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For purpose of calculating the safety stock of a particular item, we are interested in having an estimate of the MAD or MSE of forecast errors.
Q.1. For purpose of calculating the safety stock of a particular item, we are interested in having an estimate of the MAD or MSE of forecast errors. No historical forecasts are available, but historical monthly demand data for three years are available. An analyst on your staff has proposed using the MAD with the following procedure for estimating it:
Step 1 Plot the three years of data
Step 2 Fit the best straight line to it
Step 3 For each month find the absolute deviation
Where is the actual demand in month t and is the value read off the straight line – found at Step 2 – at month t.
STEP 4 MAD = average value of | over the 36 months.
- Questions needs to be answered :
- Discuss why the MAD found by this procedure might be lower than actually achievable by statistical forecasting.
- Discuss why the MAD found by this procedure might be substantially higher than that actually achievable by a forecasting procedure.
- Why might the MSE be a better choice?
