Statistics For Business and Economics

Statistics for
Business and Economics
Lectures 10 and 11
Index Numbers, Time-Series Analysis
and Forecasting
Prof. Miruna Mazurencu Marinescu, Ph.D, MBA
Chap 19-1
Chapter Goals
After completing this chapter, you should be able to:
Compute and interpret index numbers
Weighted and unweighted price index
Weighted quantity index
Test for randomness in a time series

Identify the trend, seasonality, cyclical, and irregular
components in a time series
Use smoothing-based forecasting models, including
moving average and exponential smoothing
Apply autoregressive models and autoregressive
integrated moving average models
Chap 19-2
Index Numbers
Index numbers allow relative comparisons
over time
Index numbers are reported relative to a Base
Period Index
Base period index = 100 by definition
Used for an individual item or measurement
Chap 19-3
Single Item Price Index

Consider observations over time on the price of a single
item
To form a price index, one time period is chosen as a
base, and the price for every period is expressed as a
percentage of the base period price
Let p0 denote the price in the base period
Let p1 be the price in a second period
The price index for this second period is
p1
100
p0
Chap 19-4
Index Numbers: Example

Airplane ticket prices from 1995 to 2003:
Index
Year
Price
(base year
= 2000)
1995
272
85.0
1996
288
90.0
1997
295
92.2
1998
311
97.2
1999
322
100.6
2000
320
100.0
2001
348
108.8
2002
366
114.4
2003
384
120.0
I1996
P1996
288
100
(100)
90
P2000
320
Base Year:
P2000
320
I2000 100
(100)
100
P2000
320
I2003
P2003
384
100
(100)
120
P2000
320
Chap 19-5
Index Numbers: Interpretation

Prices in 1996 were 90%
of base year prices
I1996
P1996
288
100
(100 ) 90
P2000
320
I2000

P2000
320
100
(100 ) 100
of base year prices (by
P2000
320
definition, since 2000 is the

base year)
I2003

P2003
384
100
(100 ) 120
of base year prices
P2000
320
Chap 19-6
Aggregate Price Indexes

An aggregate index is used to measure the rate
of change from a base period for a group of items
Aggregate
Price Indexes
Unweighted
aggregate
price index
Weighted
aggregate
price indexes
Laspeyres Index
Chap 19-7
Unweighted
Aggregate Price Index
Unweighted aggregate price index for period t for a group of K items:
100
i1
K
p ti
i = item
t = time period
p
i1
ti
0i
K = total number of items
= sum of the prices for the group of items at time t
i1
= sum of the prices for the group of items in time period 0
p
i1
0i
Chap 19-8
Unweighted Aggregate Price

Index: Example
Automobile Expenses:
Monthly Amounts ($):
Index
Year
Lease payment
Fuel
Repair
Total
(2001=100)
2001
260
45
40
345
100.0
2002
280
60
40
380
110.1
2003
305
55
45
405
117.4
2004
310
50
50
410
118.8
I2004
100
P
2004
2001
410
(100)
118.8
345
Unweighted total expenses were 18.8%

higher in 2004 than in 2001
Chap 19-9
Weighted
Aggregate Price Indexes
A weighted index weights the individual prices by
some measure of the quantity sold
If the weights are based on base period quantities the
index is called a Laspeyres price index
The Laspeyres price index for period t is the total cost of
purchasing the quantities traded in the base period at prices in
period t , expressed as a percentage of the total cost of
purchasing these same quantities in the base period
The Laspeyres quantity index for period t is the total cost of the
quantities traded in period t , based on the base period prices,
expressed as a percentage of the total cost of the base period
quantities
Chap 19-10
Laspeyres Price Index

Laspeyres price index for time period t:
100
q p
i 1
K
0i
q p
i1
0i
ti
0i
q0i = quantity of item i purchased in period 0

p0i = price of item i in time period 0
p ti = price of item i in period t
Chap 19-11
Laspeyres Quantity Index

Laspeyres quantity index for time period t:
100
q p
q p
i 1
K
i1
ti 0i
0i
0i
p0i = price of item i in period 0

q0i = quantity of item i in time period 0
qti = quantity of item i in period t
Chap 19-12
Time-Series Data
Numerical data ordered over time
The time intervals can be annually, quarterly,
daily, hourly, etc.
The sequence of the observations is important
Example:
Year:
2001 2002 2003 2004 2005
Sales:
75.3
74.2
78.5
79.7
80.2
Chap 19-13
Time-Series Plot
A time-series plot is a two-dimensional
plot of time series data
the vertical axis
measures the variable
of interest
the horizontal axis
corresponds to the
time periods
Chap 19-14
Time-Series Components
Time Series
Trend
Component
Seasonality
Component
Cyclical
Component
Irregular
Component
Chap 19-15
Trend Component
Long-run increase or decrease over time
(overall upward or downward movement)
Data taken over a long period of time

Sales
nd
e
r
t
d
r
Up w a
Time
Chap 19-16
Trend Component
(continued)
Trend can be upward or downward

Trend can be linear or non-linear
Sales
Sales
Time
Downward linear trend
Time
Upward nonlinear trend
Chap 19-17
Seasonal Component
Short-term regular wave-like patterns
Observed within 1 year
Often monthly or quarterly
Sales
Summer
Winter
Summer
Spring
Winter
Spring
Fall
Fall
Time (Quarterly)
Chap 19-18
Cyclical Component
Long-term wave-like patterns
Regularly occur but may vary in length
Often measured peak to peak or trough to
trough
1 Cycle
Sales
Year
Chap 19-19
Irregular Component
Unpredictable, random, residual fluctuations
Due to random variations of
Nature
Accidents or unusual events
Noise in the time series
Chap 19-20
Time-Series Component Analysis

Used primarily for forecasting
Observed value in time series is the sum or product of
components
Additive Model
X t Tt St C t I t
Multiplicative model (linear in log form)
X t Tt S t C tIt
where
Tt = Trend value at period t

St = Seasonality value for period t
Ct = Cyclical value at time t
It = Irregular (random) value for period t
Chap 19-21
Smoothing the Time Series

Calculate moving averages to get an overall
impression of the pattern of movement over
time
This smooths out the irregular component
Moving Average: averages of a designated
number of consecutive
time series values
Chap 19-22
(2m+1)-Point Moving Average

A series of arithmetic means over time
Result depends upon choice of m (the
number of data values in each average)
Examples:
For a 5 year moving average, m = 2
For a 7 year moving average, m = 3
Etc.
Replace each xt with

m
1
X
X t j (t m 1, m 2, , n m)
2m 1 j m
*
t
Chap 19-23
Moving Averages
Example: Five-year moving average
First average:
x1 x 2 x 3 x 4 x 5
5
x 5*
Second average:
x *6
x2 x3 x 4 x5 x6
5
etc.
Chap 19-24
Example: Annual Data

Year
1
2
3
4
5
6
7
8
9
10
11
etc
Sales
23
40
25
27
32
48
33
37
37
50
40
etc
Chap 19-25
Calculating Moving Averages

Let m = 2
Year
Sales
Average
Year
5-Year
Moving
Average
23
29.4
40
34.4
25
33.0
27
35.4
32
37.4
48
41.0
33
39.4
37
37
10
50
11
40
etc
29.4
23 40 25 27 32
5
Each moving average is for a consecutive

block of (2m+1) years
Chap 19-26
Annual vs. Moving Average

The 5-year
moving average
smoothes the
data and shows
the underlying
trend
Chap 19-27
Centered Moving Averages

(continued)
Let the time series have period s, where s is

even number
i.e., s = 4 for quarterly data and s = 12 for monthly data
To obtain a centered s-point moving average series

Xt*:
Form the s-point moving averages
x *t .5
s/2
s s
s
s
x
(t
1,
2,
,
n
t j
2 2
2
2
j (s/2)1
Form the centered s-point moving averages

*
*
x
x
t .5
x *t t .5
2
(t
s
s
s
1, 2, , n )
2
2
2
Chap 19-28
Centered Moving Averages

Used when an even number of values is used in the moving
average
Average periods of 2.5 or 3.5 dont match the original
periods, so we average two consecutive moving averages to
get centered moving averages
Average
Period
4-Quarter
Moving
Average
Centered
Period
Centered
Moving
Average
2.5
28.75
29.88
3.5
31.00
32.00
4.5
33.00
34.00
5.5
36.25
6.5
35.00 etc
37.50
38.13
7.5
38.75
39.00
8.5
39.25
40.13
9.5
41.00
Chap 19-29
Calculating the
Ratio-to-Moving Average
Now estimate the seasonal impact
Divide the actual sales value by the centered
moving average for that period
xt
100 *
xt
Chap 19-30
Calculating a Seasonal Index

Quarter
Sales
1
2
3
4
5
6
7
8
9
10
11
23
40
25
27
32
48
33
37
37
50
40
Centered
Moving
Average
29.88
32.00
34.00
36.25
38.13
39.00
40.13
etc
Ratio-toMoving
Average
83.7
84.4
94.1
132.4
86.5
94.9
92.2
etc
x3
25
100 * (100)
83.7
x3
29.88
Chap 19-31
Calculating Seasonal Indexes

(continued)
Fall
Fall
Fall
Quarter
Sales
1
2
3
4
5
6
7
8
9
10
11
23
40
25
27
32
48
33
37
37
50
40
Centered
Moving
Average
29.88
32.00
34.00
36.25
38.13
39.00
40.13
etc
Ratio-toMoving
Average
83.7
84.4
94.1
132.4
86.5
94.9
92.2
etc
1. Find the median

of all of the
same-season
values
2. Adjust so that
the average over
all seasons is
100
Chap 19-32
Interpreting Seasonal Indexes

Suppose we get these
seasonal indexes:
Seasonal
Season
Index
Interpretation:
Spring
0.825
Spring sales average 82.5% of the

annual average sales
Summer
1.310
Summer sales are 31.0% higher

than the annual average sales
Fall
0.920
Winter
0.945
etc
= 4.000 -- four seasons, so must sum to 4

Chap 19-33
Forecasting Time Period (t + 1)

The smoothed value in the current period (t)
is used as the forecast value for next period
(t + 1)
At time n, we obtain the forecasts of future
values, Xn+h of the series
x nh x n (h 1,2,3 )
Chap 19-34
Autoregressive Models
Used for forecasting
Takes advantage of autocorrelation
1st order - correlation between consecutive values
2nd order - correlation between values 2 periods
apart
pth order autoregressive model:
x t 1x t 1 2 x t 2 p x t p t
Random
Error
Chap 19-35
(continued)
Let Xt (t = 1, 2, . . ., n) be a time series

A model to represent that series is the autoregressive
model of order p:
x t 1x t 1 2 x t 2 p x t p t
where
, 1 2, . . .,p are fixed parameters
t are random variables that have
mean 0
constant variance
and are uncorrelated with one another
Chap 19-36
(continued)
The parameters of the autoregressive model are

estimated through a least squares algorithm, as the
values of , 1 2, . . .,p for which the sum of
squares
SS
2
(x
x
)
t
1 t 1
2 t 2
p t p
t p 1
is a minimum
Chap 19-37
Forecasting from Estimated

Consider time series observations x1, x2, . . . , xt
Suppose that an autoregressive model of order p has been fitted to
these data:
x t 1x t 1 2 x t 2 p x t p t
Standing at time n, we obtain forecasts of future values of the series
from
x t h 1x t h1 2 x t h2 p x t hp
Where for j > 0,
0,
x n j is the forecast of Xt+j standing at time
x nsimply
is
the observed value of X t+j
j
(h 1,2,3, )
n and for j
Chap 19-38
Autoregressive Model:
Example
The Office Concept Corp. has acquired a number of office
units (in thousands of square feet) over the last eight years.
Develop the second order autoregressive model.
Year
1999
2000
2001
2002
2003
2004
2005
2006
Units
4
3
2
3
2
2
4
6
Chap 19-39
Autoregressive Model:
Example Solution
Develop the 2nd order
table
Use Excel to estimate a
regression model
Excel Output
Coefficients
Intercept
3.5
X Variable 1
0.8125
X Variable 2
-0.9375
Year
xt
xt-1
99
00
01
02
03
04
05
06
4
3
2
3
2
2
4
6
-4
3
2
3
2
2
4
xt-2
--4
3
2
3
2
2
x t 3.5 0.8125x t 1 0.9375x t 2

Chap 19-40
Autoregressive Model
Example: Forecasting
Use the second-order equation to forecast
number of units for 2007:
x t 3.5 0.8125x t 1 0.9375x t 2
x 2007 3.5 0.8125(x 2006 ) 0.9375(x 2005 )
3.5 0.8125(6) 0.9375(4)
4.625
Chap 19-41
Autoregressive Modeling Steps
Choose p
Form a series of lagged predictor

variables xt-1 , xt-2 , ,xt-p
Run a regression model using all p

variables
Test model for significance
Use model for forecasting
Chap 19-42
Chapter Summary
Discussed weighted and unweighted index numbers
Addressed components of the time-series model
Addressed time series forecasting of seasonal data
using a seasonal index
Performed smoothing of data series
Moving averages
Addressed autoregressive models for forecasting
Chap 19-43

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Statistics for

Business and Economics

Test for randomness in a time series

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Single Item Price Index

Index Numbers: Example

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Index Numbers: Interpretation

Prices in 2000 were 100%

definition, since 2000 is the

Prices in 2003 were 120%

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Aggregate Price Indexes

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

K = total number of items

= sum of the prices for the group of items at time t

= sum of the prices for the group of items in time period 0

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Unweighted Aggregate Price

Unweighted total expenses were 18.8%

Laspeyres Price Index

q0i = quantity of item i purchased in period 0

Laspeyres Quantity Index

p0i = price of item i in period 0

2001 2002 2003 2004 2005

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Data taken over a long period of time

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Trend can be upward or downward

Noise in the time series

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Time-Series Component Analysis

Tt = Trend value at period t

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

It = Irregular (random) value for period t

Smoothing the Time Series

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

(2m+1)-Point Moving Average

Replace each xt with

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Example: Annual Data

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Calculating Moving Averages

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Each moving average is for a consecutive

Annual vs. Moving Average

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Centered Moving Averages

Let the time series have period s, where s is

To obtain a centered s-point moving average series

Form the centered s-point moving averages

Centered Moving Averages

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Calculating a Seasonal Index

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

Calculating Seasonal Indexes

Prof. Miruna Mazurencu Marinescu, Ph.D, MBA

1. Find the median

Interpreting Seasonal Indexes

Spring sales average 82.5% of the