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ESTIMATING & FORECASTING DEMAND

An airline seeks to estimate the


demand relationship between
seats sold (Q) and average fare (P):
Q = a + bP,
based on 16 past observations
of P & Q.

Chapter 4
slide 1

Here, the best linear equation


turns out to be:
Q = 479 1.63P.

Average
Fare

Best-fit Line

Regression Analysis
estimates the equation that
best fits the data and measures
whether the relationship is
statistically significant.

# Seats sold per flight

4.2

REGRESSION ANALYSIS
More generally, Multiple Regression
allows for multiple explanatory variables:
Q = a + bP + cP + dY.
The power of Multiple Regression:
Even with multiple variables that
simultaneously influence sales,
its able to estimate the separate
variable influences (i.e. coefficients).
Important Regression Statistics
1. R2 (ranging between 0 and 1)
measures the proportion of
variation in Q explained by
the right-hand side variables.

2. F =

R2/(k - 1)
(1 - R2)/(N - k)

The F stat (larger F better)


indicates the statistical
significance (or lack thereof)
of the relationship.

4.3

REGRESSION STATISTICS
For the estimated OLS equation:
Q = 28.8 - 2.12P + 1.03P + 3.09Y,
(.34)
(.47)
(1.00)
R2 = .78 (78% of Qs variation explained) and
F = 13.86 (well above 95% significance threshold).
Standard Errors and t-stats
Each coefficients standard error
(its standard deviation) measures
the uncertainty around its estimate.
The coefficients t-stat = coefficient/SE,
tests whether the coefficient is
statistically significantly different t 0.

Here, the t-stats are -6.24,


2.20, and 3.09, indicating
that all coefficients are
statistically significant.

REGRESSION ISSUES
The standard error of the regression
measures the uncertainty around the
forecast of Q. A 95% confidence interval
around the forecast is: 2 standard errors.
1. Which equation form?
Linear? Polynomial, Multiplicative?
2. Have explanatory variables been omitted?
3. Are the explanatory variables multicolinear?
4. Are the equation errors serially correlated?

4.4

CHOOSING A REGRESSION EQUATION


1. Does the equation make economic sense?
Are the right explanatory variables included?
2. Are the signs and the magnitudes of
the estimated coefficients reasonable?
Do they make economic sense?
3. Based on the regression statistics, does the
equation have explanatory power?
How well did it track the past data?

4.5

4.6

FORECASTING DEMAND
Time-Series Models
indentify patterns in a
single variable over time.
A Time Series can be
decomposed into:
1. Trends
2. Business Cycles
3. Seasonal Variation, and
4. Random Fluctuations.

Three equations for


estimating a time trend:
1. Linear,
Qt = a + bt
2. Quadratic,
Qt = a + bt + ct2
3. Exponential,
Qt = brt,
estimated as
log(Qt) = log(b) + log(r)t

4.7

FORECASTING DEMAND
Barometric Models
indentify patterns among
different variables over time.

Movements in
Leading Indicators
predict future changes in
economic activity.

The Index of Leading Indicators


1.
2.
3.
4.
5.

Weekly manufacturing hours


Manufacturers New Orders
Changes in Unfilled Orders
Plant and Equipment Orders
Number of Housing Building
Permits
6. Changes in Sensitive
Materials Prices

7. Percentage of firms
receiving Slower Deliveries
8. Growth in the Money Supply
9. Index of Consumer Confidence
10. The S&P 500 Index
11. Weekly Claims for
Unemployment Insurance