Quantitative Forecasting Techniques

Causal Forecasting Models

 Causal Methods
Linear Regression
 Causal methods are used when historical data are
available and the relationship between the factor to be
forecasted and other external or internal factors can be
identified.
 Linear regression: A causal method in which one variable
(the dependent variable) is related to one or more
independent variables by a linear equation.
 Dependent variable: The variable that one wants to
forecast.
 Independent variables: Variables that are assumed to
affect the dependent variable and thereby “cause” the
results observed in the past.
Y = a + b1X1 + b2X2 Causal Methods
+…..
Linear Regression
Deviation,
Y Regression
Estimate of or error
Y from
equation:
Dependent variable

regression Y = a + bX
equation
{ Actual
Y = dependent variable
X = independent variable
a = Y-intercept of the line
value b = slope of the line
of Y

Value of X used
to estimate Y

X
Independent variable
• Linear Regression Analysis

x= independent variable Y = values of y that lie on the

y= dependent variable
n= number of observations
a= vertical axis intercept
b= slope of regression line
y = mean value of dep. Variable
trend line
X = values of x that lie on the
trend line
r= coefficient of correlation
r2 = coefficient of determination

a= (∑x2 ∑y - ∑ x ∑ xy) / (n ∑ x2 – (∑x)2)

b= ( n ∑xy - ∑ x ∑ y) / (n ∑ x2 – (∑x)2 )

r= (n∑xy - ∑ x ∑ y) / √[n ∑ x2 – (∑x)2 ][n∑y2 – (∑y)2 ]

 Linear Regression
Example
The following are sales and advertising data for the past 5 months for
brass door hinges. The marketing manager says that next month the
company will spend $1,750 on advertising for the product. Use linear
regression to develop an equation and a forecast for this product.

We use the computer to determine

Sales Advertising the best values of a, b, the correlation
Month (000 units) (000 $) coefficient (r), the coefficient of
1 264 2.5 determination (r2), and the standard
2 116 1.3 error of the estimate (syx).
3 165 1.4 a = – 8.135
4 101 1.0
5 209 2.0 b = 109.229X
r = 0.98
r2 = 0.96
syx= 15.603
 Linear Regression Line for
Example 13.1
300 —
Y = a + bX
Sales (thousands of units)

250 —
Y = – 8.135 + 109.229X
200 —
a = – 8.135
150 — b = 109.229X
r = 0.98
100 — r2 = 0.96
syx= 15.603
50 —
| | | |
1.0 1.5 2.0 2.5
Advertising (thousands of dollars)

Forecast for Month 6: X = $1750, Y = – 8.135 + 109.229(1.75) = 183,016

• Linear Regression Analysis
Problem:
The Renovators construction company repairs/reconstructs old roads in
Sacramento, U.S. Over time they have found that company’s dollar volume of
reconstruction work (Sales) is dependant on the total amount of road construction
contracts offered by City Council every quarter . Management wants to establish
a mathematical relationship to help predict sales.!!!!!!!!!!!!!!!!!!!!!!!!

Year Quarter Sales Contracts

(Thousand $) (Thousand $)
1 Q1 8 150
Q2 10 170
Q3 15 190
Q4 9 170
2 Q1 12 180
Q2 13 190
Q3 12 200
Q4 16 220
Causal Forecasting Models
• We will use excel to understand following concepts and
to solve Questions (CM-1 to CM-6).
• Dependent – Independent Variables
• Plotting a Scatter gram
• Adding Trend Line
• Adding R2
• Interpreting the model (Slope and y-intercept).
• Making Forecast
Switch to Excel
(Questions CM1-CM6)