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Chapter 2

Chapter 2. Basic Considerations for Successful Forecasting. Six Considerations. Decision Environment - Loss Function Forecast Objective Forecast Statement Forecast Horizon Information Set Complexity of Methodology. Decision Environment.

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Chapter 2

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  1. Chapter 2 Basic Considerations for Successful Forecasting

  2. Six Considerations • Decision Environment - Loss Function • Forecast Objective • Forecast Statement • Forecast Horizon • Information Set • Complexity of Methodology

  3. Decision Environment • The Loss function summarizes the cost of a forecast error! • The forecast error is actual minus the forecast:

  4. Examples of Loss functions • BAKERY, Inc. is selling pies for $15 each, our cost is $10. We must choose production for tomorrow. Any pie not sold is wasted. Our forecast is used to determine the amount of pies to bake.

  5. What is the Loss function? • Key Facts: • If we produce too few pies(e>0), it costs us $5 per pie in lost sales • If we produce too many pies(e<0), it costs us $10 per pie because the pie is wasted. • Verbally, the loss is bigger if we overestimate demand than if we underestimate demand • BE CONSERVATIVE FOR THIS PROJECT!!

  6. Using Math, The Loss Function is:

  7. Common Loss Functions • L(e)=e2 • L(e)=|e| • L(e)=0 if our forecast of the change in y is correct, 1 if we miss the direction! • Many statistical estimators are based on the first loss function

  8. Forecast Objective • Event Outcome • Will LSU men go to NCAA? • Timing Forecasts • When will the economy go into recession? • When will sales be highest? • Time Series • How much will we sell next year?

  9. Forecast Statement • Point Forecast • Our sales will be 32 million next year • Interval Forecast • There is a 95% chance sales will lie between 28 and 36 million next year. • Density Forecast • Our forecast of sales is normal distributed with a mean of 32 million and s.d. 2 million

  10. Forecast Horizon • How far into the future do you want to forecast and at what time interval • Sales next month only • Monthly sales for the next two years • Annual sales over a ten year period

  11. Information Set • What Information will be used for the forecast? • Often determined by the budget for the forecast. • Should I use only lagged sales to forecast? • Will the boss buy other data for my forecast? • Can I spend two months gathering data?

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