ECON

ECONOMIC
FORECASTING
Chapter 11
 INTRODUCTION

Economic forecasting is the process of attempting to

predict the future condition of the economy using a
combination of widely followed indicators. Government
officials and business managers use economic forecasts
to determine fiscal and monetary policies and plan future
operating activities, respectively.
INTRODUCTION
Prophecy - a prediction specially one made by a prophet or under
divine inspiration.
Prediction - concerned with a estimating outcomes from unseen
data.
Forecasting - sub discipline of prediction in which we make
predictions about future on the basis of the time series data .
EXTRAPOLIATION IS
THE NAME OF THE
GAME
EXTRAPOLATION

involves making statistical forecasts by using historical

trends that are projected for a specified period of time into
the future.

EXTRAPOLATE
extend the application of (a method or conclusion,
especially one based on statistics) to an unknown situation
by assuming that existing trends will continue or similar
methods will be applicable.
Cont.

Economic forecaster must be an expert on the past and present events

to formulate certain reasonable stable relationships among
socioeconomic forces of interest to him. Assuming that such
relationship continue to prevail in the future he is able to extrapolate
into the future and devices of his knowledge about past and the present
trends. In other words he assumes that no drastic change will be
introduced into a relationship he is studying. Now, therefore,he can
expect others to have faith in the usefulness of his forecasting formula
or model.
Cont.
He must prove that he can predict an event in the past not by
consulting history but by forecasting backwards simply using his
forecasting tool to "pre-tell" past event.

for example
The Parallel case in physical science like astronomy. Using the mathematically
exact relationships among the physical bodies in the universe, an astronomer
can predict the occurrence of an eclipse of the sun sometime in the distant
future, say, at 12:05 p.m. on March 11, 2756 A.D. but it with equal is he could
employ the same formulas to work backwards: to predict that in 516 bc there
was a partial eclipse of the moon at 1:01 a.m. without having to read any
history books. His scientific tools should enable him to go either forward or
backwards.
Cont.

-Although an economic forecaster has to cope with more interference

from free agents he also should be able to go forward or backwards.
People will have confidence in his statement about the future if he
proves that he can come closer to saying what exactly happened in the
past without consulting history.

-Forecasting is possible if, despite the so called age of discontinuity,

there are lines of continuity from the past and the present into the
future. The task, therefore, of every forecaster is to do a thorough job of
learning all about the past and present.
An economic forecaster is simply applying
religiously that tagalog proverbs
"Ang hindi marunong lumingon
sa pinanggalingan ay hindi
makakarating sa paroroonan"
... Or the paraphrase of George
Santayana "
"Those who do not learn from the past
are doomed to repeat its
mistake"
THE AGE OF
DISCONTINUITY
The closing decades of the twentieth century have
been characterized as a period of disruption and
discontinuity in which the structure and meaning of
economy, polity, and society have been radically
altered
THE AGE OF
DISCONTINUITY
Cont.

What we have said about relying on the part is already

second nature to the most practical men of business.
Those who have attained business success though the
school of hard knocks appreciate fully the value of
experience- which is another name for the past.
THE AGE OF
DISCONTINUITY
Cont.
What we have said about relying on the part is already second nature
to the most practical men of business. Those who have attained
business success though the school of hard knocks appreciate fully the
value of experience- which is another name for the past.

Intuitive manager
-he depends on the laws that he has culled from his rich background of business
success and failure.
THE AGE OF
DISCONTINUITY
Cont.

-One has to be very discriminating in rejecting past experiences. It was

never the intention of ducker to suggest that the past was no longer
important as a guide to the future. But “nature never takes jump.”
Precisely because there are many continuities from the past and present
into the future, one has to be particularly on guard not to miss the few
major continuities.
THE AGE OF
DISCONTINUITY
Cont.

There are a few “modern” executives who are so mesmerized by such

expression as “future shock” they no longer give much value to the
past as a guide to the future.
The future is “shockingly” different from the past and present that
expropriation is no longer legitimate tool of forecasting. “ future
shockers”
 THE ECONOMIC
DISCONTINUITIES
2 MAJOR DISCONTINUITIES
1. The end of the cold war-
a. is very significant to the world economy at large. Communism has collapsed. Gone are days of
isolation for the communists States.
b. The USSSR (union of soviet socialist republic) has disintegrated into small, independent states-
which open themselves up to capitalist ways.
2. Moves to liberalize the economy to make the Philippines the next NIC .
a. The foreign exchange market was completely deregulated and left to the interplay of market
forces.
b. There are no lessons from the past that can be used by forecasters and planners.
 THE ECONOMIC
DISCONTINUITIES
Cont.

As long as the forecaster and the executive using economic

forecasting data are aware to those economic
discontinuities mentioned above, they are safe to make use
of all information.
The economic forecaster can continue to relate the same
economic variables with one another to come out with a
reasonable accurate set of forecast.
 FATHOMING THE
FUTURE

The executive who wants to make optimum use of the services

of economic forecasters must always keep in mind Peter
Drucker ’s dictum about planning. Contrary to common belief,
planning is not mainly concerned with deciding what to do in
the future.
Determining future decisions is often a waste of time because
we cannot predict the future accurately.
 FATHOMING THE
FUTURE
·F IRST, ONE CAN BE
REASONABLY CERTAIN
ABOUT THE HAPPENING
OF
SOME EVENTS IN THE
FUTURE.
When someone is certain about
the events in the future, he
commits
resources to such events. The
rational response to certainly
is,
3 possible states of knowledge
one can have about the future:
·S ECOND, ONE MAY BE ·T HIRD, PURE AND
UNCERTAIN ABOUT SIMPLE
SOME IGNORANCE.
POSSIBLE EVENTS IN
THE
FUTURE. The executive must be
humble enough to accept the
In the face of uncertainties, the
fact that he must remain
effective executive should
ignorant about some
provide
unknown forces in the
for contingency plans. future.
The more uncertainties there
are, the more contingency
THE PRAGMATIC MIX
 THE PRAGMATIC MIX
Cont.
The executive ’s evaluation about credibility of a forecast is found in the
executive's judgment concerning the forecaster ’s background, ability
and skills.
Government forecasters are Marketing-oriented where they only
presenting the bright side in giving out information.
it is a part of managerial expertise for an executive to pinpoint the list
by a source of economic forecasts. There are no formula establishing
credibility.
 THE PRAGMATIC MIX
Cont.
In November 1992, a UA&P economist forecasted that for the summer of
1993, about the brownouts in the Luzon grid in general and the Meralco
franchise area in particular would last for about eight hours a day. National
Power Corporation(NPC) raised their eyebrows as a response. NPC always
reassured the public that the brown outs would be the severe than that
forecasted by UA&P. As early as March 1993, what ultimate do they happen
is very well known, The brown outs had been extending to 12 hours and
NPC how to categorically state that for the summer of 1993, brown outs
with last anywhere between 7 and 10 hours a day.
 THE PRAGMATIC MIX
Cont.

Economic forecasts generally referred to such macroeconomic information as grass

national product (GNP), rate of growth of GNP, rate of inflation, unemployment rate,
increase in consumer spending, increase in business investment, size of
government deficit, etc. This data will have to be correlated by company analysts
The such internal information of sales, cost of production, profit rates, etc.
Economic forecasts generally referred to such macroeconomic information as grass
national product (GNP), rate of growth of GNP, rate of inflation, unemployment rate,
and increase in consumer spending, increase in business investment, size of
government deficit, etc. This data will have to be correlated by company analysts,
such internal information of sales, cost of production, profit rates, etc.
 THE PRAGMATIC MIX
Cont.

Company officials do not have accept us inevitable whatever pessimistic

trends they can establish from reliable forecast data. Because they believe
in a set of bleak forecasts, company officials may decide to introduce drastic
changes into the set of relationships being assumed to be stable by the
forecasting model. Let us illustrate this by an example.·
 THE PRAGMATIC MIX
Cont.
·Many years ago in 1975, this writer briefed a group of marketing executives of both
soft drink company on the economic prospects for 1976. The forecasts were grim
seen his recovery of the industrialized nations on which the recovery of the
Philippine markets was being deliberately slowed down because of the widespread
fear of inflation. The forecast for consumer spending was such that the company
could not look forward to an annual sales volume increase of more than 3%. Such
piece of news was quite depressing to the executives who were used to 10-12% sales
volume increase annually. They were bluntly told by the author that they could still
prove the forecast wrong, if they were to innovate in their marketing practices and
introduced drastic changes in some of the relationships assume to be constant by
the extrapolations. More specifically, they were encouraged to use pricing as the key
marketing variable, instead of promotion.
 THE PRAGMATIC MIX
Cont.
Consumers of soft drinks were pleasantly surprised to see a price for among the
soft drink companies in 1976. The company referred to above was able to
register a sales volume growth much higher than 3%. They economic forecast of
the author were proved wrong. The moral is clear: If you do not like forecast then
do all you can in order to prove it wrong. This point enforces the statement made
earlier: a forecast is not a prediction. However if the forecast is bright, the
executives concerned should definitely not go out of their way the disapprove
them.
RATE OF STATISTICS
It is clear that an intelligent use of economic forecasts requires a great deal of
judgment on the part of the executive.
The scientific point of economic forecasting. The role of the most important
scientific to you to lies by economic forecasters which is statistics. Forecasting is
possible only if we accept the assumption that patterns of behavior in the future
can be expected to resemble those of the past and the present.
A forecaster must find some way of describing past and present patterns of
behavior. Here in lies the role played by statistics. Statistics in a bus that analyst to
quantify past and present patterns of behavior. The forces being observed can be
described quantitatively projecting into the future.
FORECASTING TECHNIQUES

Techniques of forecasting can be grouped into two

major categories:
1. Extrapolation
2. Regression
FORECASTING TECHNIQUES

1. Extrapolation
-Extrapolation assumes that the past patterns will
be maintained in the future. Time series analysis
or trend analysis are more sophisticated names
for extrapolation assumes that all forces affecting
a certain variable change uniformly through time.
FORECASTING TECHNIQUES

1. Extrapolation Cont.
for example
Population. Demographers use a constant rate of growth of
population for projections within at least a decade. The
factors affecting population growth like deaths, births,
marriages, and immigrations going to change to drastically
over relatively short periods of time.
FORECASTING TECHNIQUES
FORECASTING TECHNIQUES
FORECASTING TECHNIQUES
FORECASTING TECHNIQUES
FORECASTING TECHNIQUES
FORECASTING TECHNIQUES
FORECASTING TECHNIQUES
FORECASTING TECHNIQUES
Cont.
FORECASTING TECHNIQUES
-Another type of economic time series that is used in
forecasting is that that of the family of business indicators.

-Pioneering work in this field was done by some American

economists during the 1940s and 1950s. As a result of their
work, certain time series were designated “leading” indicators,
that is, they give a forewarning of upturns or downturns. Among
the leading series in the US are:
FORECASTING TECHNIQUES
Cont.

-Average work week off production workers, manufacturing -

Layoff rate, manufacturing
-Value of manufacturer’s new orders, durable goods industries
-New private non-farm dwelling units started
-Contracts and orders for plant and equipment -
FORECASTING TECHNIQUES
Cont.

-Number of new business incorporations

-Currently liabilities of business failures
-Index of stock prices, 500 common stocks
-Change in book value manufacturer's inventories, materials and
supplies
FORECASTING TECHNIQUES

2. Regression Analysis
-The second category of statistical forecasting that
introduces variables other than time. This is called
econometrics due to the combination off economic
theory and statistics.
-Uses the same statistical tools employed by the time
series analysis, i.e. Method of least squares.
FORECASTING TECHNIQUES

2. Regression Analysis
-The second category of statistical forecasting that introduces
variables other than time. This is called econometrics due to the
combination off economic theory and statistics.
-Uses the same statistical tools employed by the time series analysis,
i.e. Method of least squares.The only difference are that independent
Variable(s) other than time is (are) used; and that an element of
causality is assumed to exist between the independent and
dependent variables.
.
FORECASTING TECHNIQUES

2. Regression Analysis Cont.

Suppose we hypothesize that
the demand for product A is
completely
determined by per capita
income. We may come up
with the following graphIn
Figure 114
FORECASTING TECHNIQUES

·The coefficient of FORMULA:

determinations (R²) Is a
measure of proportion of
the variation in the
dependent variable
explained by the
independent valuable.
FORECASTING TECHNIQUES

Standard error of estimates-Measures the scatter of the actual

observations about the regression line

FORMULA:
FORECASTING TECHNIQUES
For example, a survey of used car dealers in Manila was made to determine the
relationship between the amount of classified advertising of used cars and used
car sales. The table below shows the lines of classified ads and the number of
cars sold for each of six dealers who used no other advertising medium.
FORECASTING TECHNIQUES
solution:
FORECASTING TECHNIQUES
cont.
The coefficient of determination ranges from 0 to 1.00. At R²=
0, The two variables are not related. on
the other hand, when R² = 1.00.The Two variables are
perfectly related. in our example, R²= 0.98,Which means that
the two variables are highly related.
In our illustration S= .05. The standard error of estimate has
been highlighted in figure 11.5 above and below the
regression line( see dashed lines ). If the points are scattered
at random about the regression line, then Approximately two
thirds of the points should lie within the band.
FORECASTING TECHNIQUES
Multiple regression analysis.
Regression analysis enables us to measure the joint effect of
any number of independent variables upon a dependent
variable.
If the forecaster recognizes the influence of several
independent variables on the dependent 110 he must extend
this analysis to what is called multiple regression.
FORECASTING TECHNIQUES
Multiple regression analysis.
Example
if the demand for the cement is
assumed to be affected by per
capita income the total value of
construction government
expenditures and interest rates
then the multiple regression
equation twould take the
following form.
SIMULTANEOUS EQUATION
MODELS
STIMULTANEOUS EQAUTION
MODELS
A major limitation of both trend and regression
analysis is that they fail to provide for the mutual
interaction among the independent variables.
The assumption is that the stable relationship is one-sided:
there is a dependent variable that is determined by one or
more independent variables.
 STIMULTANEOUS EQAUTION MODELS
What if a number of the variables are dependent on
each other?
for example:

The level of GNP depends on the amount of private

expenditures, which in turn, depends on the level of GNP.
Personal income depends on the amount of government
expedintures, which in turn, depends on the total GNP.
 Cont.
The above relationships can be expressed by a system of
simultaneous equation, that are basis for the sophisticated
forecasting technique simultaneous equation models.

A "model" is simply a representation of reality and mathematical

form let us examine a very simple model.

Y= C+I+G (Equation1) Where ;

C= a+b Y (Equation2)
Y=GNP
I= personal consumption expenditures
G= private investment
G= government purchases
a,b= Parameters to be estimated from
historical data
 Cont.
How our future GNP and future personal consumption expenditure
forecasted?
Since there are only two equations algebra tells us that we can only
have two unknowns. If Yand C are chosen as the unknowns, Then
the values of I and G must be independently determine.

Y= C+I+G (Equation1) Where ;

C= a+b Y (Equation2)
Y=GNP
I= personal consumption expenditures
G= private investment
G= government purchases
a,b= Parameters to be estimated from
historical data
Cont.
Cont.
 Cont.

of course the model presented is quite simple and can still be refined. Among the
obvious refinements that can be hypothesized are personal consumption is also
affected by the GNP of the preceding year. Thus the consumption function could
take the form.
C = a+b1Y1 + b2 Y3-1
where Y1 and YPU1-1 stands for GNP’s of the
current and preceding year respectively. It can
also be hypothesized that the level of private
investments for the year is determined by the
levelI1= a + by
of GNP during preceding year.
Where I1 = investment
expenditure for the year
Y1-1 = GNP of preceding year
FORECASTING THE UA&P WAY
FORECASTING THE UA&P WAY
FORECASTING THE UA&P WAY
FORECASTING THE UA&P WAY
MACROECONOMIC FORECAST
FOR 1997
Cont.
Cont.
NATIONAL
INCOME
The National Income is the total amount of income accruing to a
country from economic activities in a years time. It includes
payments made to all resources either in the form of wages,
interest, rent, and profits. The progress of a country can be
determined by the growth of the national income of the country.
NATIONAL INCOME
Cont.
INCOME-SPENDING GAP
TRADE DEFICIT
TRADE DEFICIT
PRICE
 HIGHLIGHTS
1.Economic forecasting has been under heavy attack from managers, especially with
the onslaught of the stagflation of the mid-1970s which leaders by surprise.
However, the value of economic forecast has not been diminished by such failures
which have merely resulted natural limitations of any social science.

2. From his study of the past and the present, the economic forecaster formulates
certain reasonably stable relationships among the socio-economic forces of interest
to him. Assuming that such relationships will continue to prevail in the future, he is
able to extrapolate into the future on the basis of his knowledge about past and
present trends.
 HIGHLIGHTS
3. In the field of economic forecasting, the major discontinuities that should be
closely monitored are the end of the Cold War and moves toward the liberalization
of the economy. The first major development concerns the opening up of former
communist states to capitalist ways and its effects on the world economy: the
second concerns the new competitive environment businesses face as a result of
efforts to liberalize the economy.

4. Statistics enable the analyst to quantify past and present patterns of behavior If
certain sets of relationships among the various forces being observed can be
described quantitatively, projections into the future concerning these forces can be
made.
 HIGHLIGHTS
5. Among the two major categories of forecasting techniques, extrapolation is the
most convenient to prepare. Also known as time series or trend analysis, it
assumes that all forces affecting a certain variable change uniformly through time.

6. The second category of statistical forecasting that introduces some variables other
than time is regression analysis, which uses the same statistical tools employed by
time series analysis.

7. A major limitation of both trend and simple regression analyses is that they fail to
provide for the mutual interaction among the independent vari ables which brings
us to simultaneous equation models. A "model" is simply a representation of reality
in mathematical form.
1
1
Goup
memb
ers
Kayla Sofi a P. ASturias
Aimee Sheen Bautista
Jean Balicuatan
Jeciel Bornales Boro
Belarma
Rosalyn De Guzman
Billoga