 – Identification Problem: when both the demand and supply curves are subject to random fluctuations the
regression of output on price is neither the demand curve nor the supply curve. This causes the identification
problem.

2 – Multicollinearity: One of the key assumptions made in the construction of the multiple regression equation
is that the independent variables are not related to each other in any systematic way. If this assumption is
incorrect, then each estimated coefficient may give a distorted view of the impact of the change in each
independent variable.

3 – Autocorrelation: Autocorrelation represents the degree of similarity between a given time series and a
lagged version of itself over successive time intervals. Autocorrelation measures the relationship between a
variable's current value and its past values
.

12/15/2022 Managerial Economics 7


Importance of Forecasting in Business
Key macro forecasts that businesses consider prior to individual
forecasts:
• Forecasts of gross domestic product—which describe the total production of goods and services in a country.
• Forecasts of the components of GDP—for example, consumption expenditure, producer durable equipment
expenditure, and residential construction.
• Industry forecasts—for Global Foods, this would represent forecasts of sales of soft drinks, bottled water, and
its other products.
• Forecasts of sales for a specific product—for instance, diet cola.

12/15/2022 Managerial Economics 8


Importance of Forecasting in Business
Prerequisites of a good forecast:
• A forecast must be consistent with other parts of the business. For instance, a sales forecast of 10 percent
growth must ensure there are sufficient manufacturing facilities and labor force to produce this increase.
• A forecast should be based on knowledge of the relevant past. However, when underlying conditions have
changed significantly, past experience may be of no help in making a forecast. Moreover, sometimes there is
no past on which to rely. This is the case when we are dealing with a new product or technology. Under these
circumstances, analysts’ judgments must be injected into the forecasting process. In some cases, “forecasts
based purely on the opinion of ‘experts’ are used to formulate the forecast or scenario for the future.
• A forecast must consider the economic and political environment, as well as any potential changes.
• A forecast must be timely. An accurate forecast that is too late to be acted on may be worthless.

12/15/2022 Managerial Economics 9


Forecasting Techniques
• There are many different forecasting methods. One of the challenges facing a forecaster is choosing the right
technique.
• Forecasting techniques can be categorized in many ways. We use the following
• six categories:
1. Expert opinion
2. Opinion polls and market research
3. Surveys of spending plans
4. Economic indicators
5. Projections
6. Econometric models

12/15/2022 Managerial Economics 10


Forecasting Techniques
Qualitative forecasting is based on judgments of individuals or groups. The results of qualitative
forecasts may be in numerical form but generally are not based on a series of historical data.
Quantitative forecasting, in contrast, generally uses significant amounts of prior data as a basis for
prediction. Quantitative techniques can be naive or causal (explanatory).
Naive forecasting projects past data into the future without explaining future trends.
Causal or explanatory forecasting attempts to explain the functional relationships between the
variable to be estimated (the dependent variable) and the variable or variables that account for the
changes (the independent variables).

12/15/2022 Managerial Economics 11


Forecasting with Smoothing Techniques
• This method involves using an average of past observations to predict the future. If the forecaster believes
that the future reflects some average of past results, one of two forecasting methods can be applied: simple
moving average or exponential smoothing.
• Moving Average: The average of actual past results is used to forecast one period ahead. The equation for
this construction is simply

• Exponential Smoothing: The moving-average method awards equal importance to each of the observations
included in the average and gives no weight to observations preceding the oldest data included. However, the
analyst may believe that the most recent observation is more relevant to the estimate of the next period than
previous observations. In that case, it is more appropriate to employ the exponential smoothing method,
which allows for the decreasing importance of information in the more distant past. This is accomplished by
the mathematical technique of geometric progression.

12/15/2022 Managerial Economics 12

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