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Forecasting Models
Learning Objectives
1. Explain the importance of forecasting in 2. 3. 4. 5.
6.
7.
organizations. Describe the three major approaches to forecasting. Use a variety of techniques to make forecasts. Measure the accuracy of a forecast over time using various methods. Determine when a forecast can be improved. Discuss the main considerations in selecting a forecasting technique. Utilize Excel to solve various forecasting problems.
Importance of Forecasting
Forecasting
is important because it helps reduce uncertainty. provides decision makers with an improved picture
of probable future events and, thereby, enable decision makers to plan accordingly. is used for planning the system itself. is used for planning the use of the system
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The Forecasting Process
1. Determine the purpose of the forecast. 2. Determine the time horizon. 3. Select an appropriate technique. 4. Identify the necessary data, and gather it if
necessary. 5. Make the forecast. 6. Monitor forecast errors in order to determine if the forecast is performing adequately. If it is not, take appropriate corrective action.
Categories of Forecast
Qualitative Forecasts
are based on judgment and/or opinion rather than
probable future experience (i.e., the past movements or patterns in the data will persist into the future).
Explanatory Models
incorporate one or more variables that are related
to the variable of interest and, therefore, they can be used to predict future values of that variable.
technique to be used:
the importance (purpose) of the forecast the desired accuracy of the forecast the cost of developing the forecast
forecasting process the planning horizon (long- or short-term) the sophistication of the users of the forecast A good rule is to choose the simplest technique that gives acceptable results.
Forecasting approaches
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Problem 1
Problem 2
Moving Average
Exponential Smoothing
This is an averaging technique that reduces these
difficulties In addition, the weights given to previous values are not equal; instead, they decrease with the age of the data The exponential smoothed forecast can be computed using this formula: Ft = Ft-1 + ( At-1 F t-1) Where Ft= the forecast for period t F t-1= the forecast for period t-1 = smoothing constant (it should be Greek alpha ) At-1= actual demand or sales for period t-1
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The smoothing constant, , represents a
percentage of the forecast error. Each new forecast is equal to the previous forecast plus a percentage of the previous error. For example, forecast is 100 units, actual demand is 90 units, and = .10. The new forecast computed would be as follows: Ft= 100 + .10(90-100)= 99 Suppose next actual demand turns out to be 102, then the next forecast would be Ft=99 + .10(102-99)= 99.3
movement in a time series. The trend may be linear or non linear. There are two important techniques that can be used to develop forecasts when trend is present. One involves use of a trend equation and other is an extension of exponential smoothing.
Trend equation
Yt= + bt
t= a specified number of time periods from t=0 Yt= the forecast for period t = value of yt at t=0 b= slope of line
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The model is a Simple Regression model. To define
the relationship between Y and t, we need to know the value of coefficients a and b, which are estimates of and . and represents population of parameters which are almost always unknown. is the y intercept (the expected value of the dependent variable when t is zero) is the slope and indicates the amount of change in Y per unit change in t. We need to find a straight line or trend which fits well with data The best fit can be defined as the line that minimizes the sum of the squared difference between the actual data points and their respective forecasted values. This technique that produces this line is called the linear trend equations or the regression line
Example
Yt= 45 + 5t
the line is 5, which means that the value of yt will increase by five units for each one unit increase in t. If t=10, the forecast, yt , is 45+5 (10)= 95 units. We can plot the same by finding two points on the line.
Value of
t, t and t
2
Equation
n yt t y n t t
2
y b t a
n
n= the number of periods Y= a value of the time series
Problem
Monthly demand for Dans Doughnuts over the
past nine months for trays (six dozen per tray) of sugar doughnuts was Mar 112 Apr 125 May 120 Jun 133 Jul 136 Aug 146 Sept 140 Oct 155
Solution
Solution
N=9
t=45
t2= 285
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Regression Assumptions
Normality For any given value of x, there is a distribution of possible y values that has a mean equal to the expected value (i.e., y = a + bx) and the distribution is normal. Homoscedasticity The conditional distributions for all values of x have the same dispersion. Linearity. The requirement of uniform scatter also means that there should not be any patterns around the line.
Independence. Values of y should not be correlated over time. If they are, it may be more appropriate to use a time series model.