Session Overview

By the end of this section, you should be able to

• Explain cyclical variations
• Explain random variations
• Calculate cyclical relative
• Discuss the importance of time series
• Explain forecasting
• Forecast based on trend and seasonal components
• Forecast using simple exponential smoothing

Slide 2
 Session Outline
The key topics to be covered in the session are as follows:
• Cyclical Variation
• Cyclical Relative
• Irregular Variation
• Forecasting

Slide 3
 Topic 1
What is Cyclical Variation (CV)
• Cyclical variation is the recurrent up and down wavelike
variation from trend that have duration of about 2-10
years and may repeat again and again
- for a specific time series, one cycle can take 3 years but
another cycle can take about 10 years.
• Example: Business cycle- propensity, recession,
depression and recovery
• These cycles have the propensity to affect time series
value in sales, production, growth etc.

Slide 4
Example : Business Cycle
• Measuring CV is very
difficult. Why?
• Successive cycles may
vary widely in time and
pattern and usually mixed
up with irregular factors.
• .

Slide 5
 Topic 2
Measuring Cyclical Variation: Cyclical Relative
approach
• Assumption: Annual time series reflects the effects of T
and C component because the S and I components are
defined as short-run influence which occurs within the
course of each year.
• Under this assumption the multiplicative model
reduces to
Or T - trend estimate, Y - actual value

• The ratio is called the cyclical relative and

indicates the presence or absence of any cyclical influence
on an annual time series value. Slide 6
Interpretation of Cyclical Relative
• Cyclical relative= 100% implies total absence of any
cyclical influence on the time series.
• Cyclical relative<100% implies there is recession
because what was obtained (actual value – Y) is less
than what was estimated (Trend).
• Cyclical relative>100% implies there is recovery
because what was obtained (actual value or Y) is
greater than what was estimated (Trend).

Slide 7
 Example 1
• The table below shows the actual (Y) and Trend (T)
estimate of the production of aluminium ingots. Calculate
the cyclical relative and interpret your result.
Year Y T
1994 700 728
1995 850 799
1996 900 972
1997 1100 1078
1998 1225 1225
1999 1324 1347
2000 1500 1485
2001 1675 1682
2002 1700 Slide 8 1564
 Solution to Example 1
• CR for 1994 is
æ Y ö
Cyclical relative ç ´100 ÷ 96.2%. This means
Year Y T èT ø
that there is cyclical
1994 700 728 96.2 influence (recession)
1995 850 799 106.4 as what was obtained
1996 900 972 92.6 (actual value) is less
1997 1100 1078 102.0 than what was
1998 1225 1225 100.0 estimated (trend).
1999 1324 1347 98.3 • CR for 1995 is
2000 1500 1485 101.0 106.4% meaning
2001 1675 1682 99.6 there is a recovery.
2002 1700 1564 108.7
Slide 9
 Activity 1
• The table below shows the actual (Y), Trend (T) estimate and the
cyclical relative (C) of wheat production in a country. Calculate the
missing values. Interpret your results for 1998, 1999 and 2005.

Year Actual Value(Y) Trend value (T) Cyclical relative (%)

1998 1938 88
1999 1850 100
2000 1900 2242
2001 11100 10978
2002 11225 83
2003 12844 103
2004 15001 86
2005 11208 104
2006 17001 17239
Slide 10
 Irregular Variation
• This is the unpredictable or irregular fluctuation in a time
series caused by unpredictable changes in weather,
unforeseen political activities, among others, which does
not repeat in a definite time.
- Erratic variations or the residue from trend that cannot
be ascribed to cyclical or seasonal influences.
- Cyclical variation is considered to be erratic and mixed
with irregular variation and impossible to be separated.

• No specific way of measuring irregular variation because

of its uncertainty.
Slide 11
 Importance of Time Series
1. Helps in understanding past behaviour. Observing data
over a long period can help in understanding changes which
have taken place over time and consequently policy making.
2. Helps in planning for the future. Linked to policy making is
the issue of planning which require forecasting. With past and
present data one can easily forecast and plan for the future.
3. Helps in evaluating current accomplishments. Keeping
data on expected and actual performances can always help to
evaluate accomplishments.
4. Facilitates comparison. With data on different time series
one can easily make comparism and draw important
conclusions.
Slide 12
 Topic 4
What is Forecasting?
• Process of systematically estimating future conditions
from past and present conditions.
• Trend equation normally based on annual data is
mostly used in forecasting.
• After that, the data is corrected for any seasonal
influence if it exists.
• After estimating the trend value, we then use the
seasonal Index to estimate the value for a season

Slide 13
 Activity 1
• The data below shows quarterly export of a cash crop from a
country from 1995 – 2000 in million metric tons.
I II III IV Total
1995 5 8 9.5 26 48.5
1996 6.5 8.7 10.5 27 52.7
1997 6.8 9 12.1 26.5 54.4
1998 7.5 9.5 12 28 57
1999 7.8 10.5 12.5 29.5 60.3
2000 9.5 11.5 13.5 30 64.5
Question 1
a. Plot the data for all the years
b. Which component of time series is visibly present
c. Calculate the seasonal indices
d. Estimate the annual trend line using theSlidemethod
14 of least square
 Activity 1 Cont’d
e. Forecast the sales value for the year 2008
f. Forecast the sales value for the first and fourth quarters of
year 2008.
Question 2
i. Estimate the trend line using the method of moving
averages
ii. Forecast the sales value for the year 2008
iii. Forecast the sales value for the first and fourth quarters
of year 2008
iv. Compare the forecast annual and quarterly values for
2008 in question 1 to that of question 2.
Slide 15
 Exponential Smoothing
• Forecasting method that applies unequal weights to
time series observations.
• Weighting is done by using a smoothing constant
which determines how much
weight is attached to each observation.
• Recent observations are given greater weights,
while more distant observations are given
successively smaller weights.

Slide 16
 Exponential Smoothing Cont’d
• Given a smoothing constant, α, the forecast formula is:

Where - the forecast for the next period.

• smoothing constant
• - actual value for the period preceding the most recen
period
• - actual value for the kth period preceding the mos
recent period.
• Use of this formula is difficultSlide 17
 Exponential Smoothing Cont’d
• Operational formula used:

• - forecast for the next period

• - forecast for the most recent period
• - actual value for the most recent period
• is an error term.

Slide 18
 Challenge:
• How do you choose α?.
• When α is close to zero, previous forecast
error
• are given a low weight.
• If α is chosen close to 1, then forecast error is
heavily weighted by the most recent result.
• Limitation: Used for only one period forecast
because you need the actual value before you
can calculate the next forecast.
Slide 19
 Example 2
• A shopping mall experienced the following monthly sales
for the first four months of the year, in thousands of units.

January February March April

23.3 72.3 30.3 15.5

• If the forecast for January was 25000, determine the

forecasts for February through May using exponential
smoothing with a smoothing constant of α=0.15

Slide 20
 Solution to Example 2
• Formula for simple exponential smoothing is given as:
• α=0.15

Month Actual Sales ( yt ) Recent Error

~
forecast ( yt ) ( yt - yt ) = et
~ Next Sales
Forecast ( ~yt +1 )
January 23.3 25 -1.7 24.745
February 72.3 24.745 47.555 31.878
March 30.3 31.878 -1.578 31.642
April 15.5 31.642 -16.142 29.220
May - 29.220 - -
Slide 21
 Solution to Example 2 Cont’d
• The 2nd column on the table is the actual sales.
• Notice that the actual and forecast (column 3) value for January has
been given and therefore we can easily calculate the forecast error
for January as: as in column 4.
• February forecast value by using the exponential smoothing
formula as:
• Also, using the formula for march, we have:

• The results also shows that the forecast for May is 29,220.

Slide 22
 Activity 2
• The table below shows the monthly export of cocoa for
the first five months of the year in thousand metric tons.

January February March April May

15.2 30.9 41 18.3 36.2

• If the forecast for January is 20,000 metric tons,

determine forecasts for February through June using
exponential smoothing with a smoothing constant of
α=0.17
Slide 23