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An abstract view of the different methods of forecasting in a manufacturing company.

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Forecasting

MGS3100

Forecasting

Forecasting

Quantitative

Qualitative

Causal Model

Expert Judgment

Trend

Delphi Method

Time series

Grassroots

Stationary

Trend

Trend + Seasonality

Quantitative Forecasting

--Forecasting based on data and models

Casual Models:

Price

Population

Advertising

Causal

Model

Year 2000

Sales

Sales1999

Sales1998

Sales1997

Time Series

Model

Year 2000

Sales

Causal forecasting

Regression

Find a straight line that fits the data best.

Best line!

Intercept

Slope = change in y / change in x

Curve Fitting: Simple Linear Regression

One Independent Variable (X) is used to predict one

Dependent Variable (Y): Y = a + b X

Given n observations (Xi, Yi), we can fit a line to the

overall pattern of these data points. The Least

Squares Method in statistics can give us the best a

and b in the sense of minimizing (Yi - a - bXi)2:

XiYi

Xi Yi

2

X

i

( Xi ) 2

5

Find the regression line with Excel

Use Function:

a = INTERCEPT(Y range; X range)

b = SLOPE(Y range; X range)

Use Solver

Use Excels Tools | Data Analysis | Regression

Two or more independent variables are used to

predict the dependent variable:

Y = b0 + b1X1 + b2X2 + + bpXp

Use Excels Tools | Data Analysis | Regression

Look at the data

(Scatter Plot)

Observations from the

scatter Plot

more techniques

and pick the best one.

Techniques to try

Ways to evaluate

Data is reasonably

stationary

(no trend or seasonality)

Naive

Moving Averages

Simple Exponential Smoothing

MAD

MAPE

Standard Error

BIAS

trend

Regression

Linear

Non-linear Regressions (not

covered in this course)

MAD

MAPE

Standard Error

BIAS

R-Squared

a seasonal pattern

Classical decomposition

Find Seasonal Index

Use regression analyses to find

the trend component

MAD

MAPE

Standard Error

BIAS

R-Squared

7

BIAS - The arithmetic mean of the errors

BIAS

n

Excel: =AVERAGE(error range)

| Actual - Forecast | | Error |

MAD

Mean Square Error - MSE

(Actual - Forecast) (Error)

MSE

2

Standard error is square root of MSE

| Actual - Forecast |

*100%

Actual

MAPE

n

In general, the lower the error measure (BIAS, MAD,

MSE) or the higher the R2, the better the forecasting

model

9

Nave

I sold 10 units yesterday, so I think I will sell 10 units

today.

n-period moving average

For the past n days, I sold 12 units on average.

Therefore, I think I will sell 12 units today.

Exponential smoothing

I predicted to sell 10 units at the beginning of yesterday;

At the end of yesterday, I found out I sold in fact 8 units.

So, I will adjust the forecast of 10 (yesterdays forecast)

by adding adjusted error ( * error). This will compensate

over (under) forecast of yesterday.

10

Nave Model

The simplest time series forecasting

model

Idea: what happened last time (last year,

last month, yesterday) will happen again

this time

Nave Model:

Algebraic: Ft = Yt-1

11

Simple n-Period Moving Average

n

Y

Y

Y

t

1

t

2

tn

=

n

F

t

Issues of MA Model

Nave model is a special case of MA with n = 1

Idea is to reduce random variation or smooth data

All previous n observations are treated equally (equal

weights)

Suitable for relatively stable time series with no trend or

seasonal pattern

12

actual changes more slowly

13

Weighted n-Period Moving Average

F =w Y

w Y

w Y

t

1 t 1

2 t2

n tn

w1>w2>>wn

Sum of the weights = wi = 1

each previous observation in forecasting

Optimal weights can be found via Solver

14

Month Weight Data

August 17% 130

September 33% 110

October 50% 90

November forecast:

FNov = (0.50)(90)+(0.33)(110)+(0.17)(130)

= 103.4

15

Exponential Smoothing

Concept is simple!

Make a forecast, any forecast

Compare it to the actual

Next forecast is

Previous forecast plus an adjustment

Adjustment is fraction of previous forecast error

Essentially

Not really forecast as a function of time

Instead, forecast as a function of previous actual and

forecasted value

16

A special type of weighted moving average

Include all past observations

Use a unique set of weights that weight recent observations

much more heavily than very old observations:

0 1

weight

Decreasing weights

given

to older

observations

(1 )

(1 ) 2

(1 ) 3

17

Toda

y

Ft Yt 1 (1 )Yt 2 (1 ) 2 Yt 3

Ft Yt 1 (1 )Yt 2 (1 a )Yt 3

Ft Yt 1 (1 ) Ft 1

New forecast = weighted sum of last period

actual value and last period

forecast

: Smoothing constant

Ft :Forecast for period t

Ft-1:

Yt-1:

18

Properties of Simple Exponential

Smoothing

Widely used and successful model

Requires very little data

Larger , more responsive forecast; Smaller

, smoother forecast (See Table 13.2)

best can be found by Solver

Suitable for relatively stable time series

19

Trend

persistent upward or downward pattern in a time series

Seasonal

Variation dependent on the time of year

Each year shows same pattern

Cyclical

up & down movement repeating over long time frame

Each year does not show same pattern

follow no specific pattern

short duration and non-repeating

20

Cycle

Trend

Random

movement

Time

Seasonal

pattern

Time

Demand

Time

Trend with

seasonal pattern

21

Time

Trend Model

Curve fitting method used for time series

data (also called time series regression

model)

Useful when the time series has a clear trend

Can not capture seasonal patterns

Linear Trend Model: Yt = a + bt

t is time index for each period, t = 1, 2, 3,

7

6

5

4

3

2

1

0

1

10

22

Regression Recall Independent Variable X, which is now

time variable e.g., days, months, quarters, years etc.

Best line!

Intercept

Slope = change in y / change in x

23

Once data turn out to be seasonal,

deseasonalize the data.

The methods we have learned (Heuristic methods and

Regression) is not suitable for data that has

pronounced fluctuations.

Reseasonalize the forecast

Good forecast should mimic reality. Therefore, it is

needed to give seasonality back.

24

Example (SI + Regression)

Actual data

Deseasonalized data

Deseasonalize

Forecast

Reseasonalize

25

Deseasonalization

Deseasonalized data = Actual / SI

Reseasonalization

Reseasonalized forecast

= deseasonalized forecast * SI

26

Seasonal Index

Whats an index?

Ratio

SI = ratio between actual and average demand

Suppose

SI for quarter demand is 1.20

Whats that mean?

Use it to forecast demand for next fall

So, where did the 1.20 come from?!

27

Quick and dirty method of calculating SI

For each year, calculate average demand

Divide each demand by its yearly average

This creates a ratio and hence a raw index

For each quarter, there will be as many raw indices

as there are years

Average the raw indices for each of the quarters

The result will be four values, one SI per quarter

28

Classical decomposition

Start by calculating seasonal indices

Then, deseasonalize the demand

Divide actual demand values by their SI values

y = y / SI

Results in transformed data (new time series)

Seasonal effect removed

Forecast

Regression if deseasonalized data is trendy

Heuristics methods if deseasonalized data is stationary

Reseasonalize with SI

29

What are the difference?

Which one to use?

30

Can you

describe general forecasting process?

compare and contrast trend, seasonality and

cyclicality?

describe the forecasting method when data is

stationary?

describe the forecasting method when data

shows trend?

describe the forecasting method when data

shows seasonality?

31

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