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 Business Forecasting
John E. Hanke Dean Wichern
Ninth Edition
Pearson Education Limited
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 P E A R S O N C U S T O M L I B R A R Y

Table of Contents

1. Introduction to Forecasting
John E. Hanke/Dean Wichern 1
2. Exploring Data Patterns and an Introduction to Forecasting Techniques
John E. Hanke/Dean Wichern 15
3. Moving Averages and Smoothing Methods
John E. Hanke/Dean Wichern 61
4. Time Series and Their Components
John E. Hanke/Dean Wichern 119
5. Simple Linear Regression
John E. Hanke/Dean Wichern 175
6. Multiple Regression Analysis
John E. Hanke/Dean Wichern 235
7. Regression with Time Series Data
John E. Hanke/Dean Wichern 295
8. The Box-Jenkins (ARIMA) Methodology
John E. Hanke/Dean Wichern 355
9. Judgmental Forecasting and Forecast Adjustments
John E. Hanke/Dean Wichern 437
10. Managing the Forecasting Process
John E. Hanke/Dean Wichern 459
Appendix: Tables
John E. Hanke/Dean Wichern 477
Appendix: Data Sets and Databases
John E. Hanke/Dean Wichern 487
Index 501

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 INTRODUCTION TO
FORECASTING
This text is concerned with methods used to predict the uncertain nature of business
trends in an effort to help managers make better decisions and plans. Such efforts often
involve the study of historical data and the manipulation of these data in the search for
patterns that can be effectively extrapolated to produce forecasts.
In this text, we regularly remind readers that sound judgment must be used along
with numerical results if good forecasting is to result. The examples and the cases at the
end of the chapter emphasize this point. There are more discussions of the role of judg-
ment in this chapter.

THE HISTORY OF FORECASTING

In a book on the history of risk, author Peter Bernstein (1996) notes that the development
of business forecasting in the seventeenth century was a major innovation. He writes:

forecasting—long denigrated as a waste of time at best and a sin at worst—

became an absolute necessity in the course of the seventeenth century for
adventuresome entrepreneurs who were willing to take the risk of shaping the
future according to their own design.

Over the next 300 years, significant advances in data-based forecasting methods
occurred, with much of the development coming in the twentieth century. Regression
analysis, decomposition, smoothing, and autoregressive moving average methods are
examples of data-based forecasting procedures discussed in this text. These procedures
have proved to be highly effective and routinely appear in the menus of readily
available forecasting software.
Along with the development of data-based methods, the role of judgment and
judgmental approaches to forecasting has grown significantly over the last 25 years.
Without any data history, human judgment may be the only way to make predictions
about the future. In cases where data are available, judgment should be used to review
and perhaps modify the forecasts produced by quantitative procedures.
With the proliferation of powerful personal computers and the availability of
sophisticated software packages, forecasts of future values for variables of interest are
easily generated. However, this ease of computation does not replace clear thinking.
Lack of managerial oversight and improper use of forecasting techniques can lead to
costly decisions.

From Chapter 1 of Business Forecasting, Ninth Edition. John E. Hanke, Dean W. Wichern.
Copyright © 2009 by Pearson Education, Inc. All rights reserved.

1
 Introduction to Forecasting

New forecasting procedures continue to be developed as the need for accurate

forecasts accelerates.1 Particular attention is being paid to the forecasting process
in organizations with the need to coordinate objectives, methods, assessment, and
interpretation.

IS FORECASTING NECESSARY?

In spite of the inherent inaccuracies in trying to predict the future, forecasts necessar-
ily drive policy setting and planning. How can the Federal Reserve Board realistically
adjust interest rates without some notion of future economic growth and inflationary
pressures? How can an operations manager realistically set production schedules with-
out some estimate of future sales? How can a company determine staffing for its call
centers without some guess of the future demand for service? How can a bank make
realistic plans without some forecast of future deposits and loan balances? Everyone
requires forecasts. The need for forecasts cuts across all functional lines as well as all
types of organizations. Forecasts are absolutely necessary to move forward in today’s
ever-changing and highly interactive business environment.
This text discusses various ways of generating forecasts that rely on logical meth-
ods of manipulating data that have been generated by historical events. But it is our
belief that the most effective forecaster is able to formulate a skillful mix of quantita-
tive forecasting and good judgment and to avoid the extremes of total reliance on
either. At one extreme, we find the executive who, through ignorance and fear of quan-
titative techniques and computers, relies solely on intuition and feel. At the other
extreme is the forecaster skilled in the latest sophisticated data manipulation tech-
niques but unable or unwilling to relate the forecasting process to the needs of the
organization and its decision makers. We view the quantitative forecasting techniques
discussed in most of this text to be only the starting point in the effective forecasting of
outcomes important to the organization: Analysis, judgment, common sense, and busi-
ness experience must be brought to bear on the process through which these important
techniques have generated their results.
Another passage from Bernstein (1996) effectively summarizes the role of fore-
casting in organizations.

You do not plan to ship goods across the ocean, or to assemble merchandise
for sale, or to borrow money without first trying to determine what the future
may hold in store. Ensuring that the materials you order are delivered on time,
seeing to it that the items you plan to sell are produced on schedule, and get-
ting your sales facilities in place all must be planned before that moment when
the customers show up and lay their money on the counter. The successful
business executive is a forecaster first; purchasing, producing, marketing, pric-
ing, and organizing all follow.

TYPES OF FORECASTS

When managers are faced with the need to make decisions in an atmosphere of uncer-
tainty, what types of forecasts are available to them? Forecasting procedures might
first be classified as long term or short term. Long-term forecasts are necessary to set

1A recent review of the current state of forecasting is available in a special issue of the International Journal
of Forecasting, edited by R. J. Hyndman and J. K. Ord (2006).

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 Introduction to Forecasting

the general course of an organization for the long run; thus, they become the particular
focus of top management. Short-term forecasts are needed to design immediate strate-
gies and are used by middle and first-line management to meet the needs of the imme-
diate future.
Forecasts might also be classified in terms of their position on a micro–macro
continuum, that is, in terms of the extent to which they involve small details versus
large summary values. For example, a plant manager might be interested in forecasting
the number of workers needed for the next several months (a micro forecast), whereas
the federal government is forecasting the total number of people employed in the
entire country (a macro forecast). Again, different levels of management in an organi-
zation tend to focus on different levels of the micro–macro continuum. Top manage-
ment would be interested in forecasting the sales of the entire company, for example,
whereas individual salespersons would be much more interested in forecasting their
own sales volumes.
Forecasting procedures can also be classified according to whether they tend to be
more quantitative or qualitative. At one extreme, a purely qualitative technique is one
requiring no overt manipulation of data. Only the “judgment” of the forecaster is used.
Even here, of course, the forecaster’s “judgment” may actually be the result of the men-
tal manipulation of historical data. At the other extreme, purely quantitative techniques
need no input of judgment; they are mechanical procedures that produce quantitative
results. Some quantitative procedures require a much more sophisticated manipulation
of data than do others, of course. This text emphasizes the quantitative forecasting tech-
niques because a broader understanding of these very useful procedures is needed in
the effective management of modern organizations. However, we emphasize again that
judgment and common sense must be used along with mechanical and data-manipula-
tive procedures. Only in this way can intelligent forecasting take place.
Finally, forecasts might be classified according to the nature of the output. One
must decide if the forecast will be a single number best guess (a point forecast), a range
of numbers within which the future value is expected to fall (an interval forecast), or an
entire probability distribution for the future value (a density forecast). Since unpre-
dictable “shocks” will affect future values (the future is never exactly like the past),
nonzero forecast errors will occur even from very good forecasts. Thus, there is some
uncertainty associated with a particular point forecast. The uncertainty surrounding
point forecasts suggests the usefulness of an interval forecast. However, if forecasts
are solely the result of judgment, point forecasts are typically the only recourse. In
judgmental situations, it is extremely difficult to accurately describe the uncertainty
associated with the forecast.

MACROECONOMIC FORECASTING CONSIDERATIONS

We usually think of forecasting in terms of predicting important variables for an indi-

vidual company or perhaps for one component of a company. Monthly company sales,
unit sales for one of a company’s stores, and absent hours per employee per month in a
factory are examples.
By contrast, there is growing interest in forecasting important variables for the
entire economy of a country. Much work has been done in evaluating methods for
doing this kind of overall economic forecasting, called macroeconomic forecasting.
Examples of interest to the federal government of the United States are the unemploy-
ment rate, gross domestic product, and prime interest rate. Economic policy is based, in
part, on projections of important economic indicators such as these. For this reason,

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 Introduction to Forecasting

there is great interest in improving forecasting methods that focus on overall measures
of a country’s economic performance.
One of the chief difficulties in developing accurate forecasts of overall economic
activity is the unexpected and significant shift in a key economic factor. Significant
changes in oil prices, inflation surges, and broad policy changes by a country’s govern-
ment are examples of shifts in a key factor that can affect the global economy.
The possibility of such significant shifts in the economic scene has raised a key
question in macroeconomic forecasting: Should the forecasts generated by the fore-
casting model be modified using the forecaster’s judgment? Current work on forecast-
ing methodology often involves this question.
Theoretical and practical work on macroeconomic forecasting continues.
Considering the importance of accurate economic forecasting to economic policy for-
mulation in this country and others, increased attention to this kind of forecasting can
be expected in the future. A good introductory reference for macroeconomic forecast-
ing is Pindyck and Rubinfeld (1998).

CHOOSING A FORECASTING METHOD

The preceding discussion suggests several factors to be considered in choosing a fore-

casting method. The level of detail must be considered. Are forecasts of specific details
needed (a micro forecast)? Or is the future status of some overall or summary factor
needed (a macro forecast)? Is the forecast needed for some point in the near future
(a short-term forecast) or for a point in the distant future (a long-term forecast)? To
what extent are qualitative (judgment) and quantitative (data-manipulative) methods
appropriate? And, finally, what form should the forecast take (point, interval, or den-
sity forecast)?
The overriding consideration in choosing a forecasting method is that the results
must facilitate the decision-making process of the organization’s managers. Rarely
does one method work for all cases. Different products (for example, new versus estab-
lished), goals (for example, simple prediction versus the need to control an important
business driver of future values), and constraints (for example, cost, required expertise,
and immediacy) must be considered when selecting a forecasting method. With the
availability of current forecasting software, it is best to think of forecasting methods as
generic tools that can be applied simultaneously. Several methods can be tried in a
given situation. The methodology producing the most accurate forecasts in one case
may not be the best methodology in another situation. However, the method(s) chosen
should produce a forecast that is accurate, timely, and understood by management so
that the forecast can help produce better decisions.
The additional discussion available in Chase (1997) can help the forecaster select
an initial set of forecasting procedures to be considered.

FORECASTING STEPS

All formal forecasting procedures involve extending the experiences of the past
into the future. Thus, they involve the assumption that the conditions that gener-
ated past relationships and data are indistinguishable from the conditions of the
future.
A human resource department is hiring employees, in part, on the basis of a com-
pany entrance examination score because, in the past, that score seemed to be an impor-
tant predictor of job performance rating. To the extent that this relation continues to

4
 Introduction to Forecasting

hold, forecasts of future job performance—hence hiring decisions—can be improved by

using examination scores. If, for some reason, the association between examination
score and job performance changes, then forecasting job performance ratings from
examination scores using the historical model will yield inaccurate forecasts and poten-
tially poor hiring decisions. This is what makes forecasting difficult. The future is not
always like the past. To the extent it is, quantitative forecasting methods work well. To
the extent it isn’t, inaccurate forecasts can result. However, it is generally better to have
some reasonably constructed forecast than no forecast.
The recognition that forecasting techniques operate on the data generated by histor-
ical events leads to the identification of the following five steps in the forecasting process:

1. Problem formulation and data collection

2. Data manipulation and cleaning
3. Model building and evaluation
4. Model implementation (the actual forecast)
5. Forecast evaluation

In step 1, problem formulation and data collection are treated as a single step
because they are intimately related. The problem determines the appropriate data. If a
quantitative forecasting methodology is being considered, the relevant data must be
available and correct. Often accessing and assembling appropriate data is a challenging
and time-consuming task. If appropriate data are not available, the problem may have
to be redefined or a nonquantitative forecasting methodology employed. Collection
and quality control problems frequently arise whenever it becomes necessary to obtain
pertinent data for a business forecasting effort.
Step 2, data manipulation and cleaning, is often necessary. It is possible to have too
much data as well as too little in the forecasting process. Some data may not be rele-
vant to the problem. Some data may have missing values that must be estimated. Some
data may have to be reexpressed in units other than the original units. Some data may
have to be preprocessed (for example, accumulated from several sources and
summed). Other data may be appropriate but only in certain historical periods (for
example, in forecasting the sales of small cars, one may wish to use only car sales data
since the oil embargo of the 1970s rather than sales data over the past 60 years).
Ordinarily, some effort is required to get data into the form that is required for using
certain forecasting procedures.
Step 3, model building and evaluation, involves fitting the collected data into a
forecasting model that is appropriate in terms of minimizing forecasting error. The sim-
pler the model is, the better it is in terms of gaining acceptance of the forecasting
process by managers who must make the firm’s decisions. Often a balance must be
struck between a sophisticated forecasting approach that offers slightly more accuracy
and a simple approach that is easily understood and gains the support of—and is
actively used by—the company’s decision makers. Obviously, judgment is involved in
this selection process. Since this text discusses numerous forecasting models and their
applicability, the reader’s ability to exercise good judgment in the choice and use of
appropriate forecasting models will increase after studying this material.
Step 4, model implementation, is the generation of the actual model forecasts once
the appropriate data have been collected and cleaned and an appropriate forecasting
model has been chosen. Data for recent historical periods are often held back and later
used to check the accuracy of the process.
Step 5, forecast evaluation, involves comparing forecast values with actual his-
torical values. After implementation of the forecasting model is complete, forecasts

5
 Introduction to Forecasting

are made for the most recent historical periods where data values were known but
held back from the data set being analyzed. These forecasts are then compared with
the known historical values, and any forecasting errors are analyzed. Some forecast-
ing procedures sum the absolute values of the errors and may report this sum, or
they divide this sum by the number of forecast attempts to produce the average
forecast error. Other procedures produce the sum of squared errors, which is then
compared with similar figures from alternative forecasting methods. Some proce-
dures also track and report the magnitude of the error terms over the forecasting
period. Examination of error patterns often leads the analyst to modify the
forecasting model.

MANAGING THE FORECASTING PROCESS

The discussion in this chapter serves to underline our belief that management ability
and common sense must be involved in the forecasting process. The forecaster should
be thought of as an advisor to the manager rather than as a monitor of an automatic
decision-making device. Unfortunately, the latter is sometimes the case in practice,
especially with the aura of the computer. Again, quantitative forecasting techniques
must be seen as what they really are, namely, tools to be used by the manager in arriv-
ing at better decisions. According to Makridakis (1986):

The usefulness and utility of forecasting can be improved if management

adopts a more realistic attitude. Forecasting should not be viewed as a substi-
tute for prophecy but rather as the best way of identifying and extrapolating
established patterns or relationships in order to forecast. If such an attitude is
accepted, forecasting errors must be considered inevitable and the circum-
stances that cause them investigated.

Given that, several key questions should always be raised if the forecasting process is
to be properly managed:
• Why is a forecast needed?
• Who will use the forecast, and what are their specific requirements?
• What level of detail or aggregation is required, and what is the proper time horizon?
• What data are available, and will the data be sufficient to generate the needed
forecast?
• What will the forecast cost?
• How accurate can we expect the forecast to be?
• Will the forecast be made in time to help the decision-making process?
• Does the forecaster clearly understand how the forecast will be used in the
organization?
• Is a feedback process available to evaluate the forecast after it is made and to
adjust the forecasting process accordingly?

FORECASTING SOFTWARE

Today, there are a large number of computer software packages specifically designed
to provide the user with various forecasting methods. Two types of computer packages
are of primary interest to forecasters: (1) general statistical packages that include
regression analysis, time series analysis, and other techniques used frequently by

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 Introduction to Forecasting

forecasters and (2) forecasting packages that are specifically designed for forecasting
applications. In addition, some forecasting tools are available in Enterprise Resource
Planning (ERP) systems.
Graphical capabilities, interfaces to spreadsheets and external data sources, numeri-
cally and statistically reliable methods, and simple automatic algorithms for the selection
and specification of forecasting models are now common features of business forecasting
software. However, although development and awareness of forecasting software have
increased dramatically in recent years, the majority of companies still use spreadsheets
(perhaps with add-ins) to generate forecasts and develop business plans.
Examples of stand-alone software packages with forecasting tools include
Minitab, SAS, and SPSS. There are many add-ins or supplemental programs that pro-
vide forecasting tools in a spreadsheet environment. For example, the Analysis
ToolPak add-in for Microsoft Excel provides some regression analysis and smoothing
capabilities. There are currently several more comprehensive add-ins that provide a
(almost) full range of forecasting capabilities.2
It is sometimes the case, particularly in a spreadsheet setting, that “automatic”
forecasting is available. That is, the software selects the best model or procedure for
forecasting and immediately generates forecasts. We caution, however, that this con-
venience comes at a price. Automatic procedures produce numbers but rarely provide
the forecaster with real insight into the nature and quality of the forecasts. The genera-
tion of meaningful forecasts requires human intervention, a give and take between
problem knowledge and forecasting procedures (software).
Many of the techniques in this text will be illustrated with Minitab 15 and
Microsoft Excel 2003 (with the Analysis ToolPak add-in). Minitab 15 was chosen for its
ease of use and widespread availability. Excel, although limited in its forecasting func-
tionality, is frequently the tool of choice for calculating projections.

ONLINE INFORMATION

Information of interest to forecasters is available on the World Wide Web. Perhaps the
best way to learn about what’s available in cyberspace is to spend some time searching for
whatever interests you, using a browser such as Netscape or Microsoft Internet Explorer.
Any list of websites for forecasters is likely to be outdated by the time this text
appears; however, there are two websites that are likely to remain available for some
time. B&E DataLinks, available at www.econ-datalinks.org, is a website maintained
by the Business and Economic Statistics Section of the American Statistical Association.
This website contains extensive links to economic and financial data sources of interest
to forecasters. The second site, Resources for Economists on the Internet, sponsored
by the American Economic Association and available at rfe.org, contains an extensive set
of links to data sources, journals, professional organizations, and so forth.

FORECASTING EXAMPLES

Discussions in this chapter emphasize that forecasting requires a great deal of judg-
ment along with the mathematical manipulation of collected data. The following exam-
ples demonstrate the kind of thinking that often precedes a forecasting effort in a real

2At the time this text was written, the Institute for Forecasting Education provided reviews of
forecasting software on its website. These reviews can be accessed at www.forecastingeducation.com/
forecastingsoftwarereviews.asp.

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 Introduction to Forecasting

firm. Notice that the data values that will produce useful forecasts, even if they exist,
may not be apparent at the beginning of the process and may or may not be identified
as the process evolves. In other words, the initial efforts may turn out to be useless and
another approach required.
The results of the forecasting efforts for the two examples discussed here are not
shown, as they require topics that are described throughout the text. Look for the tech-
niques to be applied to these data. For the moment, we hope these examples illustrate
the forecasting effort that real managers face.

Example 1 Alomega Food Stores

Alomega Food Stores is a retail food provider with 27 stores in a midwestern state. The
company engages in various kinds of advertising and, until recently, had never studied the
effect its advertising dollars have on sales, although some data had been collected and
stored for 3 years.
The executives at Alomega decided to begin tracking their advertising efforts along
with the sales volumes for each month. Their hope was that after several months the col-
lected data could be examined to possibly reveal relationships that would help in determin-
ing future advertising expenditures.
The accounting department began extending its historical records by recording the
sales volume for each month along with the advertising dollars for both newspaper ads and
TV spots. They also recorded both sales and advertising values that had been lagged for one
and two months. This was done because some people on the executive committee thought
that sales might depend on advertising expenditures in previous months rather than in the
month the sales occurred.
The executives also believed that sales experienced a seasonal effect. For this reason, a
dummy or categorical variable was used to indicate each month. In addition, they wondered
about any trend in sales volume.
Finally, the executives believed that Alomega’s advertising dollars might have an effect
on its major competitors’ advertising budgets the following month. For each following
month, it was decided that competitors’ advertising could be classified as a (1) small amount,
(2) a moderate amount, or (3) a large amount.
After a few months of collecting data and analyzing past records, the accounting
department completed a data array for 48 months using the following variables:

• Sales dollars
• Newspaper advertising dollars
• TV advertising dollars
• Month code where January ⫽ 1, February ⫽ 2, through December ⫽ 12
• A series of 11 dummy variables to indicate month
• Newspaper advertising lagged one month
• Newspaper advertising lagged two months
• TV advertising lagged one month
• TV advertising lagged two months
• Month number from 1 to 48
• Code 1, 2, or 3 to indicate competitors’ advertising efforts the following month

Alomega managers, especially Julie Ruth, the company president, now want to learn
anything they can from the data they have collected. In addition to learning about
the effects of advertising on sales volumes and competitors’ advertising, Julie wonders
about any trend and the effect of season on sales. However, the company’s production
manager, Jackson Tilson, does not share her enthusiasm. At the end of the forecasting
planning meeting, he makes the following statement: “I’ve been trying to keep my
mouth shut during this meeting, but this is really too much. I think we’re wasting a lot of
people’s time with all this data collection and fooling around with computers. All you have
to do is talk with our people on the floor and with the grocery store managers to understand
what’s going on. I’ve seen this happen around here before, and here we go again. Some
of you people need to turn off your computers, get out of your fancy offices, and talk with a
few real people.”

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 Introduction to Forecasting

Example 1.2 Large Web-based Retailer

One of the goals of a large Internet-based retailer is to be the world’s most consumer-
centric company. The company recognizes that the ability to establish and maintain long-
term relationships with customers and to encourage repeat visits and purchases depends, in
part, on the strength of its customer service operations. For service matters that cannot be
handled using website features, customer service representatives located in contact centers
are available 24 hours a day to field voice calls and emails.
Because of its growing sales and its seasonality (service volume is relatively low in the
summer and high near the end of the year), a challenge for the company is to appropriately
staff its contact centers. The planning problem involves making decisions about hiring and
training at internally managed centers and about allocating work to outsourcers based on
the volume of voice calls and emails. The handling of each contact type must meet a targeted
service level every week.
To make the problem even more difficult, the handling time for each voice call and
email is affected by a number of contact attributes, including type of product, customer, and
purchase type. These attributes are used to classify the contacts into categories: in this case,
one “primary” category and seven “specialty” categories. Specific skill sets are needed to
resolve the different kinds of issues that arise in the various categories. Since hiring and
training require a 6-week lead time, forecasts of service contacts are necessary in order to
have the required number of service representatives available 24 hours a day, 7 days a week
throughout the year.
Pat Niebuhr and his team are responsible for developing a global staffing plan for the
contact centers. His initial challenge is to forecast contacts for the primary and specialty cat-
egories. Pat must work with monthly forecasts of total orders (which, in turn, are derived
from monthly revenue forecasts) and contacts per order (CPO) numbers supplied by the
finance department. Pat recognizes that contacts are given by

Contacts ⫽ Orders ⫻ CPO

For staff planning purposes, Pat must have forecasts of contacts on a weekly basis.
Fortunately, there is a history of actual orders, actual contacts, actual contacts per order, and
other relevant information, in some cases, recorded by day of the week. This history is
organized in a spreadsheet. Pat is considering using this historical information to develop
the forecasts he needs.

Summary
The purpose of a forecast is to reduce the range of uncertainty within which manage-
ment judgments must be made. This purpose suggests two primary rules to which the
forecasting process must adhere:

1. The forecast must be technically correct and produce forecasts accurate enough to
meet the firm’s needs.
2. The forecasting procedure and its results must be effectively presented to manage-
ment so that the forecasts are used in the decision-making process to the firm’s
advantage; results must also be justified on a cost-benefit basis.

Forecasters often pay particular attention to the first rule and expend less effort on the
second. Yet if well-prepared and cost-effective forecasts are to benefit the firm, those
who have the decision-making authority must use them. This raises the question of
what might be called the “politics” of forecasting. Substantial and sometimes major
expenditures and resource allocations within a firm often rest on management’s view
of the course of future events. Because the movement of resources and power within
an organization is often based on the perceived direction of the future (forecasts), it is
not surprising to find a certain amount of political intrigue surrounding the forecasting
process. The need to be able to effectively sell forecasts to management is at least as
important as the need to be able to develop the forecasts.

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 Introduction to Forecasting

The remainder of this text discusses various forecasting models and procedures.
First, we review basic statistical concepts and provide an introduction to correlation
and regression analysis.

CASES

CASE 1 MR. TUX

John Mosby owns several Mr. Tux rental stores, most long-term debt. He has sources for both types of
of them in the Spokane, Washington, area.3 His growth financing, but investors and bankers are
Spokane store also makes tuxedo shirts, which he dis- interested in a concrete way of forecasting future
tributes to rental shops across the country. Because sales. Although they trust John, his word that the
rental activity varies from season to season due to future of his business “looks great” leaves them
proms, reunions, and other activities, John knows that uneasy.
his business is seasonal. He would like to measure this As a first step in building a forecasting model,
seasonal effect, both to assist him in managing his John directs one of his employees, McKennah Lane,
business and to use in negotiating a loan repayment to collect monthly sales data for the past several
with his banker. years. Various techniques are used to forecast these
Of even greater interest to John is finding a way sales data for Mr. Tux and John Mosby attempts to
of forecasting his monthly sales. His business contin- choose the forecasting technique that will best meet
ues to grow, which, in turn, requires more capital and his needs.

CASE 2 CONSUMER CREDIT

COUNSELING

Consumer Credit Counseling (CCC), a private, non- financial difficulties or who want to improve their
profit corporation, was founded in 1982.4 The pur- money management skills. Money management
pose of CCC is to provide consumers with assistance educational programs are provided for schools, com-
in planning and following budgets, with assistance in munity groups, and businesses. A debt management
making arrangements with creditors to repay delin- program is offered as an alternative to bankruptcy.
quent obligations, and with money management Through this program, CCC negotiates with credi-
education. tors on behalf of the client for special payment
Private financial counseling is provided at no arrangements. The client makes a lump-sum pay-
cost to families and individuals who are experiencing ment to CCC that is then disbursed to creditors.

3We are indebted to John Mosby, the owner of Mr. Tux rental stores, for his help in preparing this case.
4We are indebted to Marv Harnishfeger, executive director of Consumer Credit Counseling of Spokane, and
Dorothy Mercer, president of its board of directors, for their help in preparing the case. Dorothy is a former
M.B.A. student of JH who has consistently kept us in touch with the use of quantitative methods in the real
world of business.

10
 Introduction to Forecasting

CCC has a blend of paid and volunteer staff; in A major portion of corporate support comes
fact, volunteers outnumber paid staff three to one. from a local utility that provides funding to support
Seven paid staff provide management, clerical sup- a full-time counselor position as well as office space
port, and about half of the counseling needs for for counseling at all offices.
CCC. Twenty-one volunteer counselors fulfill the In addition, client fees are a source of funding.
other half of the counseling needs of the service. Clients who participate in debt management pay a
CCC depends primarily on corporate funding to monthly fee of $15 to help cover the administrative
support operations and services. The Fair Share cost of this program. (Fees are reduced or waived
Funding Program allows creditors who receive pay- for clients who are unable to afford them.)
ments from client debt management programs to This background will be used as CCC faces diffi-
donate back to the service a portion of the funds cult problems related to forecasting important
returned to them through these programs. variables.

Minitab Applications

Minitab is a sophisticated statistical program that improves with each release.

Described here is Release 15.
Figure 1 shows you four important aspects of Minitab. The menu bar is where you
choose commands. For instance, click on Stat and a pull-down menu appears that con-
tains all of the statistical techniques available. The toolbar displays buttons for com-
monly used functions. Note that these buttons change depending on which Minitab
window is open. There are two separate windows on the Minitab screen: the data win-
dow, where you enter, edit, and view the column data for each worksheet; and the ses-
sion window, which displays text output, such as tables of statistics.
Specific instructions will be given to enable you to enter data into the Minitab
spreadsheet and to activate forecasting procedures to produce needed forecasts.

FIGURE 1 Basic Minitab Screen

Menu bar
Toolbar

Session
window

Data
window

11
 Introduction to Forecasting

Menu bar
Toolbar

Formula
bar

Worksheet

FIGURE 2 Basic Excel Screen

Excel Applications

Excel is a popular spreadsheet program that is frequently used for forecasting. Figure 2
shows the opening screen of Version 2003. Data are entered in the rows and columns of
the spreadsheet, and then commands are issued to perform various operations on the
entered data.
For example, annual salaries for a number of employees could be entered into col-
umn A and the average of these values calculated by Excel. As another example,
employee ages could be placed in column B and the relationship between age and
salary examined.
There are several statistical functions available on Excel that may not be on the
drop-down menus on your screen. To activate these functions, click on the following:

Tools>Add-Ins

The Add-Ins dialog box appears. Select Analysis ToolPak and click on OK.
It is strongly recommended that an Excel add-in be used to help with the multi-
tude of statistical computations required by the forecasting techniques discussed in
this text.

References
Bernstein, P. L. Against the Gods: The Remarkable Chase, C. W., Jr. “Selecting the Appropriate
Story of Risk. New York: Wiley, 1996. Forecasting Method.” Journal of Business
Carlberg, C. “Use Excel’s Forecasting to Get Forecasting 15 (Fall 1997): 2.
Terrific Projections.” Denver Business Journal 47 Diebold, F. X. Elements of Forecasting, 3rd ed.
(18) (1996): 2B. Cincinnati, Ohio: South-Western, 2004.

12
 Introduction to Forecasting

Georgoff, D. M., and R. G. Mardick. “Manager’s Newbold, P., and T. Bos. Introductory Business and
Guide to Forecasting.” Harvard Business Review Economic Forecasting, 2nd ed. Cincinnati, Ohio:
1 (1986): 110–120. South-Western, 1994.
Hogarth, R. M., and S. Makridakis. “Forecasting and Ord, J. K., and S. Lowe. “Automatic Forecasting.”
Planning: An Evaluation.” Management Science American Statistician 50 (1996): 88–94.
27 (2) (1981): 115–138. Perry, S. “Applied Business Forecasting.”
Hyndman, R. J., and J. K. Ord, eds. “Special Issue: Management Accounting 72 (3) (1994): 40.
Twenty Five Years of Forecasting.” International Pindyck, R. S., and D. L. Rubinfeld. Econometric
Journal of Forecasting 22 (2006): 413–636. Models and Economic Forecasts, 4th ed. New
Levenbach, H., and J. P. Cleary. Forecasting Practice York: McGraw-Hill, 1998.
and Process for Demand Management. Belmont, Wright, G., and P. Ayton, eds. Judgemental
Calif.: Thomson Brooks/Cole, 2006. Forecasting. New York: Wiley, 1987.
Makridakis, S. “The Art and Science of Forecasting.”
International Journal of Forecasting 2 (1986): 15–39.

13
This page intentionally left blank
 EXPLORING DATA PATTERNS
AND AN INTRODUCTION TO
FORECASTING TECHNIQUES
One of the most time-consuming and difficult parts of forecasting is the collection of
valid and reliable data. Data processing personnel are fond of using the expression
“garbage in, garbage out” (GIGO). This expression also applies to forecasting. A fore-
cast can be no more accurate than the data on which it is based. The most sophisticated
forecasting model will fail if it is applied to unreliable data.
Modern computer power and capacity have led to an accumulation of an incred-
ible amount of data on almost all subjects. The difficult task facing most forecasters
is how to find relevant data that will help solve their specific decision-making
problems.
Four criteria can be applied when determining whether data will be useful:
1. Data should be reliable and accurate. Proper care must be taken that data are col-
lected from a reliable source with proper attention given to accuracy.
2. Data should be relevant. The data must be representative of the circumstances for
which they are being used.
3. Data should be consistent. When definitions concerning data collection change,
adjustments need to be made to retain consistency in historical patterns. This
can be a problem, for example, when government agencies change the mix or
“market basket” used in determining a cost-of-living index. Years ago personal
computers were not part of the mix of products being purchased by consumers;
now they are.
4. Data should be timely. Data collected, summarized, and published on a timely
basis will be of greatest value to the forecaster. There can be too little data (not
enough history on which to base future outcomes) or too much data (data from
irrelevant historical periods far in the past).
Generally, two types of data are of interest to the forecaster. The first is data col-
lected at a single point in time, be it an hour, a day, a week, a month, or a quarter. The
second is observations of data made over time. When all observations are from the
same time period, we call them cross-sectional data. The objective is to examine such
data and then to extrapolate or extend the revealed relationships to the larger popu-
lation. Drawing a random sample of personnel files to study the circumstances of the
employees of a company is one example. Gathering data on the age and current
maintenance cost of nine Spokane Transit Authority buses is another. A scatter dia-
gram such as Figure 1 helps us visualize the relationship and suggests age might be
used to help in forecasting the annual maintenance budget.

From Chapter 3 of Business Forecasting, Ninth Edition. John E. Hanke, Dean W. Wichern.
Copyright © 2009 by Pearson Education, Inc. All rights reserved.

15
 Exploring Data Patterns and an Introduction to Forecasting Techniques

FIGURE 1 Scatter Diagram of Age and Maintenance Cost for

Nine Spokane Transit Authority Buses

Cross-sectional data are observations collected at a single point in time.

Any variable that consists of data that are collected, recorded, or observed over
successive increments of time is called a time series. Monthly U.S. beer production is an
example of a time series.

A time series consists of data that are collected, recorded, or observed over suc-
cessive increments of time.

EXPLORING TIME SERIES DATA PATTERNS

One of the most important steps in selecting an appropriate forecasting method for
time series data is to consider the different types of data patterns. There are typically
four general types of patterns: horizontal, trend, seasonal, and cyclical.
When data collected over time fluctuate around a constant level or mean, a
horizontal pattern exists. This type of series is said to be stationary in its mean. Monthly
sales for a food product that do not increase or decrease consistently over an extended
period would be considered to have a horizontal pattern.
When data grow or decline over several time periods, a trend pattern exists. Figure 2
shows the long-term growth (trend) of a time series variable (such as housing costs)
with data points one year apart. A linear trend line has been drawn to illustrate this
growth. Although the variable housing costs have not increased every year, the move-
ment of the variable has been generally upward between periods 1 and 20. Examples of
the basic forces that affect and help explain the trend of a series are population growth,
price inflation, technological change, consumer preferences, and productivity increases.

16
Exploring Data Patterns and an Introduction to Forecasting Techniques

25

Cyclical Peak

20

Cost
15
Cyclical Valley
Trend Line

10

0 10 20
Year

FIGURE 2 Trend and Cyclical Components of an Annual

Time Series Such as Housing Costs

Many macroeconomic variables, like the U.S. gross national product (GNP),
employment, and industrial production exhibit trendlike behavior. Figure 10 contains
another example of a time series with a prevailing trend. This figure shows the growth
of operating revenue for Sears from 1955 to 2004.

The trend is the long-term component that represents the growth or decline in
the time series over an extended period of time.

When observations exhibit rises and falls that are not of a fixed period, a cyclical
pattern exists. The cyclical component is the wavelike fluctuation around the trend that
is usually affected by general economic conditions. A cyclical component, if it exists,
typically completes one cycle over several years. Cyclical fluctuations are often influ-
enced by changes in economic expansions and contractions, commonly referred to as
the business cycle. Figure 2 also shows a time series with a cyclical component. The
cyclical peak at year 9 illustrates an economic expansion and the cyclical valley at year
12 an economic contraction.

The cyclical component is the wavelike fluctuation around the trend.

When observations are influenced by seasonal factors, a seasonal pattern exists.

The seasonal component refers to a pattern of change that repeats itself year after year.
For a monthly series, the seasonal component measures the variability of the series
each January, each February, and so on. For a quarterly series, there are four seasonal
elements, one for each quarter. Figure 3 shows that electrical usage for Washington

17
 Exploring Data Patterns and an Introduction to Forecasting Techniques

Electrical Usage for Washington Water Power: 1980 –1991

1,100

1,000

900

Kilowatts
800

700

600

500

1980 1982 1984 1986 1988 1990

Year

FIGURE 3 Electrical Usage for Washington Water Power

Company, 1980–1991

Water Power residential customers is highest in the first quarter (winter months) of
each year. Figure 14 shows that the quarterly sales for Coastal Marine are typically low
in the first quarter of each year. Seasonal variation may reflect weather conditions,
school schedules, holidays, or length of calendar months.

The seasonal component is a pattern of change that repeats itself year after year.

EXPLORING DATA PATTERNS WITH AUTOCORRELATION ANALYSIS

When a variable is measured over time, observations in different time periods are fre-
quently related or correlated. This correlation is measured using the autocorrelation
coefficient.

Autocorrelation is the correlation between a variable lagged one or more time

periods and itself.

Data patterns, including components such as trend and seasonality, can be studied
using autocorrelations. The patterns can be identified by examining the autocorrela-
tion coefficients at different time lags of a variable.
The concept of autocorrelation is illustrated by the data presented in Table 1. Note
that variables Yt - 1 and Yt - 2 are actually the Y values that have been lagged by one and
two time periods, respectively. The values for March, which are shown on the row for
time period 3, are March sales, Yt = 125; February sales, Yt - 1 = 130; and January sales,
Yt - 2 = 123.

18
Exploring Data Patterns and an Introduction to Forecasting Techniques

TABLE 1 VCR Data for Example 1

Time Original Data Y Lagged One Y Lagged Two

t Month Yt Period Yt-1 Periods Yt-2

1 January 123
2 February 130 123
3 March 125 130 123
4 April 138 125 130
5 May 145 138 125
6 June 142 145 138
7 July 141 142 145
8 August 146 141 142
9 September 147 146 141
10 October 157 147 146
11 November 150 157 147
12 December 160 150 157

Equation 1 is the formula for computing the lag k autocorrelation coefficient (rk)
between observations, Yt and Yt - k that are k periods apart.

a 1Yt - Y 21Yt - k - Y 2
t=k+1
rk = n k = 0, 1, 2, Á (1)
a 1Yt - Y 2
2
t=1

where
rk = the autocorrelation coefficient for a lag of k periods
Y = the mean of the values of the series
Yt = the observation in time period t
Yt - k = the observation k time periods earlier or at time period t - k

Example 1
Harry Vernon has collected data on the number of VCRs sold last year by Vernon’s Music
Store. The data are presented in Table 1. Table 2 shows the computations that lead to the cal-
culation of the lag 1 autocorrelation coefficient. Figure 4 contains a scatter diagram of the
pairs of observations (Yt, Yt - 1). It is clear from the scatter diagram that the lag 1 correlation
will be positive.
The lag 1 autocorrelation coefficient (r1), or the autocorrelation between Yt and Yt-1 ,
is computed using the totals from Table 2 and Equation 1. Thus,

a 1Yt-1 - Y 21Yt - Y2 843

t=1+1
r1 = n = = .572
a 1Yt - Y2
2 1,474
t=1

As suggested by the plot in Figure 4, positive lag 1 autocorrelation exists in this time
series. The correlation between Yt and Yt-1 or the autocorrelation for time lag 1, is .572. This
means that the successive monthly sales of VCRs are somewhat correlated with each other.
This information may give Harry valuable insights about his time series, may help him pre-
pare to use an advanced forecasting method, and may warn him about using regression
analysis with his data.

19
 Exploring Data Patterns and an Introduction to Forecasting Techniques

TABLE 2 Computation of the Lag 1 Autocorrelation Coefficient

for the Data in Table 1

1Yt - Y 2 1Yt - 1 - Y 2 1Y - Y 22 (Yt - Y 2 (Yt–1 — Y )

—
Time t Yt Yt - 1
1 123 — –19 — 361 —
2 130 123 -12 -19 144 228
3 125 130 -17 -12 289 204
4 138 125 -4 -17 16 68
5 145 138 3 -4 9 -12
6 142 145 0 3 0 0
7 141 142 -1 0 1 0
8 146 141 4 -1 16 -4
9 147 146 5 4 25 20
10 157 147 15 5 225 75
11 150 157 8 15 64 120
12 160 150 18 8 324 144
Total 1,704 0 1,474 843
1,704
Y = = 142
12
843
r1 = = .572
1,474

The second-order autocorrelation coefficient (r2), or the correlation between Yt and

Yt-2 for Harry’s data, is also computed using Equation 1.

a 1Yt - Y21Yt - 2 - Y2 682

t=2+1
r2 = n = = .463
a 1Yt - Y2
2 1,474
t=1
Yt

Yt⫺1

FIGURE 4 Scatter Diagram for Vernon’s Music Store Data for

Example 1

20
Exploring Data Patterns and an Introduction to Forecasting Techniques

It appears that moderate autocorrelation exists in this time series lagged two time peri-
ods. The correlation between Yt and Yt - 2, or the autocorrelation for time lag 2, is .463. Notice
that the autocorrelation coefficient at time lag 2 (.463) is less than the autocorrelation coef-
ficient at time lag 1 (.572). Generally, as the number of time lags (k) increases, the magni-
tudes of the autocorrelation coefficients decrease.

Figure 5 shows a plot of the autocorrelations versus time lags for the Harry Vernon
data used in Example 1. The horizontal scale on the bottom of the graph shows each time
lag of interest: 1, 2, 3, and so on.The vertical scale on the left shows the possible range of an
autocorrelation coefficient, -1 to 1. The horizontal line in the middle of the graph repre-
sents autocorrelations of zero.The vertical line that extends upward above time lag 1 shows
an autocorrelation coefficient of .57, or r1 = .57. The vertical line that extends upward
above time lag 2 shows an autocorrelation coefficient of .46, or r2 = .46. The dotted lines
and the T (test) and LBQ (Ljung-Box Q) statistics displayed in the Session window will be
discussed in Examples 2 and 3. Patterns in a correlogram are used to analyze key features
of the data, a concept demonstrated in the next section. The Minitab computer package
(see the Minitab Applications section at the end of the chapter for specific instructions) can
be used to compute autocorrelations and develop correlograms.

The correlogram or autocorrelation function is a graph of the autocorrelations for

various lags of a time series.

FIGURE 5 Correlogram or Autocorrelation Function for the Data

Used in Example 1

21
 Exploring Data Patterns and an Introduction to Forecasting Techniques

With a display such as that in Figure 5, the data patterns, including trend and sea-
sonality, can be studied. Autocorrelation coefficients for different time lags for a vari-
able can be used to answer the following questions about a time series:
1. Are the data random?
2. Do the data have a trend (are they nonstationary)?
3. Are the data stationary?
4. Are the data seasonal?
If a series is random, the autocorrelations between Yt and Yt - k for any time lag k
are close to zero. The successive values of a time series are not related to each other.
If a series has a trend, successive observations are highly correlated, and the auto-
correlation coefficients typically are significantly different from zero for the first sev-
eral time lags and then gradually drop toward zero as the number of lags increases.
The autocorrelation coefficient for time lag 1 will often be very large (close to 1). The
autocorrelation coefficient for time lag 2 will also be large. However, it will not be as
large as for time lag 1.
If a series has a seasonal pattern, a significant autocorrelation coefficient will occur
at the seasonal time lag or multiples of the seasonal lag. The seasonal lag is 4 for quar-
terly data and 12 for monthly data.
How does an analyst determine whether an autocorrelation coefficient is signifi-
cantly different from zero for the data of Table 1? Quenouille (1949) and others have
demonstrated that the autocorrelation coefficients of random data have a sampling dis-
tribution that can be approximated by a normal curve with a mean of zero and an
approximate standard deviation of 1> 1n. Knowing this, the analyst can compare the
sample autocorrelation coefficients with this theoretical sampling distribution and deter-
mine whether, for given time lags, they come from a population whose mean is zero.
Actually, some software packages use a slightly different formula, as shown in
Equation 2, to compute the standard deviations (or standard errors) of the autocorre-
lation coefficients. This formula assumes that any autocorrelation before time lag k is
different from zero and any autocorrelation at time lags greater than or equal to k is
zero. For an autocorrelation at time lag 1, the standard error 1> 1n is used.

k-1
1 + 2 a r 2i
SE1rk2 =
i=1
(2)
T n

where
SE1rk2 = the standard error 1estimated standard deviation2
of the autocorrelation at time lag k
ri = the autocorrelation at time lag i
k = the time lag
n = the number of observations in the time series
This computation will be demonstrated in Example 2. If the series is truly random,
almost all of the sample autocorrelation coefficients should lie within a range specified
by zero, plus or minus a certain number of standard errors. At a specified confidence
level, a series can be considered random if each of the calculated autocorrelation coef-
ficients is within the interval about 0 given by 0 ± t × SE(rk), where the multiplier t is an
appropriate percentage point of a t distribution.

22
Exploring Data Patterns and an Introduction to Forecasting Techniques

Although testing each rk to see if it is individually significantly different from 0 is

useful, it is also good practice to examine a set of consecutive rk’s as a group. We can
use a portmanteau test to see whether the set, say, of the first 10 rk values, is signifi-
cantly different from a set in which all 10 values are zero.
One common portmanteau test is based on the Ljung-Box Q statistic (Equation
3). This test is usually applied to the residuals of a forecast model. If the autocorre-
lations are computed from a random (white noise) process, the statistic Q has a chi-
square distribution with m (the number of time lags to be tested) degrees of free-
dom. For the residuals of a forecast model, however, the statistic Q has a chi-square
distribution with the degrees of freedom equal to m minus the number of parame-
ters estimated in the model. The value of the Q statistic can be compared with the
chi-square table (Table 4 in Appendix: Tables) to determine if it is larger than we
would expect it to be under the null hypothesis that all the autocorrelations in the
set are zero. Alternatively, the p-value generated by the test statistic Q can be com-
puted and interpreted. The Q statistic is given in Equation 3. It will be demonstrated
in Example 3.

m
r 2k
Q = n1n + 22 a (3)
k=1 n - k

where
n = the number of observations in the time series
k = the time lag
m = the number of time lags to be tested
rk = the sample autocorrelation function of the residuals lagged k time periods

Are the Data Random?

A simple random model, often called a white noise model, is displayed in Equation 4.
Observation Yt is composed of two parts: c, the overall level, and ␧t, which is the ran-
dom error component. It is important to note that the ␧t component is assumed to be
uncorrelated from period to period.

Yt = c + ␧t (4)

Are the data in Table 1 consistent with this model? This issue will be explored in
Examples 2 and 3.

Example 2
A hypothesis test is developed to determine whether a particular autocorrelation coefficient
is significantly different from zero for the correlogram shown in Figure 5. The null and alter-
native hypotheses for testing the significance of the lag 1 population autocorrelation coeffi-
cient are

H0 : r1 = 0
H1 : r1 Z 0

If the null hypothesis is true, the test statistic

r1 - r1 r1 - 0 r1
SE1r12 SE1r12 SE1r12
t = = = (5)

23
 Exploring Data Patterns and an Introduction to Forecasting Techniques

has a t distribution with df = n - 1. Here, n - 1 = 12 - 1 = 11, so for a 5% significance

level, the decision rule is as follows:

If t 6 2.2 or t 7 2.2, reject H0 and conclude the lag 1 autocorrelation is significantly

different from 0.

The critical values ⫾2.2 are the upper and lower .025 points of a t distribution with 11
degrees of freedom. The standard error of r1 is SE1r12 = 11>12 = 1.083 = .289, and the
value of the test statistic becomes

r1 .572
SE1r12
t = = = 1.98
.289

Using the decision rule above, H0 : r1 = 0 cannot be rejected, since -2.2 < 1.98 < 2.2.
Notice the value of our test statistic, t = 1.98, is the same as the quantity in the Lag 1 row
under the heading T in the Minitab output in Figure 5. The T values in the Minitab out-
put are simply the values of the test statistic for testing for zero autocorrelation at the
various lags.
To test for zero autocorrelation at time lag 2, we consider

H0 : r2 = 0
H1 : r2 Z 0

and the test statistic

r2 - r2 r2 - 0 r2
SE1r22 SE122 SE1r22
t = = =

Using Equation 2,

k-1 2-1
1 + 2 a r 2i 1 + 2 a r 2i
1 + 21.57222
SE1r22 = T
i=1 i=1 1.6544
= T = = = 1.138 = .371
n n Q 12 A 12

and

.463
t = = 1.25
.371

This result agrees with the T value for Lag 2 in the Minitab output in Figure 5.
Using the decision rule above, H0 : r1 = 0 cannot be rejected at the .05 level, since
-2.2 ⬍ 1.25 ⬍ 2.2. An alternative way to check for significant autocorrelation is to construct,
say, 95% confidence limits centered at 0. These limits for time lags 1 and 2 are as follows:

lag 1: 0 ; t.025 * SE1r12 or 0 ; 2.21.2892 : 1-.636, .6362

lag 2: 0 ; t.025 * SE1r22 or 0 ; 2.21.3712 : 1-.816, .8162

Autocorrelation significantly different from 0 is indicated whenever a value for rk falls out-
side the corresponding confidence limits. The 95% confidence limits are shown in Figure 5 by
the dashed lines in the graphical display of the autocorrelation function.

Example 3
Minitab was used to generate the time series of 40 pseudo-random three-digit numbers
shown in Table 3. Figure 6 shows a time series graph of these data. Because these data are
random (independent of one another and all from the same population), autocorrelations for

24
Another random document with
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its outlet in unsystematic and uncriticised imaginative construction.
Metaphysics they will certainly have, and if not conscious and
coherent, then unconscious and incoherent Metaphysics. The soul
that is not at rest in itself without some “sight of that immortal sea
which brought it hither,” if hindered from beholding the object of its
quest through the clear glass of rational reflection, will none the less
seek to discern it amid the distorting hazes and mists of superstition.
It is in such seekers after the Infinite that Metaphysics has its natural
and proper followers, and for them the study is its own justification
and its own reward. If a work like the present should prove of any
help to such students, whether by offering positive suggestions
which they can accept, or by assisting them to know definitely why
they reject its conclusions, it will perhaps have achieved as much as
its writer could reasonably expect.

Consult further:—F. H. Bradley, Appearance and Reality, chap. 27;

J. E. McTaggart, Studies m Hegelian Cosmology, chap. 9.

235. I use the epithet in its familiar Platonic sense. The “pure”
pleasure is that which is not dependent, in whole or in part, for its
pleasantness upon a previous ἔνδεια, or actual experience of craving
or desire. I do not mean, as Plato possibly did, that a “mixed”
pleasure, preceded by such ἔνδεια, is a contrast-effect without
positive quality of its own.
236. Compare the argument of Appearance and Reality, chap. 26,
pp. 469-485 (1st ed.), and the famous scholium to Prop. 17 of part 1
of Spinoza’s Ethics, where it is contended that “if intellect and volition
belong to the eternal essence of God, each of these attributes must
at least be understood in a different sense from the current.”
237. I say “finite or infinite” advisedly. The mystic’s condemnation
of the relational scheme as inadequate to express the full nature of
the real, holds good just as much in application to actual finite
experience as in application to the ultimate whole. We may say not
only of “God,” but of human persons, that they are much more than
the “union of thought and will” as such. And in personal human love,
no less than in the saint’s “beatific vision” or the philosopher’s
“intellectual love of God,” we have a type of experience which may
for some psychological purposes be analysed into a combination of
ideational and volitional processes, but emphatically does not, in its
concrete existence, consist of a synthesis of actual ideas and actual
volitions. See ante, p. 152.
238. Studies in Hegelian Cosmology, p. 292.
 INDEX

Absolute, meaning of, 53 ff.;

general character of, 60 ff.;
not unknowable, 71 ff.;
not a “self,” 343 ff.;
is it a society? 100, 347 ff.;
a spiritual individual, 98 ff.;
not necessarily the same as “God,” 399 ff.;
not “union of thought and will,” 409 ff.
Activity not identical with conation, 55;
and causation, 169;
empirical nature of, 189.
Agnosticism, 68, 69, 71, 72;
how far justifiable, 412.
Appearance and Reality, connection between, 105 ff.
Aristotle, 6, 42, 97, 266, 361, 386.
Attention, selective, 55, 66, 80;
“span” of, 226, 244.
Avenarius, 35, 45, 80, 121, 174, 298 ff. 315.

Baldwin, J. M., 206.

Berkeley, 26, 64 ff., 75, 184, 185, 201 ff.
Body, my own, as describable object, 282.
Body, my own, and others, 203 ff.
Body and Soul, theories of, 313 ff.;
 in what sense the same, 332.
Bosanquet, B., 19, 26, 164.
Bradley, F. H., 9, 11, 23, 26, 55, 67, 88, 90, 131, 146, 199, 227, 243,
259, 289, 318, 326, 335, 338, 355, 364, 370, 384, 411.

Causation, 165 ff.;

cause not identical with ground, 166;
causation a postulate, 167 ff.;
popular as distinguished from scientific sense, 169;
causation and the indefinite regress, 177 ff.;
continuity of causation, 171 ff.;
Immanent and Transeunt Causality, 183 ff.;
psychophysical causation, 322 ff.
Causes, Plurality of, 180 ff.
Chance, “pure,” meaning of, 231, 232;
chance and “free-will,” 378.
Change, 158-164.
Character and freedom, 374.
Choice and motives, 373.
Consciousness, a misleading term, 79.
Consequence (see Ground).
Continuity, nature of, 171
(see Causation);
continuity of space and time, 244, 250.
Contradiction, principle of, 19 ff.
Cosmology Rational, nature of, 43-49, 192-197.
Couturat, L., 149, 260.

Dedekind, 116, 149, 171.

Degrees of Reality, 108 ff.
Descartes, 128, 185, 318, 400 ff.
Description, as scientific ideal, 174;
in physical Science, 280 ff.;
in Psychology, 308 ff.
Determinism, 370-376.
Discontinuity of teleological series, 311.
Distance in space and time, 250.

Ends in Nature, 272, 405, 406.

Energy, conservation of, 292;
kinetic and non-kinetic, 291;
doctrine of, and psychophysical interaction, 322 ff.
Epiphenomenalism, 317, 318-320.
Epistemology and Metaphysics, 16.
Evil, problem of, 391 ff., 395 ff.
Evolution, not identical with mere change, 267;
implies real ends, 268 ff.;
is of finite beings only, 274 ff.;
implies real progress and degeneration, 275;
originates new individuals, 276.
Experience, what, 23 ff., 33 ff.;
“pure,” 35, 54.

Feeling, 23 ff., 55;

in the Absolute, 467 ff.
Freedom, meaning of, 359 ff.
Free-will, origins of belief in, 361 ff.

Geulincx, 184, 185, 186, 317.

Gibson, W. R. B., 288, 329, 366.
God, proofs of being of, 400 ff.
Ground and Consequence, meaning of principle of, 164, 165.
Harmony, Pre-established, 187, 317.
Hegel, 40 ff., 42 ff., 391, 401.
Herbart, 39, 42, 68.
Hobhouse, L. T., 74, 137, 138, 199.
Hume, 29, 7, 133, 169, 172, 183, 400 ff.

Identity, Psychophysical, doctrine of, 102, 321, 331, 332.

Identity, a teleological concept, 335.
(See also Unity of Thing).
Imitation, significance of, for personality, 206.
Immanent Causality, 183 ff.
Immediacy, 32.
“Immortality,” 354 ff.
Indeterminism, 376-379.
Individuality, nature of, 57, 98 ff.;
degrees of, 109 ff.;
infinite and finite, 115 ff.
Infinite Regress, 148 ff., 156;
in space and time, 255 ff., 259;
in causal relation, 177.
Infinity, meaning of, 116.
Interaction, Psychophysical, 317, 329-331.
Introjection, meaning of, 81;
origin of, 81, 299 ff.;
justification of, 301 ff.

James, W., 53, 91, 318, 370, 383, 390, 400.

Kant, 11, 24, 39, 43, 69, 134, 188, 242 ff., 259, 359, 366, 387, 400 ff.

Law, meaning of, 218 ff.

Laws in Nature, 196, 229.
Leibnitz, 68, 82, 86, 91 ff., 117, 187 ff., 317, 366, 401, 404.
Locke, 128, 136, 200, 318, 353, 365, 366.
Lotze, 41, 42, 133, 224, 289.

Mach, E., 174, 175, 192, 223, 228, 283, 290.

Machine, nature of a, 236, 237.
McTaggart, J. E., 345, 357, 391, 398, 413.
Malebranche, 184, 185, 317.
Mass, definition of, 289;
conservation of, 290;
a relative concept, 290, 291.
Matter, meaning of, 198 ff.
Mechanical view of Nature, 233 ff., 237 ff., 283 ff.;
postulates of, 284, 292 ff.
Mechanism, meaning of, 196, 237 ff.
Method of Metaphysics, 38 ff.
Mill, J. S., 24, 180 ff., 370.
Monadism, 86, 91, 94.
Monism, 85.
Münsterberg, H., 45, 67, 198, 283, 303 ff., 315, 318, 321, 324, 329.
Mysticism, 14, 33, 153;
in what sense justifiable, 413.

Necessity and causal relation, 183.

Newton, 128, 200.
Nietzsche, 276.
Number-series, 151 ff., 248-250, 259.
Occasionalism, 184, 317.
Ontology, character of, 42.
Order, a teleological concept, 118;
order in space and time, 251.
Organism, nature of a, 96.

Parallelism, Psychophysical, 317, 320-329.

Pearson, K., 75, 290.
Phenomenalism, 10, 136.
Physical order, nature of the, 194 ff., 198, 208, 282.
Plato, 3, 55, 77, 95, 276, 366, 386, 393, 398, 409.
Pleasure-pain, 55, 344.
Plotinus, 398.
Pluralism, 86 ff.
Position not a principle of individuation, 58;
relativity of, 253.
Pragmatism, 317.
Prediction in science, 219 ff.
Progress not infinite, 387-389.
Psychical order, nature of the, 298 ff.
Psychology, character of, as a science, 296 ff.
Psychology and Physiology, 303 ff.
Psychology, Rational, nature of, 43 ff.
Purpose, nature of, 55 ff.

Qualities, primary and secondary, 128 ff.

Quality and relation, 140 ff.
Quality and substance, 128 ff.
Quality, spatial and temporal, 244.

Rashdall, H., 347, 393, 400.

Realism, Agnostic, 68, 71, 72;
Dogmatic, 69, 72-75.
Relation and quality, 140 ff.
Relations and relatedness, 155.
Religion, metaphysical presuppositions of, 389 ff.
Responsibility and the self, 335.
Royce, J., 13, 33, 51, 56, 76, 116, 145, 148 ff., 206, 226, 239, 263,
270, 277, 307, 398.
Russell, B., 36, 58, 91, 142, 189, 243, 250, 253, 404.

Self, 98, 107;

nature of, 334-340;
a teleological concept, 335;
temporal character of, 341, 342.
Self-consciousness, genuine and fictitious, 79.
Sidgwick, H., 130, 359, 370.
Space, perceptual, 243-245;
conceptual genesis of, 245-249;
infinity of, 247;
divisibility of, 248;
continuity of, 248, 250;
homogeneity of, 251;
relativity of, 251;
is it one or many? 253, 257;
is not ultimate, 254-257;
antinomies of, 259 ff.;
of what is it phenomenal? 260.
Spencer, H., 40, 68.
Spinoza, 62, 101 ff., 318, 399, 411.
Stout, G. F., 33, 67, 135, 154 ff., 208, 247, 318, 324, 332, 378.
Subjectivism, what, 75;
fallacy of, 76-81, 204 ff.
Substance, concept of, 128 ff.;
and quality, 128-140.
Sufficient Reason, principle of, 164.

Teleological description not impossible, 309.

Teleological series, discontinuity of, 311.
Teleology, nature of, 55, 99, 125, 287, 371 ff.;
in Psychology, 305 ff.;
in Biology, 308;
and Psychophysical Parallelism, 326 ff.
Thought and the Absolute, 61;
not ultimate, 409.
Time, perceptual, 243-245;
conceptual, genesis of, 245-249;
infinity of, 247;
divisibility of, 248;
continuity of, 248, 250;
homogeneity of, 251;
relativity of, 251;
is it one or many? 253, 257;
not ultimate, 254-257;
antinomies of, 259 ff.;
of what is it phenomenal? 262;
time and the self, 341, 344.
Truth, degrees of, 214.

Uniformities, statistical, 220 ff.

Uniformity in physical nature, 222, 227.
Unity of things teleological, 123-128.
Ward, J., 45, 64, 174, 225, 228, 289 318, 324, 326-328.
Whole and Part, category of, 96.
Will, nature of, 61, 118;
not ultimate, 410.
 Transcriber’s Note
Two words on the first line of p. 70 of this edition
(noted below) were missing (blank). They have been
supplied from the 5th edition, published in 1920.
On p. 226, a footnote at (226.42) refers to Mr. H. G.
Wells’s tale, The New Accumulator, which is certainly a
reference to his 1901 tale “The New Accelerator”.
On p. 340, the first paragraph refers to ‘two points’,
and prefaces the first with ‘(a)’. But there is no ‘(b)’ to
denote the second point. It seems likely that ‘(b)’ should
precede the next paragraph, or perhaps following the
introductory ‘Further’.
The Index reference to p. 467 for ‘Feeling in the
Absolute’ cannot be verified. The page does not exist,
and no other page can be identified with certainty.
Errors deemed most likely to be the printer’s have
been corrected, and are noted here. The references are
to the page and line in the original.
The most common error is missing punctuation: 6.14
purpose[.], 38.29 inquiry[.], 44.12 periphery[.], 44.41
other[.], 56.47 failure[.], 58.27 theory[.], 62.39
“purposive[”], 67.17 life[.], 67.19 subject[.], 79.46
“matter[”], 82.13 it[.], 88.40 exclusive[.], 89.41 facts[.],
99.13 purpose[.], 108.24 admitted[.], 128.23
[“]substance”, 143.19 arisen[.], 215.10 [“]Nature, 224.22
purpose[.], 236.14 based[.], 251.45 series[.], 274.16
advance[.], 320.32 fatum[.], 361.22 considerations[.],
390.5 “temperament[”], 410.22 thing[.]
The name of Professor Hugo Münsterberg is spelled
variably as Münsterberg, Munsterberg, and occasionally
with a partial umlaut. The spelling has been rendered as
Münsterberg to facilitate text searches at 215.5, 305.15,
315.8, 329.40, 418.3.
Other corrected errors are:
xviii.11 to a[s]certain Inserted.
xxiii.12 The concept of [e]volution Restored.
37.9 carry out ou[t/r] programme Replaced.
46.46 Grundz[u/ü]ge der Psychologie Replaced.
66.44 on which it “works.[’/”] Replaced.
70.1.1 a modification of your Restored.
[experience].
70.1.2 to ask what [you] mean Restored.
82.22 to know your own meaning[./,] Replaced.
134.42 too diffuse and technical[,/.] Replaced.
136.24 does no[t] destroy Restored.
149.12 in our illustration 12, [23/22], 32 ... Replaced.
180.46 increases indefinitely[)]. Removed.
215.6 Grundz[u/ü]ge der Psychologie Replaced.
215.12 [“]J. Ward Removed.
229.16 deal only with the problem[,/.] Replaced.
306.4 the physical order was Inserted.
const[r]ucted
318.8 H[o/ö]ffding Replaced.
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