# Managerial Economics Study Set 11

Business

## Quiz 6 :Forecasting

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Blue Chip Financial Forecasts gives the latest prevailing opinion about the future direction of the economy. Survey participants include 50 business economists from Deutsche Banc Alex. Brown, Banc of America Securities, Fannie Mae, and other prominent corporations. Each prediction is published along with the average or consensus forecast. Also published are averages of the ten highest and ten lowest forecasts; a median forecast; the number of forecasts raised, lowered, or left unchanged from a month ago; and a diffusion index that indicates shifts in sentiment that sometimes occur prior to changes in the consensus forecast. Explain how this approach helps limit the steamroller or bandwagon problems of the panel consensus method.
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Although the panel consensus method provides forecasts that involve collective viewpoints of experts, however such forecasts can be biased as it can be affected by strong personality of one or more key individuals.
To alleviate such problems the method adopted by BCFF is similar to that of the Delphi Method. In the Delphi method, members of the panel of experts respond to a series of questions related to the forecasting problem. An independent party to draw out a consensus opinion out of it analyzes the responses.
Such an approach followed by BCFF to make forecasts reduces the steamroller or bandwagon problems of the panel discussion method as it reduces the risk of biased forecasts due to group pressures which otherwise could be derived out of regular group meetings.

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Sales Forecast Modeling. Toys Unlimited Ltd., must forecast sales for a popular adult computer game to avoid stockouts or excessive inventory charges during the upcoming Christmas season. In percentage terms, the company estimates that game sales fall at double the rate of price increases and that they grow at triple the rate of customer traffic increases. Furthermore, these effects seem to be independent. A. Write an equation for estimating the Christmas season sales, using the variables S = sales, P = price, T = traffic, and t = time. B. Forecast this season's sales if Toys Unlimited sold 10,000 games last season at $15 each, this season's price is anticipated to be$16.50, and customer traffic is expected to rise by 15 percent over previous levels.
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a) For TUL, the forecasts of Christmas season sales should be based on the following equation:
…… (1)
Here is the forecast for Christmas season sales is last season sales and
S is the change in sales.
Based on the company estimates
S can be written as:
…… (2)
Here
is the rate of change of prices and
is the rate of change of customer traffic.
Substituting Equation (2) in Equation (1),
…… (3)
The forecast of Christmas sales for TUL should be based on Equation (3).
b) For the given the values of variables in Equation (3) the forecast for Christmas season sales are as follows:
Hence, for the given data forecast for this season Christmas sales are 12,500 games.

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Would a linear regression model of the advertising- sales relation be appropriate for forecasting the advertising levels at which threshold or saturation effects become prevalent? Explain.
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A linear regression model of advertising-sales relationship for forecasting advertising levels at which threshold or saturation effects become prevalent will not be appropriate as there is an irregular relationship between the two and hence non-linear method of estimation is appropriate. Quadratic and log-linear models are often used for this purpose.

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Explain why revenue and profit data reported by shippers such as FedEx Corp. and United Parcel Service, Inc., can provide useful information about trends in the overall economy.
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Perhaps the most famous early econometric forecasting firm was Wharton Economic Forecasting Associates (WEFA), founded by Nobel Prize winner Lawrence Klein. A spin-off of the Wharton School of the University of Pennsylvania, where Klein taught, WEFA was merged with Data Resources, Inc., in 2001 to form Global Insight. Describe the data requirements that must be met if econometric analysis is to provide a useful forecasting tool.
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Revenue Forecasting. Kate Austen must generate a sales forecast to convince the loan officer at a local bank of the viability of Marina Del Rey, a trendy west-coast restaurant. Austen assumes that next-period sales are a function of current income, advertising, and advertising by a competing restaurant. A. Write an equation for predicting sales if Austen assumes that the percentage change in sales is twice as large as the percentage changes in income and advertising but that it is only one-half as large as, and the opposite sign of, the percentage change in competitor advertising. Use the variables S = sales, Y = income, A = advertising, and CA = competitor advertising. B. During the current period, sales total $500,000, median income per capita in the local market is$71,400, advertising is$20,000, and competitor advertising is$66,000. Previous-period levels were $70,000 (income),$25,000 (advertising), and $60,000 (competitor advertising). Forecast next-period sales. Essay Answer: Tags Choose question tag Forecasting the success of new product introductions is notoriously difficult. Describe some of the macroeconomic and microeconomic factors that a firm might consider in forecasting sales for a new teethwhitening product. Essay Answer: Tags Choose question tag What are the main characteristics of accurate forecasts? Essay Answer: Tags Choose question tag Sales Trend Analysis. Environmental Designs, Inc., produces and installs energy-efficient window systems in commercial buildings. During the past 10 years, sales revenue has increased from$25 million to $65 million. A. Calculate the company's growth rate in sales using the constant growth model with annual compounding. B. Derive a 5-year and a 10-year sales forecast. Essay Answer: Tags Choose question tag Cost Forecasting. Dorothy Gale, a quality control supervisor for Wizard Products, Inc., is concerned about unit labor cost increases for the assembly of electrical snap-action switches. Costs have increased from$80 to $100 per unit over the previous 3 years. Gale thinks that importing switches from foreign suppliers at a cost of$115.90 per unit may soon be desirable. A. Calculate the company's unit labor cost growth rate using the constant rate of change model with continuous compounding. B. Forecast when unit labor costs will equal the current cost of importing.
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Growth Rate Estimation. Almost 2 million persons per year visit wondrous Glacier National Park. Due to the weather, monthly park attendance figures varied widely during a recent year: A. Notice that park attendance is lower in December than in January, despite a 42.4 percent average rate of growth in monthly attendance. How is that possible? B. Suppose the data described in the table measured park attendance over a number of years rather than during a single year. Explain how the arithmetic average annual rate of growth gives a misleading picture of the growth in park attendance.
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Cite some examples of forecasting problems that might be addressed using regression analysis of complex multiple-equation systems of economic relations.
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Constant Growth Model. The U.S. Bureau of the Census publishes employment statistics and demand forecasts for various occupations. A. Using a spreadsheet or handheld calculator, calculate the 10-year growth rate forecast using the constant growth model with annual compounding, and the constant growth model with continuous compounding for each occupation. B. Compare your answers and discuss any differences.
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Simultaneous Equations. Supersonic Industries, based in Seattle, Washington, manufactures a wide range of parts for aircraft manufacturers. The company is currently evaluating the merits of building a new plant to fulfill a new contract with the federal government. The alternatives to expansion are to use additional overtime, to reduce other production, or both. The company will add new capacity only if the economy appears to be expanding. Therefore, forecasting the general pace of economic activity for the United States is an important input to the decision-making process. The firm has collected data and estimated the following relations for the U.S. economy: Forecast each of the preceding variables through the simultaneous relations expressed in the multiple-equation system. Assume that all random disturbances average out to zero.
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Unit Sales Forecasting. Claire Littleton has discovered that the change in product A demand in any given week is inversely proportional to the change in sales of product B in the previous week. That is, if sales of B rose by X percent last week, sales of A can be expected to fall by X percent this week. A. Write the equation for next week's sales of A , using the variables A = sales of product A, B = sales of product B , and t = time. Assume that there will be no shortages of either product. B. Last week, 100 units of A and 90 units of B were sold. Two weeks ago, 75 units of B were sold. What would you predict the sales of A to be this week?
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"Interest rates were expected to increase by 85 percent of all consumers in the May 2004 survey, more than ever before," said Richard Curtin, the director of the University of Michigan's Surveys of Consumers. "More consumers in the May 2004 survey cited the advantage of obtaining a mortgage in advance of any additional increases in interest rates than any other time in nearly 10 years," said Curtin. Discuss this statement and explain why consumer surveys are an imperfect guide to consumer expectations.
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In prepared remarks before Congress in mid-2007, Federal Reserve chairman Ben Bernanke testified: "The principal source of the slowdown in economic growth... has been the substantial correction in the housing market. [and] The near-term prospects for the housing market remain uncertain." What makes forecasting turning points difficult? What methods do economists use to forecast turning points in the overall economy?
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Discuss some of the microeconomic and macroeconomic factors a firm must consider in its own sales and profit forecasting.
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Cost Forecasting. Dr. Izobel Stevens is supervising physician at the Westbury HMO, a New York City-based medical facility serving the poor and indigent. Stevens is evaluating the cost-effectiveness of a preventive maintenance program, and believes that monthly downtime on the packaging line caused by equipment breakdown is related to the hours spent each month on preventive maintenance. A. Write an equation to predict next month's downtime using the variables D = downtime, M = preventive maintenance, t = time, a 0 = constant term, and a 1 = regression slope coefficient. Assume that downtime in the forecast (next) month decreases by the same percentage as preventive maintenance increased during the month preceding the current one. B. If 40 hours were spent last month on preventive maintenance and this month's downtime was 500 hours, what should downtime be next month if preventive maintenance this month is 50 hours? Use the equation developed in part A.
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