QCT 3

--6.7 points each for a total of 80 points

Salvatore’s Chapter 6:

a. Discussion Questions: 1,7, and 15 1: (a) What is forecasting? Why is it so important in the management of business firms and other enterprises? (b) What are the different types of forecasting? (c) How can the firm determine the most suitable forecasting method to use? a) Forecasting is used to try and predict the economic activity of a firm’s future. It aims to reduce risk/uncertainty that is faced in the short-term operational decision making. It is also used to plan for the firm’s long-term growth. Forecasting helps make decisions by using macroforecasts of the general economic activity as inputs for their microforecasts of the industry’s and firm’s demand and sales.

Forecasting helps decide a firm’s marketing strategy, production needs, sales forecast, and helps predict financial needs such as cash flow, profits, and outside financing. Furthermore, it helps make personal based decisions, as well as assist for the long-term future of the firm (Salvatore, 2012). b) Forcasting types range from expensive to inexpensive, as well as simple to complex. Forecasting techniques can be qualitative, and others can be quantitative. Salvatore focuses on qualitative forecasts. These forecasts include: time-series, smoothing techniques (moving averages), barometric forecasts with leading indicators, econometric forecasts, and input-output forecasts. c) A firm determines the most suitable forecasting method to use by using the following criterion:

1. the cost of preparing the forecast and the benefit that results from its use

2. the lead time in decision making

3. the time period of the forecast (short or long term)

4. the level of accuracy required

5. the quality and availability of the data

6. the level of complexity of the relationships to be forecast

In general, “the greater the level of accuracy required and the more complex the relationships to be forecast, the more sophisticated and expensive will be the forecasting exercise (Salvatore, 2012).”

7: (a) Which type of smoothing technique is generally better? (b) How do we determine which of two smoothing techniques is better? (c) How can we forecast the values of a time series that contains a secular trend as well as strong seasonal and random variations?

a) Out ot the two smoothing techniques, exponential smoothing is the better of the techniques. Exponential smoothing is applied to time series data for making forecasts. It is essentially a random process like time series data. Unlinke the other smoothing techniques this technique doesn’t require a minimum number of observations, because the results can be produced.

b) Two techniques are:

Weighted moving average: This concept is effective in smoothing out the sudden fluctuations in demand pattern so as to provide the stable estimates. In this weights decline exponentially. However, it requires maintenance of past data records.

Exponential smoothing: This technique requires fewer records of the past data. In this method, we specifically choose double exponential smoothing method as it smooth’s out the trend in the data. One uses larger smoothing constants when less smoothing is required and vice versa.

When time series data is stable with no significant trend (seasonal/cyclical), smoothing methods can be used to average out the irregular components of the time series data.

c) By using the moving average method, values of the time series can be forecasted. These contain secular trend, along with strong seasonal and random variation. Moving averages average the time series over a certain number of periods. This is done to modify the effect of cyclical variation i.e. a plot of the moving averages yields a “smooth” time series curve that clearly shows the long term trend and clearly shows the effect of averaging out the random variations to reveal the trend.

15: Explain why it is still useful to pursue forecasting even though it is often off the mark by wide margins.

Forecasting helps to identify foreseen future inactivities that could potentially affect the performance of the company using the forecasting. Forecasting allows for those forming the company to know of the possible future demand of what it is they are providing.

Forecasting, also known as the method of estimation in unknown business situations, helps with obtaining the best knowledge of what might occur in the market. Forecasting is important to manufacturing companies, because it helps predict the consumer demand for a particular product might be. The forecast needs to be as correct as possible to help avoid more expenses because of the stock level on hand. Also, when forming a company, forecasting is important because it can help predict the possible future demand. Forecasting is not without its faults. Included within the faults of forecasting can be dramatic economical changes that cannot be predicted. These changes can be postitive or negative.

Forecasting material, labor, and other resources is essential for good forecasting. By forecasting these well, suitable action can be taken to ensure the proper inventory is on hand. Also, it can help plan a balanced work-load. Good labor relations may be maintained, as there would be lesser hiring and firing activities by the management with better manpower planning.

Forecasting is useful because of:

1. Effective handling of uncertainty

2. Better labor relations

3. Balanced work-load

4. Minimization in the fluctuations of production

5. Better use of production facilities

6. Better material management

7. Better customer service

8. Better utilization of capital and resources

9. Better design of facilities and production system. Efforts in forecasting activity involve two types of costs. While more effort in forecasting causes increased cost due to data collection and analysis; lesser forecasting activity involves lost revenue, which may be due to unplanned labor, unplanned material or unplanned capital cost.

A balance of forecasting effort and a zone near to accuracy cost trade off is essential.

b. Problems: 7 and appendix problems 1 & 3 (pp. 256–257) 7: The following table presents data on three leading indicators for a three-month period. Construct the diffusion index from moth 2 to 3. Diffusion index from month 1 to 2 is 66.7 (=2/3) because two indicators move up and one moves down.

|Month |Leading Indicator A |Leading Indicator B |Leading Indicator C |Diffusion Index |
|1 |100 |200 |30 | |
|2 |110 |230 |27 | |
|3 |120 |240 |33 | |
|Values |1 |1 |1 |30 |

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1: The following table reports the Consumer Price Index for the Los Angeles area on a monthly basis from January 1998 to December 2000 (base year= 1982-1984). Eliminating the data for 2000, use Excel to forecast the index for all of 2000 using a three- and sex-month average. Which provides a better forecast for 2000 using the data provided? (SEE ATTACHED EXCEL SHEET)

3-month moving average gives the better forecast for 2000 than the 6-month moving average method because of low MAD. The higher the MAD, the worst is the performance.

3: Forecast the data for 2000 again in Problem 2 with exponential smoothing with w=0.3 and w=0.7. Is this a better forecast than the moving average? (Compare RMSEs for moving average and exponential smoothing forecasts to answer “Is this a better forecast thanthe moving average?” (SEE ATTACHED EXCEL SHEET)

According to RMSE, moving average method is better than the exponential smoothing method because of the low RMSE. The lower the RMSE, the better is the performance and hence the forecast values.

Salvatore’s Chapter 7:

a. Discussion Questions: 3, 11, and 12 3: (a) How is the law of diminishing returns reflected in the shape of the total product curve? (b) What is the relationship between diminishing returns and the stages of production? Law of diminishing returns: as more and more of a variable factor is added to a fixed factor, output will rise initially but will eventually fall. Initially, in region [0 – A], there are increasing returns. In the zone [A – B] there are decreasing returns, and beyond B there are negative returns. This theory supports the shape of the marginal and average cost curves. Both of these curves will be u-shaped as eventually diminishing returns will lead to costs increasing. Initially increasing returns mean that both AC and MC will fall, but once diminishing returns set in both curves start to rise again. The marginal cost curve will intersect the average cost curve at its minimum point. The actual position of the AC curve will vary with a number of factors. Costs of factor inputs (labour, materials, services etc). The cheaper the inputs the lower the average cost will be at any given output. Productivity – productivity can be defined as output per unit input. The more productive the firm, the more output it gets from its inputs and the lower the average cost at any output. Productivity is measured in a number of ways: Marginal product (MP) – the change in total output resulting from the adding of one extra unit of a variable factor, often labor. Average product (AP) - total output / units of variable factor being used. The choice of factor inputs will be driven by their costs, productivity and effect on product cost. An efficient firm will make its choices so as to minimise its average cost at the production rate being worked

11: Minimum wage legislation requires most firms to pay workers no less than the legislated minimum wage per hour. Using marginal productivity theory, explain how a change in the minimum wage affects the employment of unskilled labor. Marginal productivity theory provides for a worker to be paid according to the marginal product, or the real qage paid to the worker would be equal to marginal product of that particular worker. However, if there is an increase in the minimum wage, then in order to marginal productivity theory to work, the marginal product of the labor needs to increase. Using the law of diminishing returns (marginal product declines as more labors are hired), the marginal product of labor should only increase with less workers or labor is hired. So, an increase in minimum wage would mean a decrease in employment of unskilled workers or labor. By using the labor demand and labor supply concept, the above concept can be further explained. Take for instance, the minimum wage was set about the equilibrium wage. When the minimum wage increase, the quantity of labor would exceed the amount of demanded labor (this is represented by the marginal product curve). This implies the increase (or decline) in employment status (employed or unemployed).

12: It is always better to hire a more qualified and productive worker than a less qualified and productive one regarless of cost. True or false? Explain. TRUE Take manual workers for instance. With manual workers, an internal distinction is made between qualified productive workers and unqualified. Both groups belong to unions to the same confederation. In Demark, there are two reasons why there is a distinction. In this case, the qualified productive workers’ union seized the initiative. Thus, they took over from the employers’ association’s control over sectors of industry that were delimited. They sought to reserve the areas of work for themselves, even though there was an increased mechanization. This increased mechanization was put on them by the unqualified productive workers. The second to look at is the way in which the payment systems are applied. They apply to qualified productive workers who have allowed the development of pay bargaining at enterprise level while the collective agreement still exists. The unqualified productive workers were subject to a system of fixed level of pay when the agreement is concluded and stays that way until it expires. b. Problems: 4, 12, and 13 4: Ms. Smith, the owner and manager of the Clear Duplicating Service located near a major university, is contemplating keeping her shop open after 4 P.M. and until midnight. In order to do so, she would have to hire additional workers. She estimates that the additional workers would generate the folliwng total output (where each unit of output refers to 100 pages duplicated). If the price of each unit of output is $10 and each worker hired must be paid $40 per day, how many woerkes should Ms. Smith hire?

MRP=MR x MP = P x MP = $10 x MP (Use information in the problem to calculate MP)

MRC=wages=$40.

|Workers hired |Total Product |MP * |Marginal Revenue Per |MRP |
| | | |Product (MR) |(MP X MR) |
|0 |0 |0 |10 |0 |
|1 |12 |12 |10 |120 |
|2 |22 |10 |10 |100 |
|3 |30 |8 |10 |80 |
|4 |36 |6 |10 |60 |
|5 |40 |4 |10 |40 |
|6 |42 |2 |10 |20 |

*MP (Marginal Product) is the input contribution of the additional worker to the total productivity. For example 1 worker can generate 12 units of product and 2 workers can generate 22 units of product. So the 2nd worker contributes an additional of (22-12) 11 units of product to the total output.

When the 5th worker is hired, MRP=MRC=$40

When the 6th worker is hired, income generated by the additional worker ($20) is lower than the MRC, in this case, the wage ($40) to be paid to the worker, hence the number of workers to be hired to ensure maximum profit is 5 WORKERS

12: Suppose that the production function for a commodity is give by where Q is the quantity of output, L is the quantity of labor, and K is the quantity of capital (a) Indicate whether this production function exhibits constant, increasing, or decreasing returns to scale. (b) Does the production function exhibit diminishing returns? If so, when does the law of diminishing returns begin to operate? Could we ever get negative returns?

a) The production function exhibits constant returns to scale because:

L = 1 and K = 1,

Q = 10√ LK = 10

L = 2 and K = 2

Q = 10 √4 = 20 b) The production function exhibits diminishing returns to capital and labor throughout. For example, holding capital constant at K = 1 and increasing labor from L = 1 to L = 2 increases Q from 10 to 10 √2 = 14.14. Therefore, MPL = 4.14. Increasing labor to L = 3 results in Q = 10 3 = 17.32, and MPL = 3.18 (i.e., the MPL declines). Therefore, if we increase L from 2 to 3 then the production function results in diminishing returns.

13: Indicate whether each of the following statements is true or false and give the reason (a) A firm should stop expanding output after reaching diminishing returns and (b) If large and small firms operate in the same industry, we must have constant returns to scale. a) TRUE In the short run the stage where returns are diminishing production must stop as adding more output reduces the marginal output. (b) FALSE The size of a firm has no relation to returns to scale. The later is based n cost curves, not size. constant returns is a feature of the production function and is not linked to the size of the firm. If all firms use a production function with CRS then they all will have CRS, and the firm size has no role in this.