Forecasting Theories

Several theories have been generated out of researches conducted by individuals and institutions on business forecasting important amongst these are as follows:

1. Sequence or time-lag theory:- It is the most important theory of business forecasting. It is totally based on the assumption that most of the business data have the lead relationship changes in business are successive and not simultaneous. There is a time-lag between different movements, for e.g. , the expenditure on advertisement may not at once lead to increase in sales. Similarly, When government makes use of deficit financing it leads to inflationary pressure-the purchasing power of people goes up-the wholesale prices. The retail prices start increasing. With the rise in retail prices the cost of living goes up and with it there is a demand for increased wage. Thus, one factor, more money in circulation, has affected  different  fields of economic activity not simultaneously but successively, similarly, when the excise duties are increased by the government they result in increases in prices which would lead to higher demand for wages.

2. Action and reaction theory:- This Action and reaction theory is based on two assumptions (1) every action has a reaction  & (2) magnitude of the original action influences the reaction. Thus if the price of Rice  has gone up above a certain level in a certain time period, there is likelihood that after some time it will go down below the normal level, thus, according to this theory a certain level of business activity is normal-sub normal or abnormal conditions cannot remaining so for ever- there is a bound to be reaction to them. And hence, we find four phases of a business cycle:

• Prosperity
• Decline.
• Depression and
• Improvement.

3. Economic rhythm theory:- The basic assumption of this theory is that the history repeats itself and hence the exponents of this theory believe that economic phenomena behave in a rhythmic order. Cycles of early the similar intensity and duration tend to recur. Thus, the available historical data have to be analyzed into their component parts and various types of fluctuations. Influencing them has to be segregated. A trend is then obtained that  will represent a long-term tendency or growth of decline. This trend line is projected a number of years into the future either by the freehand technique or by the mathematical technique. This is completed on the assumption that the trend line represents the normal growth or decline of the series.

4. Specific historical analogy:- This theory is hazed on a more realistic assumption, that all the business cycles are not uniform in amplitude or duration and as such the use of history is made not by projecting any  economic rhythm into the future, but by selecting some specific previous conditions which has many of the earmarks of the present and concluding that what happened in the earlier situation will happen in the present one also. What is done is that a time series relating to  a  data in question is thoroughly scrutinized and from it such period is selected in which conditions were similar to those prevailing at the time of making the forecasts. The course that events tool in the past under similar situations is then studied which gives an idea of the likely course which the phenomenon in question would follow. For e.g. , after world war many people forecast a depression because of world war.

5. Cross-section analysis:- This theory is based on the knowledge and interpretation of the current forces rather than projection of past trends. The theory assumes that no two cycles are similar. By the like causes always give  like results. All the factors bearing upon a given condition are assembled and relying upon the knowledge of economic processes. The forecaster concludes whether the condition is favorable or not, immediate recognition is given to the fact that business conditions are shaped by simultaneous inflationary and deflationary forces. The Predominance of inflationary forces results in booms, whereas predominance of deflationary forces leads to depression. The forecaster who utilizes this technique enumerates stable forces and a third which sets forth deflationary forces on the basis of judgment. Obviously, the dominant dories change from time to time; factors which require  careful attention include technological development supply-demand relationship government policies and businessmen expectation. In regard to the later, serial organization regularly conduct survey of executive opinions concerning future trends of general business conditions and selected series of business data.