Department of Business Economics

BEC 3340: Managerial Economics

2022
Tutorial 06: Demand Forecasting (Part I)

Kamshagini Nallainathan
CPM – 19601
MC-94269

01. How important is demand forecasting in the decision-making process of a firm?

Explain with two real-world examples.

A company's decisions can be divided into two categories: (1) operational decisions
and (2) growth decisions. While growth decisions concentrate on the long-term
strategic journey of the firm, operational decisions examine the immediate, day-to-
day operations of a company.

If we look at the operational choices, they consist of:

(a) Production choices: If future sales are predicted to increase, management must take
the necessary actions to raise the company's production levels. Additionally, which
product in the line needs more care and concentration during production requires
consideration. Conversely, a future with decreasing demand will show that lessening
production is necessary.

(b) Marketing decisions – depending on the sales forecast and the type of product the firm is
producing, decisions on prices to be charged have to be made. If the demand is declining,
perhaps a price reduction would entice the customer to buy more. Also, the level of
promotion needed has to be decided. A forecast of rising demand may indicate that spending
a lot on advertising is not needed as people will anyway buy one’s product without
advertising.

(c) Finance decisions – the cost of capital and the equity structure of the firm may have to be
evaluated to facilitate larger production capacities if the demand is expected to rise.

(d) Personnel needs – with an anticipated rise in demand, the firm will have to plan on how to
allocate work among employees, the salary structure, whether they are to work overtime or
not, and when and how many to hire newly to the firm. If sales are to drop drastically on the
other hand, perhaps some nonessential personnel would have to be let go.

When making decisions about growth, factors to consider include:

(a) The need for expansion, or the need to increase capacity in the face of rising demand over the
long term.

(b) There is a long-term need for contraction, which means reducing the capacity of demand.
02. How do firms use the long-term macro-forecasts of the economy to forecast its long-
term growth?

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 Provide one unique example from a particular industry. The long-term macro-forecasts
consider the overall level of economic growth. Although other statistical projections are
also used, the nation's gross domestic product (GDP) growth is frequently used as a proxy
for this. These statistical projections can be found in a variety of places, including (in Sri
Lanka) The Central Bank, the Department of Census and Statistics (DCS), the Ceylon
Chamber of Commerce, Ministry of Finance, lone research organizations, and even
employed economists within a business These macro-forecasts typically give an indication
of the state of the economy, which will have an effect on how demand and sales for the
various firms will perform in the future. Of course, this is dependent on the type of product
that is produced or offered.

For instance, many businesses in the hospitality sector realized that their capacity
would not be fully utilized in the long run and that alternative uses for that capacity
needed to be found during the recession brought on by the COVID-19 outbreak. On
the other hand, because of anticipated growth in demand, manufacturers of personal
protective equipment (PPE) had to expand their capacity and enable mass production
of these products. Therefore, despite the recession being predicted by the
macroforecast, each of these businesses faced challenges specific to their sector.
03. “Different kinds of forecasts are used to reduce the risk and uncertainty in
operations of a firm”. Explain the validity of the above statement.
A company must forecast different operational activity levels and the resources
needed for each in order to plan its short-term operations. The quantity of raw
materials, equipment, storage space, employees, supervisors, etc. that will be used is
included in production forecasts. Forecasts for marketing will evaluate the size of the
sales force, the distribution networks, the promotional efforts, and the associated
costs. Estimating cashflows, profitability levels, and external financing will be aided
by financial forecasts. required as well as the price of external financing sources like
share and debt instrument issuance. The planned level of human resources, the supply
and demand for human resources, and the types of Need for workers/employees
04. Describe the objectives of demand forecasting using a real-world example.

Business decisions are made in the face of risk and uncertainty, as we have established.
Thus, the main goal of demand forecasting is to lower the level of risk and uncertainty
that the company must deal with when making decisions related to: (1) short-term
operational decisions and (2) long-term growth.

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 05. Distinguish between qualitative techniques and quantitative techniques of
forecasting and mention qualitative and quantitative techniques used for demand
forecasting.
Surveys and polls on client preferences and opinions are the most used qualitative techniques.
Managers can utilize the qualitative data collected to get insight into the changing trends in
client tastes and preferences. Customers' future business expectations as a result of economic
development might also be investigated.
Qualitative analysis also gives insight into the future of a freshly released product on the
market. Because there is no historical data for this product, a quantitative analysis is not
feasible, hence qualitative projections are the best alternative.

Quantitative data, on the other hand, use a variety of statistical approaches and econometric
tools to forecast quantitative features of a product, such as sales volume in rupees or units,
based on previous/historical data. They may provide a more accurate forecast for items in a
generally stable economy with a consistent demand pattern in the past.

06. Define the time series analysis and explain occasions that time series forecasting
can be used for demand forecasting.
Time-series analysis is also known as time series data analysis. Time-series data are the
values of a variable (for example, sales) ordered in chronological order (that is, in the order of
the passage of time) by days, weeks, months, quarters, or years.
The first stage in time-series analysis is to plot the historical data on the explanatory variable
(i.e., the variable needed to forecast, such as sales) on the vertical (Y) axis and time on the
horizontal (X) axis. This allows for a visual examination of the data's overall movement over
time.
Time-series analysis predicts future values of a time series (i.e., the explained variable) based
solely on previous data. The assumption here is that the time series would maintain prior data
trends and that this will be reflected in the future as well. However, this is a wide assumption,
ad so me-series analysis is a crude forecasting approach.

07. Identify the reasons for the fluctuations in time series data.

1. Secular Trend
This is the data series' long-run rise or decline. Some time series may exhibit an increasing or
rising tendency, such as the demand for smartphones increasing as the population grows. Other
time series, on the other hand, may exhibit a diminishing tendency over time, with the classic
example being how demand for typewriters plummeted with the new millennium and the broad
popularity and accessibility of the personal computer.

2. Cyclical Fluctuations
These are the main expansions and contractions in time series that occur every few years on
average. Such cycles may occur for no apparent cause. They may be triggered by changes in
GDP, inflation, currency rates, interest rates, or a combination of these factors. For example, the
housing market goes through a 15-year cycle.
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Figure 1 depicts the two aforementioned fluctuations, which are long-term cycles that often last
more than a year.

Figure 1

3. Seasonal Variation
This refers to the yearly oscillations in economic activity caused by: (1) meteorological
patterns, such as how the Yala and Maha monsoons effect agricultural produce output,
and (2) societal conventions, such as religious and cultural holidays.

4. Irregular or random influences

These are the fluctuations in the data series caused by unexpected events such as wars, natural
catastrophes, strikes, and so on. The SARS-CoV-2 virus epidemic in late 2019 was such an
unexpected event that it created significant irregular shocks in the global economy.

These two last swings are of a more short-term character, often assessed in terms of months,
quarters, and so on, as indicated in Figure 2.

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 Figure 2

Of fact, true data variation is a synthesis of all four categories discussed above. It is also worth
noting that cyclical and irregular patterns are, by definition, unexpected. That is, they are not
known until they happen. Attempting to anticipate them via time-series analysis is thus futile.
As a result of this constraint, we forecast using solely secular and seasonal fluctuations in time-
series analysis.
8. Briefly explains the trend projection of time series analysis.
This is the most basic type of time-series analysis, in which previous data patterns are fitted
into a straight line to the data. The trend line, data line, or regression line are all names for this
line. It can be created graphically to best match the data, or more objectively using regression
analysis.
Trend projection has two techniques of analysis:
(a) Constant Absolute Amount of Growth Model (CAAGM); and
(b) Constant Percentage Growth Model (CPGM).
Under CAAGM the linear regression formula is written as:

𝑆𝑡 = 𝑆0 + 𝑏𝑡
Where;

St = value of the series to be forecasted for period t

S0 = estimated value of the time series in the base period (i.e.: at t = 0). This is the intercept of
the line.
b = absolute amount of growth per period
t = time period in which the series is to be forecast

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