Statistics For Business and Economics: Simple Regression

Statistics for
Business and Economics

6th Edition
Chapter 12
Simple Regression
Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-1
Chapter Goals
After completing this chapter, you should be

able to:
 Explain the correlation coefficient and perform a
hypothesis test for zero population correlation
 Explain the simple linear regression model
 Obtain and interpret the simple linear regression
equation for a set of data
 Describe R2 as a measure of explanatory power of the
regression model
 Understand the assumptions behind regression
analysis
Chapter Goals
(continued)
After completing this chapter, you should be

able to:
 Explain measures of variation and determine whether
the independent variable is significant
 Calculate and interpret confidence intervals for the
regression coefficients
 Use a regression equation for prediction
 Form forecast intervals around an estimated Y value
for a given X
 Use graphical analysis to recognize potential problems
in regression analysis
Correlation Analysis
 Correlation analysis is used to measure
strength of the association (linear relationship)
between two variables
 Correlation is only concerned with strength of the
relationship
 No causal effect is implied with correlation
 Correlation was first presented in Chapter 3
Correlation Analysis
 The population correlation coefficient is
denoted ρ (the Greek letter rho)
 The sample correlation coefficient is
s xy
r
sxsy
where
s xy 
 (x  x)(y i i  y)
n 1
Hypothesis Test for Correlation
 To test the null hypothesis of no linear

association,
H0 : ρ  0
the test statistic follows the Student’s t
distribution with (n – 2 ) degrees of freedom:
r (n  2)
t
(1  r )2
Decision Rules
Hypothesis Test for Correlation
Lower-tail test: Upper-tail test: Two-tail test:

H0: ρ  0 H0: ρ ≤ 0 H0: ρ = 0
H1: ρ < 0 H1: ρ > 0 H1: ρ ≠ 0
a a a/2 a/2
-ta ta -ta/2 ta/2

Reject H0 if t < -tn-2, a Reject H0 if t > tn-2, a Reject H0 if t < -tn-2, a/2
or t > tn-2, a/2
r (n  2)
Where t  has n - 2 d.f.
(1  r ) 2
Introduction to
Regression Analysis
 Regression analysis is used to:
 Predict the value of a dependent variable based on
the value of at least one independent variable
 Explain the impact of changes in an independent
variable on the dependent variable
Dependent variable: the variable we wish to explain
(also called the endogenous variable)
Independent variable: the variable used to explain
the dependent variable
(also called the exogenous variable)
Linear Regression Model
 The relationship between X and Y is

described by a linear function
 Changes in Y are assumed to be caused by
changes in X
 Linear regression population equation model
Yi  β0  β1xi  εi
 Where 0 and 1 are the population model

coefficients and  is a random error term.
Simple Linear Regression
Model
The population regression model:
Population Random
Population Independent Error
Slope
Y intercept Variable term
Coefficient
Dependent
Variable
Yi  β0  β1Xi  ε i
Linear component Random Error
component
Model
(continued)
Y Yi  β0  β1Xi  ε i
Observed Value
of Y for Xi
εi Slope = β1
Predicted Value Random Error
of Y for Xi
for this Xi value
Intercept = β0
Xi X
Equation
The simple linear regression equation provides an
estimate of the population regression line
Estimated Estimate of Estimate of the
(or predicted) the regression regression slope
y value for intercept
observation i
Value of x for
yˆ i  b0  b1xi observation i
The individual random error terms ei have a mean of zero
ei  (yi - yˆ i )  yi - (b0  b1xi )
Least Squares Estimators
 b0 and b1 are obtained by finding the values

of b0 and b1 that minimize the sum of the
squared differences between y and ŷ :
min SSE  min  ei2
 min  (y i yˆ i )2
 min  [y i  (b 0  b1x i )] 2
Differential calculus is used to obtain the

coefficient estimators b0 and b1 that minimize SSE
Least Squares Estimators
(continued)
 The slope coefficient estimator is

n
 (x  x)(yi i  y)
sY
b1  i1
n
 rxy
 i
sX
 2 x
(x x)
i1
 And the constant or y-intercept is
b0  y  b1x
 The regression line always goes through the mean x, y

Finding the Least Squares
Equation
 The coefficients b0 and b1 , and other

regression results in this chapter, will be
found using a computer
 Hand calculations are tedious
 Statistical routines are built into Excel
 Other statistical analysis software can be used
Linear Regression Model
Assumptions
 The true relationship form is linear (Y is a linear function

of X, plus random error)
 The error terms, εi are independent of the x values
 The error terms are random variables with mean 0 and
constant variance, σ2
(the constant variance property is called homoscedasticity)
E[ε i ]  0 and E[ε i ]  σ 2 for (i  1, , n)

2
 The random error terms, εi, are not correlated with one
another, so that
E[ε iε j ]  0 for all i  j
Interpretation of the
Slope and the Intercept
 b0 is the estimated average value of y

when the value of x is zero (if x = 0 is
in the range of observed x values)
 b1 is the estimated change in the

average value of y as a result of a
one-unit change in x
Example
 A real estate agent wishes to examine the

relationship between the selling price of a home
and its size (measured in square feet)
 A random sample of 10 houses is selected

 Dependent variable (Y) = house price in $1000s
 Independent variable (X) = square feet
Sample Data for House Price
Model
House Price in $1000s Square Feet
(Y) (X)
245 1400
312 1600
279 1700
308 1875
199 1100
219 1550
405 2350
324 2450
319 1425
255 1700
Graphical Presentation
 House price model: scatter plot

450
400
House Price ($1000s)
350
300
250
200
150
100
50
0
0 500 1000 1500 2000 2500 3000
Square Feet
Regression Using Excel
 Tools / Data Analysis / Regression
Excel Output
Regression Statistics
Multiple R 0.76211 The regression equation is:
R Square 0.58082
Adjusted R Square 0.52842 house price  98.24833  0.10977 (square feet)
Standard Error 41.33032
Observations 10
ANOVA
df SS MS F Significance F
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580
Graphical Presentation
 House price model: scatter plot and

regression
450
line
400
350 Slope
300
250
= 0.10977
200
150
100
50
Intercept 0
= 98.248 0 500 1000 1500 2000 2500 3000
Square Feet
house price  98.24833  0.10977 (square feet)
Intercept, b0
 b0 is the estimated average value of Y when the

value of X is zero (if X = 0 is in the range of
observed X values)
 Here, no houses had 0 square feet, so b0 = 98.24833
just indicates that, for houses within the range of
sizes observed, $98,248.33 is the portion of the
house price not explained by square feet
Slope Coefficient, b1
 b1 measures the estimated change in the

average value of Y as a result of a one-
unit change in X
 Here, b1 = .10977 tells us that the average value of a
house increases by .10977($1000) = $109.77, on
average, for each additional one square foot of size
Measures of Variation
 Total variation is made up of two parts:

SST  SSR  SSE
Total Sum of Regression Sum Error Sum of
Squares of Squares Squares
SST  (yi  y)2 SSR  (yˆ i  y)2 SSE  (yi  yˆ i )2

where:
y = Average value of the dependent variable
yi = Observed values of the dependent variable
ŷi = Predicted value of y for the given xi value
(continued)
 SST = total sum of squares

 Measures the variation of the yi values around their
mean, y
 SSR = regression sum of squares
 Explained variation attributable to the linear
relationship between x and y
 SSE = error sum of squares
 Variation attributable to factors other than the linear
relationship between x and y
(continued)
Y
yi
 2 
SSE = (yi - yi ) y
_
SST = (yi - y)2

y  _2
_ SSR = (yi - y) _
y y
xi X
Coefficient of Determination, R2
 The coefficient of determination is the portion
of the total variation in the dependent variable
that is explained by variation in the
independent variable
 The coefficient of determination is also called
R-squared and is denoted as R2
SSR regression sum of squares
R  2

SST total sum of squares
note: 0 R 1 2
Examples of Approximate
r2 Values
Y
r2 = 1
Perfect linear relationship

between X and Y:
X
r2 = 1
Y 100% of the variation in Y is
explained by variation in X
X
r2 =1
r2 Values
Y
0 < r2 < 1
Weaker linear relationships

between X and Y:
X
Some but not all of the
Y
variation in Y is explained
by variation in X
X
r2 Values
r2 = 0
Y
No linear relationship
between X and Y:
The value of Y does not

X depend on X. (None of the
r2 = 0
variation in Y is explained
by variation in X)
Excel Output
SSR 18934.9348
R  2
  0.58082
Multiple R 0.76211 SST 32600.5000
R Square 0.58082
Adjusted R Square 0.52842 58.08% of the variation in
Standard Error 41.33032 house prices is explained by
Observations 10
variation in square feet
ANOVA
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580
Correlation and R2
 The coefficient of determination, R2, for a

simple regression is equal to the simple
correlation squared
R r 2 2
xy
Estimation of Model
Error Variance
 An estimator for the variance of the population model

error is
n
SSE  i
e 2
σˆ  s 
2
 2 i1
n2 n2
e
 Division by n – 2 instead of n – 1 is because the simple regression

model uses two estimated parameters, b0 and b1, instead of one
se  s2e is called the standard error of the estimate
Excel Output
Multiple R 0.76211 se  41.33032
R Square 0.58082
Adjusted R Square 0.52842
Observations 10
ANOVA
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580
Comparing Standard Errors
se is a measure of the variation of observed y
values from the regression line
Y Y
small se X large se X
The magnitude of se should always be judged relative to the size

of the y values in the sample data
i.e., se = $41.33K is moderately small relative to house prices in

the $200 - $300K range
Inferences About the
Regression Model
 The variance of the regression slope coefficient

(b1) is estimated by
2 2
s s
s b1 
2 e
 e
 (x i  x) (n  1)s x
2 2
where:
s b1 = Estimate of the standard error of the least squares slope
SSE
se  = Standard error of the estimate
n2
Excel Output
Multiple R 0.76211
R Square 0.58082
Adjusted R Square 0.52842
Standard Error
Observations
41.33032
10
sb1  0.03297
ANOVA
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580
Comparing Standard Errors of
the Slope
Sb1 is a measure of the variation in the slope of regression
lines from different possible samples
Y Y
small Sb1 X large Sb1 X
Inference about the Slope:
t Test
 t test for a population slope
 Is there a linear relationship between X and Y?
 Null and alternative hypotheses
H0: β1 = 0 (no linear relationship)
H1: β1  0 (linear relationship does exist)
 Test statistic
b1  β1
where:
t b1 = regression slope
coefficient
sb1 β1 = hypothesized slope
sb1 = standard
d.f.  n  2 error of the slope
Inference about the Slope:
t Test
(continued)
House Price Estimated Regression Equation:

Square Feet
in $1000s
(x)
(y) house price  98.25  0.1098 (sq.ft.)
245 1400
312 1600
279 1700
308 1875 The slope of this model is 0.1098
199 1100
219 1550
Does square footage of the house
405 2350 affect its sales price?
324 2450
319 1425
255 1700
Inferences about the Slope:
t Test Example
b1 s b1
H0: β1 = 0 From Excel output:
H1: β1  0 Coefficients Standard Error t Stat P-value
Intercept 98.24833 58.03348 1.69296 0.12892
Square Feet 0.10977 0.03297 3.32938 0.01039
b1  β1 0.10977  0
t  t  3.32938
sb1 0.03297
t Test Example
(continued)
Test Statistic: t = 3.329
b1 s b1 t
Intercept 98.24833 58.03348 1.69296 0.12892
d.f. = 10-2 = 8 Square Feet 0.10977 0.03297 3.32938 0.01039
t8,.025 = 2.3060
Decision:
a/2=.025 a/2=.025 Reject H0
Conclusion:
Reject H0 Do not reject H0 Reject H0
There is sufficient evidence
-tn-2,α/2 0 tn-2,α/2 that square footage affects
-2.3060 2.3060 3.329 house price
t Test Example
(continued)
P-value = 0.01039
P-value
Intercept 98.24833 58.03348 1.69296 0.12892
Square Feet 0.10977 0.03297 3.32938 0.01039
This is a two-tail test, so Decision: P-value < α so

the p-value is Reject H0
P(t > 3.329)+P(t < -3.329) Conclusion:
= 0.01039 There is sufficient evidence
(for 8 d.f.) that square footage affects
house price
Confidence Interval Estimate
for the Slope
Confidence Interval Estimate of the Slope:
b1  t n2,α/2sb1  β1  b1  t n2,α/2sb1
d.f. = n - 2
Excel Printout for House Prices:

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580
At 95% level of confidence, the confidence interval for

the slope is (0.0337, 0.1858)
for the Slope
(continued)

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580
Since the units of the house price variable is

$1000s, we are 95% confident that the average
impact on sales price is between $33.70 and
$185.80 per square foot of house size
This 95% confidence interval does not include 0.

Conclusion: There is a significant relationship between
house price and square feet at the .05 level of significance
F-Test for Significance
 F Test statistic: MSR

F
MSE
where SSR
MSR 
k
SSE
MSE 
n  k 1
where F follows an F distribution with k numerator and (n – k - 1)
denominator degrees of freedom
(k = the number of independent variables in the regression model)
Excel Output
Multiple R 0.76211
MSR 18934.9348
R Square 0.58082 F   11.0848
Adjusted R Square 0.52842 MSE 1708.1957
Observations 10 With 1 and 8 degrees P-value for
of freedom the F-Test
ANOVA
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580
F-Test for Significance
(continued)
H0: β1 = 0 Test Statistic:

H1: β1 ≠ 0 MSR
F  11.08
a = .05 MSE
df1= 1 df2 = 8
Decision:
Critical Reject H0 at a = 0.05
Value:
Fa = 5.32
a = .05 Conclusion:
There is sufficient evidence that
0 F house size affects selling price
Do not Reject H0
reject H0
F.05 = 5.32
Prediction
 The regression equation can be used to

predict a value for y, given a particular x
 For a specified value, xn+1 , the predicted

value is
yˆ n1  b0  b1xn1
Predictions Using
Regression Analysis
Predict the price for a house
with 2000 square feet:
house price  98.25  0.1098 (sq.ft.)
 98.25  0.1098(200 0)
 317.85
The predicted price for a house with 2000
square feet is 317.85($1,000s) = $317,850
Relevant Data Range
 When using a regression model for prediction,
only predict within the relevant range of data
Relevant data range
450
400
350
300
250
200
150 Risky to try to
100
extrapolate far
50
0
beyond the range
0 500 1000 1500 2000 2500 3000 of observed X’s
Square Feet
Estimating Mean Values and
Predicting Individual Values
Goal: Form intervals around y to express
uncertainty about the value of y for a given xi
Confidence
Interval for
the expected
Y 
y
value of y,
given xi

y = b0+b1xi
Prediction Interval
for an single
observed y, given xi
xi X
Confidence Interval for
the Average Y, Given X
Confidence interval estimate for the
expected value of y given a particular xi
Confidence interval for E(Yn1 | Xn1 ) :
 1 (x n1  x)2 
yˆ n1  t n2,α/2se   2
 n  (x i  x) 
Notice that the formula involves the term (x n1  x)

2
so the size of interval varies according to the distance

xn+1 is from the mean, x
Prediction Interval for
an Individual Y, Given X
Confidence interval estimate for an actual
observed value of y given a particular xi
Confidence interval for yˆ n1 :
 1 (x n1  x)2 
yˆ n1  t n2,α/2se 1  2
 n  (x i  x) 
This extra term adds to the interval width to reflect

the added uncertainty for an individual case
Estimation of Mean Values:
Example
Confidence Interval Estimate for E(Yn+1|Xn+1)
Find the 95% confidence interval for the mean price

of 2,000 square-foot houses

Predicted Price yi = 317.85 ($1,000s)
1 (x i  x)2
yˆ n1  t n-2,α/2 se   317.85  37.12
n  (x i  x) 2
The confidence interval endpoints are 280.66 and 354.90,

or from $280,660 to $354,900
Estimation of Individual Values:
Example

Confidence Interval Estimate for yn+1
Find the 95% confidence interval for an individual

house with 2,000 square feet

Predicted Price yi = 317.85 ($1,000s)
1 (Xi  X)2
yˆ n1  t n-1,α/2se 1   317.85  102.28
n  (Xi  X) 2
The confidence interval endpoints are 215.50 and

420.07, or from $215,500 to $420,070
Finding Confidence and
Prediction Intervals in Excel
 In Excel, use
PHStat | regression | simple linear regression …
 Check the
“confidence and prediction interval for x=”
box and enter the x-value and confidence level
desired
Finding Confidence and
Prediction Intervals in Excel
(continued)
Input values

y

for E(Yn+1|Xn+1)


for individual yn+1
Graphical Analysis
 The linear regression model is based on

minimizing the sum of squared errors
 If outliers exist, their potentially large squared
errors may have a strong influence on the fitted
regression line
 Be sure to examine your data graphically for
outliers and extreme points
 Decide, based on your model and logic, whether
the extreme points should remain or be removed
Chapter Summary
 Introduced the linear regression model
 Reviewed correlation and the assumptions of
linear regression
 Discussed estimating the simple linear
regression coefficients
 Described measures of variation
 Described inference about the slope
 Addressed estimation of mean values and
prediction of individual values

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Statistics For Business and Economics: Simple Regression

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Statistics for

Business and Economics

After completing this chapter, you should be

After completing this chapter, you should be

 To test the null hypothesis of no linear

Lower-tail test: Upper-tail test: Two-tail test:

-ta ta -ta/2 ta/2

 The relationship between X and Y is

 Where 0 and 1 are the population model

The individual random error terms ei have a mean of zero

ei  (yi - yˆ i )  yi - (b0  b1xi )

 b0 and b1 are obtained by finding the values

Differential calculus is used to obtain the

 The slope coefficient estimator is

 And the constant or y-intercept is

 The regression line always goes through the mean x, y

 The coefficients b0 and b1 , and other

 The true relationship form is linear (Y is a linear function

E[ε i ]  0 and E[ε i ]  σ 2 for (i  1, , n)

 b0 is the estimated average value of y

 b1 is the estimated change in the

 A real estate agent wishes to examine the

 A random sample of 10 houses is selected

 House price model: scatter plot

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

 House price model: scatter plot and

house price  98.24833  0.10977 (square feet)

house price  98.24833  0.10977 (square feet)

 b0 is the estimated average value of Y when the

house price  98.24833  0.10977 (square feet)

 b1 measures the estimated change in the

 Total variation is made up of two parts:

SST  (yi  y)2 SSR  (yˆ i  y)2 SSE  (yi  yˆ i )2

 SST = total sum of squares

Perfect linear relationship

Weaker linear relationships

The value of Y does not

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

 The coefficient of determination, R2, for a

 An estimator for the variance of the population model

 Division by n – 2 instead of n – 1 is because the simple regression

se  s2e is called the standard error of the estimate

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

The magnitude of se should always be judged relative to the size

i.e., se = $41.33K is moderately small relative to house prices in

 The variance of the regression slope coefficient

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

small Sb1 X large Sb1 X

House Price Estimated Regression Equation:

This is a two-tail test, so Decision: P-value < α so

Excel Printout for House Prices:

At 95% level of confidence, the confidence interval for

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Since the units of the house price variable is

This 95% confidence interval does not include 0.

 F Test statistic: MSR

(k = the number of independent variables in the regression model)

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

H0: β1 = 0 Test Statistic: