Statistics for Business and Economics (13e)

Statistics for
Business and Economics (13e)
Anderson, Sweeney, Williams, Camm, Cochran
© 2017 Cengage Learning

Slides by John Loucks

St. Edwards University

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
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 Statistics for Business and Economics (13e)

Chapter 17, Part A

Time Series Analysis and Forecasting
• Forecasting Methods
• Time Series Patterns
• Forecast Accuracy
• Moving Averages and Exponential Smoothing

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 Statistics for Business and Economics (13e)

Forecasting Methods: Qualitative

• Forecasting methods can be classified as qualitative or quantitative.
• Qualitative methods generally involve the use of expert judgment to develop
forecasts.
• Such methods are appropriate when historical data on the variable being
forecast are either not applicable or unavailable.
• We will focus exclusively on quantitative forecasting methods in this chapter.

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 Statistics for Business and Economics (13e)

Forecasting Methods: Quantitative

• Quantitative forecasting methods can be used when:
• Past information about the variable being forecast is available,
• The information can be quantified, and
• It is reasonable to assume the pattern of the past will continue
• In such cases, a forecast can be developed using a time series method or a
causal method.

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 Statistics for Business and Economics (13e)

Forecasting Methods: Quantitative

• Quantitative methods are based on an analysis of historical data concerning
one or more time series.
• A time series is a set of observations measured at successive points in time or
over successive periods of time.
• If the historical data used are restricted to past values of the series that we are
trying to forecast, the procedure is called a time series method.
• If the historical data used involve other time series that are believed to be
related to the time series that we are trying to forecast, the procedure is
called a causal method.

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 Statistics for Business and Economics (13e)

Forecasting Methods: Quantitative

• Time Series Analysis
• The objective of time series analysis is to discover a pattern in the historical
data or time series and then extrapolate the pattern into the future.
• The forecast is based solely on past values of the variable and/or past forecast
errors.

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 Statistics for Business and Economics (13e)

Forecasting Methods: Quantitative

• Causal Methods
• Causal forecasting methods are based on the assumption that the variable we
are forecasting has a cause-effect relationship with one or more other
variables.
• Looking at regression analysis as a forecasting tool, we can view the time
series value that we want to forecast as the dependent variable.
• If we can identify a good set of related independent, or explanatory, variables
we may be able to develop an estimated regression equation for forecasting
the time series.

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 Statistics for Business and Economics (13e)

Forecasting Methods: Quantitative

• Regression Analysis
• By treating time as the independent variable and the time series as a
dependent variable, regression analysis can also be used as a time series
method.
• Time-series regression refers to the use of regression analysis when the sole
independent variable is time.
• Cross-sectional regression refers to the use of regression analysis when the
independent variable(s) is(are) something other than time.

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 Statistics for Business and Economics (13e)

Forecasting Methods
Forecasting
Methods

Quantitative Qualitative

Causal Time Series

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 Statistics for Business and Economics (13e)

Time Series Patterns

• A time series is a sequence of observations on a variable measured at
successive points in time or over successive periods of time.
• The pattern of the data is an important factor in understanding how the time
series has behaved in the past.
• If such behavior can be expected to continue in the future, we can use it to
guide us in selecting an appropriate forecasting method.

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 Statistics for Business and Economics (13e)

Time Series Plot

• A useful first step in selecting an appropriate forecasting method is to
construct a time series plot.
• A time series plot is a graphical presentation of the relationship between time
and the time series variable.
• Time is on the horizontal axis, and the time series values are shown on the
vertical axis.

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 Statistics for Business and Economics (13e)

Time Series Plot

• Example: Rosco Drugs
Sales of Comfort brand headache tonic (in bottles) for the past 10 weeks at
Rosco Drugs are shown below. Rosco Drugs would like to identify the
underlying pattern in the data to guide it in selecting an appropriate forecasting
method.
Week Sales Week Sales
1 110 6 120
2 115 7 130
3 125 8 115
4 120 9 110
5 125 10 130

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 Statistics for Business and Economics (13e)

Time Series Patterns

• The common types of data patterns that can be identified when examining a
time series plot include:
• Horizontal
• Trend
• Seasonal
• Trend and Seasonal
• Cyclical

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 Statistics for Business and Economics (13e)

Time Series Patterns

• Horizontal Pattern
• A horizontal pattern exists when the data fluctuate around a constant
mean.
• Changes in business conditions can often result in a time series that has a
horizontal pattern shifting to a new level.
• A change in the level of the time series makes it more difficult to choose an
appropriate forecasting method.

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 Statistics for Business and Economics (13e)

Time Series Patterns

• Trend Pattern
• A time series may show gradual shifts or movements to relatively higher or
lower values over a longer period of time.
• Trend is usually the result of long-term factors such as changes in the
population, demographics, technology, or consumer preferences.
• A systematic increase or decrease might be linear or nonlinear.
• A trend pattern can be identified by analyzing multiyear movements in
historical data.

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 Statistics for Business and Economics (13e)

Time Series Patterns

• Seasonal Pattern
• Seasonal patterns are recognized by seeing the same repeating pattern of
highs and lows over successive periods of time within a year.
• A seasonal pattern might occur within a day, week, month, quarter, year, or
some other interval no greater than a year.
• A seasonal pattern does not necessarily refer to the four seasons of the year
(spring, summer, fall, and winter).

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 Statistics for Business and Economics (13e)

Time Series Patterns

• Trend and Seasonal Pattern
• Some time series include a combination of a trend and seasonal pattern.
• In such cases we need to use a forecasting method that has the capability
to deal with both trend and seasonality.
• Time series decomposition can be used to separate or decompose a time
series into trend and seasonal components.

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 Statistics for Business and Economics (13e)

Time Series Patterns

• Cyclical Pattern
• A cyclical pattern exists if the time series plot shows an alternating
sequence of points below and above the trend line lasting more than one
year.
• Often, the cyclical component of a time series is due to multiyear business
cycles.
• Business cycles are extremely difficult, if not impossible, to forecast.
• In this chapter we do not deal with cyclical effects that may be present in
the time series.

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 Statistics for Business and Economics (13e)

Selecting a Forecasting Method

• The underlying pattern in the time series is an important factor in selecting a
forecasting method.
• Thus, a time series plot should be one of the first things developed when
trying to determine what forecasting method to use.
• If we see a horizontal pattern, then we need to select a method appropriate
for this type of pattern.
• If we observe a trend in the data, then we need to use a method that has the
capability to handle trend effectively.

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 Statistics for Business and Economics (13e)

Forecast Accuracy
• Measures of forecast accuracy are used to determine how well a particular
forecasting method is able to reproduce the time series data that are already
available.
• Measures of forecast accuracy are important factors in comparing different
forecasting methods.
• By selecting the method that has the best accuracy for the data already
known, we hope to increase the likelihood that we will obtain better forecasts
for future time periods.

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 Statistics for Business and Economics (13e)

Forecast Accuracy
• The key concept associated with measuring forecast accuracy is forecast error.
Forecast Error = Actual Value - Forecast

• A positive forecast error indicates the forecasting method underestimated the

actual value.
• A negative forecast error indicates the forecasting method overestimated the
actual value.

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 Statistics for Business and Economics (13e)

Forecast Accuracy
• Mean Error (ME)
A simple measure of forecast accuracy is the mean or average of the forecast
errors. Because positive and negative forecast errors tend to offset one
another, the mean error is likely to be small. Thus, the mean error is not a very
useful measure.
• Mean Absolute Error (MAE)
This measure avoids the problem of positive and negative errors offsetting
one another. It is the mean of the absolute values of the forecast errors.

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
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 Statistics for Business and Economics (13e)

Forecast Accuracy
• Mean Squared Error (MSE)
This is another measure that avoids the problem of positive and negative
errors offsetting one another. It is the average of the squared forecast errors.
• Mean Absolute Percentage Error (MAPE)
The size of MAE and MSE depend upon the scale of the data, so it is difficult
to make comparisons for different time intervals. To make such comparisons
we need to work with relative or percentage error measures. The MAPE is the
average of the absolute percentage errors of the forecasts.

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 Statistics for Business and Economics (13e)

Forecast Accuracy
• To demonstrate the computation of these measures of forecast accuracy we
will introduce the simplest of forecasting methods.
• The naive forecasting method uses the most recent observation in the time
series as the forecast for the next time period.
Ft+1 = Actual Value in Period t

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 Statistics for Business and Economics (13e)

Forecast Accuracy
• Example: Rosco Drugs
Sales of Comfort brand headache tonic (in bottles) for the past 10 weeks at
Rosco Drugs are shown below. If Rosco uses the naïve forecast method to
forecast sales for weeks 2 – 10, what are the resulting MAE, MSE, and MAPE
values?
Week Sales Week Sales
1 110 6 120
2 115 7 130
3 125 8 115
4 120 9 110
5 125 10 130

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 Statistics for Business and Economics (13e)

Forecast Accuracy
Naïve Forecast Absolute Squared Abs.%
Week Sales Forecast Error Error Error Error
1 110
2 115 110 5 5 25 4.35
3 125 115 10 10 100 8.00
4 120 125 -5 5 25 4.17
5 125 120 5 5 25 4.00
6 120 25 4.17
125 -5 5
7 130 100 7.69
120 10 10
8 115 125 13.04
130 -15 15
9 110 25 4.55
115 -5 5
10 130 400 15.38
110 20 20
Total 80 850 65.35

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 Statistics for Business and Economics (13e)

Forecast Accuracy
• Naive Forecast Accuracy
80
MAE= =8.89
9
8 50
MSE= =94.44
9
65.35
MAPE = =7.26 %
9

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 Statistics for Business and Economics (13e)

Moving Averages and Exponential Smoothing

• Now we discuss three forecasting methods that are appropriate for a time
series with a horizontal pattern:
• Moving Averages
• Weighted Moving Averages
• Exponential Smoothing
• They are called smoothing methods because their objective is to smooth out
the random fluctuations in the time series.
• They are most appropriate for short-range forecasts.

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 Statistics for Business and Economics (13e)

Moving Averages
• The moving averages method uses the average of the most recent k data values
in the time series as the forecast for the next period.

𝐹 𝑡 +1 =
∑ ( most recent 𝑘 data values) 𝑌 𝑡 +𝑌 𝑡 −1 + …+𝑌 𝑡 − 𝑘+1
=
𝑘 𝑘
where:
where: FFt+1
t+1=
= forecast
forecast of
of the
the time
time series
series for
for period
period tt ++ 11
= Actual value of the time series in period t.

• Each observation in the moving average calculation receives the same weight.

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 Statistics for Business and Economics (13e)

Moving Averages
• The term moving is used because every time a new observation becomes
available for the time series, it replaces the oldest observation in the equation.
• As a result, the average will change, or move, as new observations become
available.

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 Statistics for Business and Economics (13e)

Moving Averages
• To use moving averages to forecast, we must first select the order k, or
number of time series values, to be included in the moving average.
• A smaller value of k will track shifts in a time series more quickly than a
larger value of k.
• If more past observations are considered relevant, then a larger value of k
is better.

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 Statistics for Business and Economics (13e)

Moving Averages
• Example: Rosco Drugs
If Rosco Drugs uses a 3-period moving average to forecast sales, what are
the forecasts for weeks 4-11?
Week Sales Week Sales
1 110 6 120
2 115 7 130
3 125 8 115
4 120 9 110
5 125 10 130

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 Statistics for Business and Economics (13e)

Moving Averages
Week Sales 3MA Forecast
1 110
2 115
3 125
4 120 116.7
5 125 120.0
6 120 123.3
7 130 121.7
8 115 125.0
9 110 121.7
10 130 118.3
11 118.3

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 Statistics for Business and Economics (13e)

Moving Averages
3MA Forecast Absolute Squared Abs.%
Week Sales Forecast Error Error Error Error
1 110
2 115
3 125
4 120 116.7 3.3 3.3 10.89 2.75
5 125 120.0 5.0 5.0 25.00 4.00
6 120 123.3 -3.3 3.3 10.89 2.75
7 130 121.7 8.3 8.3 68.89 6.38
8 115 125.0 -10.0 10.0 100.00 8.70
9 110 121.7 -11.7 11.7 136.89 10.64
10 130 118.3 11.7 11.7 136.89 9.00
Total 3.33 53.3 489.45 44.22

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 Statistics for Business and Economics (13e)

Moving Averages
• 3-MA Forecast Accuracy
53.3
MAE= =7.61
7
489.45
MSE= =69.92
7
44.22
MAPE = =6.32 %
7
The 3-week moving average approach provided
more accurate forecasts than the naive approach.

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 Statistics for Business and Economics (13e)

Weighted Moving Averages

• Weighted Moving Averages
• To use this method we must first select the number of data values to be
included in the average.
• Next, we must choose the weight for each of the data values.
• The more recent observations are typically given more weight than
older observations.
• For convenience, the weights should sum to 1.

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 Statistics for Business and Economics (13e)

Weighted Moving Averages

• Weighted Moving Averages
• An example of a 3-period weighted moving average (3WMA) is:
3WMA = .2(110) + .3(115) + .5(125) = 119
• In this example the weights are .2, .3, and .5 (which sum to 1).
• 125 is the most recent of the three observations.

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 Statistics for Business and Economics (13e)

Exponential Smoothing
• This method is a special case of a weighted moving averages method; we
select only the weight for the most recent observation.
• The weights for the other data values are computed automatically and
become smaller as the observations grow older.
• The exponential smoothing forecast is a weighted average of all the
observations in the time series.
• The term exponential smoothing comes from the exponential nature of the
weighting scheme for the historical values.

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 Statistics for Business and Economics (13e)

Exponential Smoothing
• Exponential Smoothing Forecast
Ft+1 = aYt + (1 – a)Ft
where:
Ft+1 = forecast of the time series for period t + 1
Yt = actual value of the time series in period t
Ft = forecast of the time series for period t
a = smoothing constant (0 < a < 1)
and let:
F2 = Y1 (to initiate the computations)

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 Statistics for Business and Economics (13e)

Exponential Smoothing
• Exponential Smoothing Forecast
• With algebraic manipulation, we can rewrite Ft+1 = aYt + (1 – a)Ft as:
Ft+1 = Ft + a (Yt – Ft)

• We see that the new forecast Ft+1 is equal to the previous forecast Ft plus
an adjustment, which is a times the most recent forecast error, Yt – Ft.

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 Statistics for Business and Economics (13e)

Exponential Smoothing
• Example: Rosco Drugs
If Rosco Drugs uses exponential smoothing to forecast sales, which value
for the smoothing constant , .1 or .8, gives better forecasts?
Week Sales Week Sales
1 110 6 120
2 115 7 130
3 125 8 115
4 120 9 110
5 125 10 130

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 Statistics for Business and Economics (13e)

Exponential Smoothing
• Using Smoothing Constant Value  = .1
F2 = Y1 = 110
F3 = .1Y2 + .9F2 = .1(115) + .9(110) = 110.50
F4 = .1Y3 + .9F3 = .1(125) + .9(110.5) = 111.95
F5 = .1Y4 + .9F4 = .1(120) + .9(111.95) = 112.76
F6 = .1Y5 + .9F5 = .1(125) + .9(112.76) = 113.98
F7 = .1Y6 + .9F6 = .1(120) + .9(113.98) = 114.58
F8 = .1Y7 + .9F7 = .1(130) + .9(114.58) = 116.12
F9 = .1Y8 + .9F8 = .1(115) + .9(116.12) = 116.01
F10= .1Y9 + .9F9 = .1(110) + .9(116.01) = 115.41

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 Statistics for Business and Economics (13e)

Exponential Smoothing
• Using Smoothing Constant Value  = .8
F2 = = 110
F3 = .8(115) + .2(110) = 114.00
F4 = .8(125) + .2(114) = 122.80
F5 = .8(120) + .2(122.80) = 120.56
F6 = .8(125) + .2(120.56) = 124.11
F7 = .8(120) + .2(124.11) = 120.82
F8 = .8(130) + .2(120.82) = 128.16
F9 = .8(115) + .2(128.16) = 117.63
F10= .8(110) + .2(117.63) = 111.53

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 Statistics for Business and Economics (13e)

Exponential Smoothing (a = .1)

a = .1 Forecast Absolute Squared Abs.%
Week Sales Forecast Error Error Error Error
1 110
2 115 110.00 5.00 5.00 25.00 4.35
3 125 110.50 14.50 14.50 210.25 11.60
4 120 111.95 8.05 8.05 64.80 6.71
5 125 112.76 12.24 12.24 149.94 9.79
6 120 113.98 6.02 6.02 36.25 5.02
7 130 114.58 15.42 15.42 237.73 11.86
8 115 116.12 -1.12 1.12 1.26 0.97
9 110 116.01 -6.01 6.01 36.12 5.46
10 130 115.41 14.59 14.59 212.87 11.22
Total 82.95 974.22 66.98

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website or school-approved learning management system for classroom use.
44
 Statistics for Business and Economics (13e)

Exponential Smoothing (a = .1)

• Forecast Accuracy
82.95
MAE= =9.22
9
974.22
MSE= =108.25
9
66.98
MAPE= =7.44 %
9
Exponential smoothing (with a = .1) provided
less accurate forecasts than the 3-MA approach.

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website or school-approved learning management system for classroom use.
45
 Statistics for Business and Economics (13e)

Exponential Smoothing (a = .8)

a = .8 Forecast Absolute Squared Abs.%
Week Sales Forecast Error Error Error Error
1 110
2 115 110.00 5.00 5.00 25.00 4.35
3 125 114.00 11.00 11.00 121.00 8.80
4 120 122.80 -2.20 2.20 7.84 1.83
5 125 120.56 4.44 4.44 19.71 3.55
6 120 124.11 -4.11 4.11 16.91 3.43
7 130 120.82 9.18 9.18 84.23 7.06
8 115 128.16 -13.16 13.16 173.30 11.44
9 110 117.63 -7.63 7.63 58.26 6.94
10 130 111.53 18.47 18.47 341.27 14.21
Total 75.19 847.52 61.61

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website or school-approved learning management system for classroom use.
46
 Statistics for Business and Economics (13e)

Exponential Smoothing (a = .8)

• Forecast Accuracy
75.19
MAE= =8.35
9
847.52
MSE= =94.17
9
61.61
MAPE= =6.85 %
9
Exponential smoothing (with a = .8) provided
more accurate forecasts than ES with a = .1, but
less accurate than the moving average (with k = 3).

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website or school-approved learning management system for classroom use.
47
 Statistics for Business and Economics (13e)

End of Chapter 17, Part A

© 2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website or school-approved learning management system for classroom use.
48