Dr. Saeed A. D.

Alghamdi

Statistics Department
Faculty of Sciences
Building 90, Room 26F41
King Abdulaziz University
http://saalghamdy.kau.edu.sa
 Statistical Techniques in
Business & Economics
Fourteenth Edition

Douglas A. Lind
William G. Marchal
Samuel A.Wathen

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

 Correlation and
Linear Regression
Chapter 13

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning Objectives
LO1 Define the terms used in correlation analysis.
LO2 Calculate, test, and interpret the relationship between two
variables using the correlation coefficient.
LO3 Apply regression analysis to estimate the linear relationship
between two variables
LO4 Interpret the regression analysis.
LO5 Calculate and interpret confidence and prediction intervals.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-4
 LO1 Define the terms used in correlation analysis.

Correlation Analysis
EXAMPLES
1. Is there a relationship between the amount Healthtex spends per month on advertising
and its sales in the month?
2. Can we base an estimate of the cost to heat a home in January on the number of square
feet in the home?
3. Is there a relationship between the miles per gallon achieved by large pickup trucks and
the size of the engine?
4. Is there a relationship between the number of hours that students studied for an exam
and the score earned?

 Correlation Analysis is the study of the relationship between variables. It is also

defined as group of techniques to measure the association between two variables.

 Scatter Diagram is a chart that portrays the relationship between the two variables. It
is the usual first step in correlations analysis

 The Dependent Variable is the variable being predicted or estimated.

 The Independent Variable provides the basis for estimation. It is the predictor
variable.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-5
 LO1 Define the terms used in correlation analysis.

Scatter Diagram Example

The sales manager of Copier Sales of America, which has a large sales force throughout
the United States and Canada, wants to determine whether there is a relationship
between the number of sales calls made in a month and the number of copiers sold
that month. The manager selects a random sample of 10 representatives and determines
the number of sales calls each representative made last month and the number of copiers
sold.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-6
 LO2 Calculate, test and interpret the relationship between two variables using the correlation coefficient.

The Coefficient of Correlation, r

The Coefficient of Correlation (r) is a measure of the strength of the relationship
between two variables.

 It shows the direction and strength

of the linear relationship between
two interval or ratio-scale variables
 It can range from -1.00 to +1.00.
 Values close to 0.0 indicate weak
correlation.
 Negative values indicate an
inverse relationship and positive
values indicate a direct
relationship.
 Values of -1.00 or +1.00 indicate
perfect and strong correlation.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-7
 LO2 Calculate, test and interpret the relationship between two variables using the correlation coefficient.

Correlation Coefficient - Example

Using the Copier Sales of America data Using the formula:
which its scatterplot is shown below,
compute the correlation coefficient.

How do we interpret a correlation of 0.759?

First, it is positive, so we see there is a direct
relationship between the number of sales calls and the
number of copiers sold. The value of 0.759 is fairly
close to 1.00, so we conclude that the association is
strong.
Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-8
 LO2 Calculate, test and interpret the relationship between two variables using the correlation coefficient.

The Coefficient of Determination, r2

The coefficient of determination (r2) is the proportion of the total variation in the
dependent variable (Y) that is explained or accounted for by the variation in the
independent variable (X). It is the square of the coefficient of correlation.

 It ranges from 0 to 1.
 It does not give any information on the direction of the relationship between
the variables.

EXAMPLE
Using the Copier Sales of America data in the pervious example, compute and
interpret the coefficient of determination.
Regression Analysis
r² 0.576
r 0.759
Since the correlation coefficient is 0.759, then the coefficient of determination is
0.579 which means that 57.6% of the variation in the number of copiers sold is
explained or accounted for by the variation in the number of sales calls.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-9
 LO2 Calculate, test and interpret the relationship between two variables using the correlation coefficient.

Testing the Significance of the Correlation Coefficient

H0: ρ = 0 (the correlation in the population is 0)
H1: ρ ≠ 0 (the correlation in the population is not 0)

EXAMPLE
Using the Copier Sales of America data in the pervious example, test the significance of the
correlation coefficient at 5% significance level.

Regression output
variables coefficients std. error t (df=8) p-value
Intercept 18.9474 8.4988 2.229 .0563
c 1.1842 0.3591 3.297 .0109
The p-value is 0.0109 which is less than 0.05 indicating the rejection of H0. This means
that the correlation in the population is not zero. From a practical standpoint, it indicates to
the sales manager that there is a correlation with respect to the number of sales calls made
and the number of copiers sold in the population of salespeople.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-10
 LO3 Apply regression analysis to estimate the linear relationship between two variables.

Regression Analysis
In regression analysis we use the independent variable (X) to estimate the dependent
variable (Y).
 The relationship between the variables is linear.
 Both variables must be at least interval scale.
 The least squares criterion is used to determine the equation.

REGRESSION EQUATION An equation that expresses the linear relationship between

two variables.

LEAST SQUARES PRINCIPLE Determining a regression equation by minimizing the

sum of the squares of the vertical distances between the actual Y values and the
predicted values of Y.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-11
 LO3 Apply regression analysis to estimate the linear relationship between two variables.

Linear Regression Model

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-12
 LO4 Interpret the regression analysis.

Regression Equation - Example

Recall the example involving Copier Sales of Step 1 – Find the slope (b) of the line
America. The sales manager gathered
information on the number of sales calls made
and the number of copiers sold for a random
sample of 10 sales representatives.
Use the least squares method to determine a Step 2 – Find the y-intercept (a)
linear equation to express the relationship
between the two variables.
What is the expected number of copiers sold
by a representative who made 20 calls?

The regression equation is :

^
Y = a + bX
^
Y = 18.9476 + 1.1842 X
^
Y = 18.9476 + 1.1842(20)
^
Y = 42.6316

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-13
 LO4 Interpret the regression analysis.

Assumptions Underlying Linear Regression

 For each value of X, there is a group of Y values, and these Y values are
normally distributed.

 The means of these normal distributions of Y values all lie on the straight line of
regression.
 The standard deviations of these normal distributions are equal, and the best
estimate for it is the standard error of the estimate s y . x .
 The Y values are statistically independent. This means that in the selection of
a sample, the Y values chosen for a particular X value do not depend on the Y
values for any other X values.
Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-14
 LO4 Interpret the regression analysis.

The Standard Error of the Estimate

 The standard error of the estimate EXAMPLE
measures the scatter, or dispersion, of Recall the example involving Copier Sales of
the observed values around the line of America. The sales manager determined the least
regression squares regression equation is given below.
 Formulas used to compute the ^

standard error: Σ( Y − Y )2
s y .x =
n−2
784.211
= = 9.901
ΣY − aΣY − bΣXY
2
10 − 2
s y. x =
n−2
Std. Error 9.901

^
Σ(Y − Y ) 2
s y. x = Determine the standard error of estimate as a measure
n−2 of how well the values fit the regression line.
Compute the estimated y values using the regression
equation: ^
Y = 18.9476 + 1.1842 X
Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-15
 LO5 Calculate and interpret confidence and prediction intervals..

Confidence Interval and Prediction Interval Estimates of Y

• A confidence interval reports the mean value of Y for a given X.

• A prediction interval reports the range of values of Y for a particular value of X.

Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-16
 LO5 Calculate and interpret confidence and prediction intervals..

Confidence Interval - Example

We return to the Copier Sales of America illustration. Determine a 95 percent confidence
interval for all sales representatives who make 25 calls.

The regression equation is :

^
Y = 18.9476 + 1.1842 X
Step 1 – Compute the point estimate of Y ^
Y = 18.9476 + 1.1842( 25)
^
Step 2 – Find the value of t Y = 48.5526
 To find the t value, we need to first know the number of degrees of freedom. In this
case the degrees of freedom is n - 2 = 10 – 2 = 8.
 We set the confidence level at 95 percent.
 The value of t is 2.306.
( ) ∑( )
2
−
2
Step 3 – Compute X − X and X X
Step 4 – Substitute in the formula.
Thus, the 95 percent confidence interval for the
average sales of all sales representatives who make
25 calls is from 40.917 up to 56.188 copiers.
Predicted values for: s
95% Confidence Interval
Number Sales Calls Predicted lower upper
25 48.553 40.917 56.188
Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-17
 LO5 Calculate and interpret confidence and prediction intervals..

Prediction Interval Estimates of Y- Example

We return to the Copier Sales of America illustration. Determine a 95 percent prediction
interval for Sheila Baker, a West Coast sales representative who made 25 calls.
The regression equation is :
^
Step 1 – Compute the point estimate of Y Y = 18.9476 + 1.1842 X
^
Y = 18.9476 + 1.1842(25)
^
Y = 48.5526
Step 2 – Using the information computed earlier in the confidence interval estimation
example, use the formula:

Thus, if Sheila Baker makes 25 sales calls, the number of copiers she will sell will be
between about 24 and 73 copiers.
Predicted values for: s
95% Confidence Interval 95% Prediction Interval
Number Sales Calls Predicted lower upper lower upper
25 48.553 40.917 56.188 24.478 72.627
Modified by Dr. Saeed A. D. Alghamdi, Statistics Department, Faculty of Sciences, KAU 13-18