Forecasting Tutorial

Question-1:

The demand for a product in each of the last five months is shown below. Month Demand ('00s) 1 13 2 17 3 19 4 23 5 24

i) Use a two-month moving average to generate a forecast for demand in month 6. ii) Apply exponential smoothing with a smoothing constant of 0.9 to generate a forecast for demand for demand in month 6. iii) Which of these two forecasts do you prefer and why?
To answer this question we need to calculate Mean Square Error (MSE) for both calculations, the method with lower MSD gives a better forecast

Mean Square Error/Deviation Where : MSE : Mean Square Error/Deviation Di : The actual value in time period i Fi: The forecast value in time period i

Two Months Moving Average Calculations

Month 1 2 3 4 5 Demand ('00s) 13 17 19 23 24 F (2 Months MA) D-F (D-F)^2

15 18 21 23.5 Sum MSE

4 5 3

16 25 9 50 16.66667

i) The forecast for month six is just the moving average for the month before that i.e. the moving average for month 5= m5 = 23.50.

Part ii) Applying exponential smoothing with a smoothing constant of 0.9, we get:

Forecast = Dt + (1- ) Ft
Exponential Smoothing F 13 16.6 18.76 22.58 23.86

Month 1 2 3 4 5

Demand ('00s) 13 17 19 23 24

D-F 4 2.4 4.24 1.424 Sum

(D-F)^2 16 5.76 17.98 2.03 41.77 10.44

Note Alpha=

0.9

MSE

ii) As before the forecast for month six is just the average for month 5= M5 = 23.86 Part iii) Which of these two forecasts do you prefer and why? To answer this question we calculate Mean Square Error (MSE) for both calculations, the method with lower MSE gives a better forecast Overall then we see that exponential smoothing appears to give the best one-month ahead forecasts as it has a lower MSE. Hence, we prefer the forecast of 23.86 that has been produced by exponential smoothing.

Question-2:

The table below shows the demand for a new aftershave in a shop for each of the last 7 months. Month Demand
i)

1 23

2 29

3 33

4 40

5 41

6 43

7 49

Calculate a two-month moving average for months two to seven. What would be your forecast for the demand in month eight? ii) Apply exponential smoothing with a smoothing constant of 0.1 to derive a forecast for the demand in month eight. iii) Which of the two forecasts for month eight do you prefer and why?
Month 1 2 3 4 5 6 7 Demand 23 29 33 40 41 43 49 2 months MA (F) D-F (D-F)^2

26 31 36.5 40.5 42 46

7 9 4.5 2.5 7

49 81 20.25 6.25 49

Sum MSE

205.5 41.1

The forecast for month eight is just the moving average for the month before that i.e. the moving average for month 7 = m7 = 46. Applying exponential smoothing with a smoothing constant of 0.1 we get: Month 1 2 3 4 5 6 7 Demand 23 29 33 40 41 43 49 Exponential Smoothing F 23 23.60 24.54 26.09 27.58 29.12 31.11 D-F 6 9.40 15.46 14.91 15.42 19.88 Sum MSE (D-F)^2 36 88.36 239.01 222.43 237.86 395.23 1218.884 203.1473

ALPHA=

0.1

Overall then we see that the two-month moving average appears to give the best one-month ahead forecasts as it has a lower MSE. Hence, we prefer the forecast of 46 that has been produced by the two-month moving average.

Question-3:
The table below shows the temperature (degrees C), at 11 p.m., over the last ten days: Day Temperature 1 1.5 2 2.3 3 3.7 4 3.0 5 1.4 6 -1.3 7 -2.4 8 -3.7 9 -0.5 10 1.3

i) Calculate a three-day moving average for each day. ii) What would be your forecast for the temperature at 11 p.m. on day 11? iii) Apply exponential smoothing with a smoothing constant of 0.8 to derive a forecast for the temperature at 11 p.m. on day 11. iv) Which of the two forecasts for the temperature at 11 p.m. on day 11 do you prefer and why?

Solution
Now we cannot calculate a 3-day moving average until we have at least 3 observations i.e. we can only calculate such an average from month 3 onward. Hence, we have: Day 1 2 3 4 5 6 7 8 9 10 Temperature 1.5 2.3 3.7 3 1.4 -1.3 -2.4 -3.7 -0.5 1.3 F (3 Days MA) D-F (D-F)^2

2.500 3.000 2.700 1.033 -0.767 -2.467 -2.200 -0.967

0.500 -1.600 -4.000 -3.433 -2.933 1.967 3.500 Sum MSE

0.250 2.560 16.000 11.788 8.604 3.868 12.250 55.32 7.903

Hence the forecast for the temperature at 11 p.m. on day 11 is just m10 = -0.97.
Day 1 2 3 4 5 6 7 8 9 10 Temperature 1.5 2.3 3.7 3 1.4 -1.3 -2.4 -3.7 -0.5 1.3 Exponential Smoothing F 1.500 2.140 3.388 3.078 1.736 -0.693 -2.059 -3.372 -1.074 0.825 D-F 0.800 1.560 -0.388 -1.678 -3.036 -1.707 -1.641 2.872 2.374 Sum ALPHA= 0.8 MSE 3.861 (D-F)^2 0.64 2.43 0.15 2.81 9.21 2.91 2.69 8.25 5.64 34.75

Hence the forecast for the temperature at 11 p.m. on day 11 is just M10 = 0.83.

To compare the two forecasts we calculate the mean squared error (MSE). If we do this we find that for the moving average MSE=7.90 and for the exponentially smoothed average with a smoothing constant of 0.8 MSD=3.86. Hence, overall prefer the exponentially smoothed forecast as that seems to give the best one-day ahead forecasts as it has a smaller MSE