Business &

Economic
Forecasting

Managerial Economics
 “Part of my advantage is that my strength is economic
forecasting, but that only works in free markets, when
markets are smarter than people. That’s how I started. I
watched the stock market, how equities reacted to change
in levels of economic activity, and I could understand how
price signals worked and how to forecast them.” –Stanley
Druckenmiller (an American investor, hedge fund
manager and philanthropist)

References: Managerial Economics by Luke M. Froeb, etal; c2014

Managerial Economics and Business Strategy by Michael Baye ; c2010
Study Guide and Case Book for Managerial Economics
What is Economic Forecasting? (Investopedia)

Economic forecasting is the process of attempting to predict the future condition of the economy using a

combination of important and widely followed indicators.

Economic forecasting involves the building of statistical models with inputs of several key variables, or

indicators, typically in an attempt to come up with a future gross domestic product (GDP) growth rate.

Primary economic indicators include inflation, interest rates, industrial production, consumer confidence, 

worker productivity, retail sales, and unemployment rates.

Business managers rely on economic forecasts, using them as a guide to plan future 

operating activities. Private sector companies may have in-house economists to focus on forecasts

most pertinent to their specific businesses (e.g., a shipping company that wants to know how much of

GDP growth is driven by trade.) Alternatively, they might rely on Reports or academic economists,

those attached to think tanks or boutique consultants. 

Although surveys are of considerable use, most major firms seem to base their forecasts in large

part on the quantitative analysis of economic time series.

The classical approach to business forecasting assumes that an economic time series can be

decomposed into four (4) components: trend, seasonal variation, cyclical variation, and irregular

movements.
If the trend in a time series is LINEAR, simple regression may be used to estimate an equation

representing the trend. If it seems to be NONLINEAR, a quadratic equation may be estimated by

multiple regression, or an exponential trend may be fitted.

The seasonal variation in a particular time series is described by a figure for each month (the

seasonal index) that shows the extent to which the month’s value typically departs from what

would be expected on the basis of trend and cyclical variation. Such seasonal indexes can be used

to deseasonalize a time series, that is, to remove seasonal element from the data.
A seasonal index is a measure of how a particular season through some

cycle compares with the average season of that cycle. By deseasonalizing

data, we're removing seasonal fluctuations, or patterns in the data, to

predict or approximate future data values.

Study the separate case illustrating this concept.

Be ready for a graded discussion/recitation on Friday, January 29, 2021.

Many businesses and economic time series go up and down with the fluctuations of the economy as a whole.

This cyclical variation, as well as trend and seasonal variation, is reflected in many time series. It is customary
to divide business fluctuations into four phases: TROUGH, EXPANSION, PEAK and RECESSION.
 
 

Variables that go down before the peak and up before the trough are called leading series. Some important

leading series are new orders for durable goods, average work week, building contracts, stock prices, certain

wholesale prices, and claims for unemployment insurance.

 
 Economists sometimes use leading series, which are often called leading indicators to forecast whether a

turning point is about to occur. If a large number of leading indicators turn downward, this is viewed as

a sign of a coming peak. If a large number turn upward, this is thought to signal an impending trough.

Although these indicators are not very reliable, they are watched closely and are used to supplement

other, more sophisticated forecasting techniques.

The simplest kind of forecasting method is a straightforward extrapolation of a trend. To allow

for seasonal variation, such an extrapolation can be multiplied by the seasonal index (divided

by 100) for the month to which the forecast applies. This entire procedure is simply a

mechanical extrapolation of the time series into the future.

In recent years, managerial economists have tended to base their forecasts less on simple

extrapolations and more on equations (or systems of equations) showing the effects of various

independent variables on the variable (or variable) one wants to forecast. These equations (or

systems of equations) are called ECONOMETRIC MODELS.

Thank
You!