Statistics For Management II, Chapter Two – Statistical Estimation 2023

Chapter Two: Statistical Estimation

2. Definitions
Estimation is the process of predicting or estimating the unknown population parameter through
sampling. That is it is the process of using sample statistic so as to estimate an unknown
population parameter.
Estimator is a sample statistic that is used to estimate an unknown population parameter.
Example: sample mean, sample standard deviation, etc.
Point estimate – A single number computed from a sample and used to estimate a
population parameter.
Interval estimate – The interval, within which a population parameter probably lies
based on sample information.
Sampling error – The difference between a sample statistic and its corresponding
population parameter.
Confidence interval – an interval estimate which is associated with degree of confidence
of containing the population parameter is called Confidence
Interval.
2.1 Statistical Estimation
Managers in business, education, social work, and other fields make decisions without complete
information. Automobile manufacturers do not know exactly how many people will purchase new
cars next year. The college registrar does not know exactly how many students will enroll next
fall, but based on the past experience may lay down an estimate plan. Everyone makes estimates.
When you get ready to cross a street, you estimate the speed of the car that is approaching, the
distance between you and the car and your own speed. Having made these quick estimates, you
decide whether to wait, walk or run. In such decisions without complete information, there is a
considerable uncertainty.

In statistical inference, one estimates about the population based on the result obtained from the
sample selected from that population. Thus, estimation is a process by which we estimate various
unknown population parameters from sample statistics.

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 Statistics For Management II, Chapter Two – Statistical Estimation 2023

Any sample statistic that is used to estimate a population parameter is called an estimator and an
estimate is a numerical value of an estimator.
The sample mean is often used as an estimator of the population mean. Suppose that we calculate
the mean daily revenue of a store for a random sample of 6 days and find it to be 1110 birr. If we
use this value to estimate the daily revenue for the whole year, then the value 1110 birr would be
an estimate.

2.2 Kinds of Estimates

There are two kinds of estimates, point estimates and interval estimates.
2.2.1 Point Estimation
Point estimation is a statistical procedure in which we use a single value to estimate a population
parameter. A point estimate is a single number that is used as an estimate of a population
parameter, and is derived from a random sample taken from the population of interest.
Some of the most important point estimators are given below:
Population Parameter Point Estimator (Sample Estimates)
Mean, 
X=
∑ Xi
n
Variance, 2
S
2
=
∑ ( Xi − X )2
n−1
Standard deviation,  S = √S 2

Proportion, π X
P=
n

Example 1 To set the price of a product, one strategy is competition-oriented in which you fix the
price of your product at the average level charged by other producers. Suppose you want to
market a 200-gram bar or soap that you produce. The current wholesale prices charged by a
random sample of 10 soap producers (in birr) are:

1.00 1.35 1.50 0.95 0.90 1.25 1.00 1.20 0.90 and 1.50

What is an estimate of the mean wholesale price charged by all soap producers? Find an estimate
of the standard deviation in the wholesale prices of all the producers?

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Solution

 The mean wholesale price or the population mean () is estimated by the sample mean X ,
X = ∑ xi/n
given by i = (1.00 + 1.35 + ---- + 1.50) / 10 = 1.155. Thus, an estimate of the
mean wholesale price charged by all soap producers is 1.155 Birr. Based on this information,
you might set the wholesale price per unit of your product at 1.155 Birr.
 The standard deviation in the wholesale prices of all producers, what we call the population
standard deviation () and is estimated by the sample standard deviation.

S=
√ ∑ ( Xi − X )2
i
n−1
=
√
(1.00 − 1. 155 )2 + ( 1. 35 −1. 155 )2 + −−−−+ ( 1.50 − 1 .155 )2

= 0.237
9

Thus, the wholesale prices fluctuate below and above their mean by about 0.237 Birr, which is an
estimate of the standard deviation in the wholesale prices of all producers.
Example 2: - suppose you are interested to know the proportion of fishes that are poisoned as a
result of chemical pollution of a certain lake. In a random sample of 400 fishes caught from this
lake, 55 were found out to be inedible. Out of all fishes in this lake, what is an estimate of the
proportion of inedible fishes?
Solution
The proportion of inedible fishes in the entire lake is what we call population proportion (  ).
Thus is estimated by the sample proportion:
X 55
=
P = n 400 = 0.1375 = 13.75 percent.
Although point estimates are often useful, they do have one serious drawback: we do not know
how close or far these values are from the population value they are supposed to estimate, and
hence, we cannot be certain of their reliability. In other words, a point estimate will be more
useful if it is accompanied by an estimate of the error that might be involved. To this end, we use
interval estimation.

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 Statistics For Management II, Chapter Two – Statistical Estimation 2023

2.2.2 Interval Estimation

Interval estimation is a statistical procedure in which we find a random interval with a specified
probability of containing the parameter being estimated. An interval estimate is an interval that
provides an upper bound and a lower bound for a specific population parameter whose value is
unknown. This interval estimate has an associated degree of confidence of containing the
population parameter. Such interval estimates are also called Confidence intervals and are
calculated from random samples.

The interval estimate is an interval that includes the point estimate. For example, if the sample
mean is say 0.28, one may report that the population mean is in the range of 0.25 and 0.31 with a
probability of 0.95. i.e. the 95 percent confidence interval of the population mean is (0.25, 0.31).
Clearly this interval contains the point estimated 0.28.

A) Confidence Interval for the Population Mean ()

Case I. Sampling From a Normally Distributed Population with Known standard deviation 

Recall that Z denotes the value of Z for which the area under standard normal curve to its right is
equal to . Analogously, Z / 2 denotes value of Z for which the area to its right /2 and, Z/2
denotes the value for which the area to its left is  / 2.
P (- Z/2 < Z < Z/2) = 1 - 
X−μ
But we know that Z = σ / √n follows standard normal distribution. Thus

P
(
− Z α /2 <
X−μ
σ / √n )
< Z α / 2 = 1 −α

P (− Z α / 2 . σ / √ n < X − μ < Z α / 2 . σ / √n ) = 1− α
P ( X − Z α / 2 . σ / √ n < μ < X + Z α / 2 . σ / √ n ) = 1− α
Thus, a (1 - ) 100 % confidence interval for the population mean  is given by:

X ± Zα / 2 σ / √ n
α
Z
Where, X is the sample mean, α / 2 is the value of Z for which the area to its right is 2 .

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More often, the common confidence intervals are the 99, 95 and 90 percent confidence intervals.
If we use the 95 percent level of confidence, then we expect about 95 percent of the intervals to
contain the parameter being estimated. Another interpretation of the 95 percent confidence
interval is that 95 percent of the sample means for a specified sample size will be within 1.96
(obtained by dividing 0.95 by 2) standard deviations of the hypothesized population mean.
Similarly, for a 99 percent confidence interval, 99 percent of the sample means will lie within
2.58 standard deviations of the hypothesized population mean.
Values of Za/2 for the most commonly used confidence
Confidence level a a /2 Z a /2
90 % 0.1 0.05 1.645
95 % 0.05 0.025 1.96
99% 0.01 0.005 2.58

Here, 1 – 95% confidence level is known as significant level () = 0.05, then the (1 -) 100
percent confidence interval, which is the (1 – 0.05) 100 = 95 percent confidence interval and if 
= 0.01, then the (1 -) 100 percent confidence interval will be the (1 – 0.01) 100 % which is the
99 % confidence interval. Where  is called the confidence coefficient (significant level).
Then, total area under the normal curve is 1. Or one can report as, 95 % of the area under the
standard normal curve is between Z values - 1.96 and 1.96 and similarly 99 % of the area under
the standard normal curve is between Z value – 2.58 and 2.58.

Thus, the 95 percent confidence interval of the mean for known standard deviation  is given by,
σ
X ± 1. 96
√n
And the 99 % confidence interval is given by;
σ
X ± 2.58
√n
Example: A normal infinite population has a standard deviation of 10. A random sample of size
25 has a mean of 50. Construct a 95% confidence interval of the population mean?
Given  = 10 n = 25
 = 50 95% confidence interval.
Answer: Pr( X -Z α/2 σ /√ n ¿ μ≤ X +Z α/2 σ /√ n ) = 50 - (1.96) 2    50 + (1.96)2
46.08    53.92

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 Statistics For Management II, Chapter Two – Statistical Estimation 2023

P (46.08   53.92) = 0.95.

In this case we may say that “we are 95% confident that the populations mean lies with in 46.08
and 53.92.” This statement does not mean that the chance is 0.95 that the population mean of all
the random variables falls within the interval established from this one sample. Instead, it means
that if we select many random samples of the same size and if we compute a confidence interval
for each of these samples, then in about 95 percent of these cases, the population mean will lie
within that interval

Exercise: A normal infinite population has a standard deviation of 10. A random sample of size
25 has a mean of 50. Construct a 95% confidence interval of the population mean?

Case II. Calculating Confidence Interval Estimate of a Population Mean: Normal

Population with  Unknown
When the population standard deviation is unknown, we use the sample standard deviation,
S, as an estimate of . The sample standard deviation is given by:

√( Xi − X )2
S= n−1
s
s x = √n
In this case, the construction of confidence interval estimate depends up on whether the sample
size is larger or small:
Case1. When the sample size is large and unknown (A sample size is large when n  30)

Confidence interval estimate for population mean () is given by:

μ = X ± Z α/2 s/ √ n
For instance, the 95 % confidence interval can be given by;
S
X ± 1. 96
√n
And the 99 % confidence interval is given by
S
X ± 2 .58
√n Where;
X - Sample mean, S – sample standard deviation

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2.58 is Z/2 √n - the root of the sample size.

Example 1; In a certain small city, to estimate the mean monthly expenditure for food, a random
sample of 25 households was randomly selected yielding a mean of 200 birr. From experience, it
is known that such expenditures are normally distributed with a standard deviation of 50 Birr.

a) What is the point estimate of the mean monthly expenditures for food of all households in
the city?
b) Find a 95 percent confidence interval for the mean monthly expenditures for food of all
households in the city.
Solution: -
a) Given
X = 200 Birr
s = 50 Birr
n = 25
A point estimate of the population mean  is the sample mean X
Thus, μ = X = 200 Birr.
b) For 95 % confidence interval, let us find confidence coefficient.
95
(1 - ) 100 % = 95 %  1 -  = 100
95 100 − 95
=
  = 1 - 100 100
5
= 0. 05
 = 100
 = 0.05 (significant level)
Then Z/2 = Z0.05/2 = Z0.025 = 1.96 (from the table of standard normal)
Thus, a 95 % confidence interval for the mean is
s
X ± Zα / 2
√n

= 200  (1.96)
( )
50
√25
= 200  19.6
= (180.40 Birr, 219.60 Birr)
i.e. we are 95 percent confident that the true mean monthly expenditure for food () is between
180.40 Birr and 219.60 Birr.

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Example 2: A manufacturer claims that his tyre lasts 20,000 miles on average. A consumer
organization tests a random sample of 64 tyres and reported an average of 19,200 miles with a
standard deviation of 2,000 miles. Does a 99 % confidence interval for the mean life of all tyres
produced by the manufacturer support the claim?
Solution: -

Given: n = 64, X = 19,200 miles, S = 2000 miles. Though we have no information about the
normality of the population by central limit theorem, for large n, say n  30. We assume that the
distribution is normal. In our case as n = 64  30 then we consider the normality.
Then for 99 % confidence interval,  = 0.01 and /2 = 0.005
And from the table of standard normal,
Z/2 = Z0.005 = 2.58
Thus, A 99 % confidence interval for the mean () will be:

X ± Zα / 2 S / √n

= 19,200  (2.58) (2000 / √ 64 )

= 19,200  645
= (18,555 miles, 19,845 miles)
Hence, we are 99 percent confident that the true mean mileage is at most 19,845. Which is less
than the claimed mean 20,000 miles. Therefore, the claim is not true.
Exercise
The wildlife department has been feeding a special food to rainbow trout finger lings in a pond. A
sample of the weight of 40 trout revealed that the mean weight is 402.7 grams and the standard
deviation 8.8 grams.
1. What is the estimated mean weight of the population?
What is that estimate called?
2. What is the 99 percent confidence interval?
3. What are the 99 percent confidence limits?
5. Interpret your findings?

Case II. When the Sample Size is Small and Unknown  (A sample size is small when n < 30).

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If the population variance 2 is not known, then it must be estimated by the sample satandard
deviation S where;
√( Xi − X )2
S= n−1
s
s x = √n

Under this situation, since  is estimated by S, the sampling distribution of the mean deviates

from the Normal distribution for small size, or we say the sampling distribution of X follows the
students’ t- distribution with n – 1 degrees of freedom.

For n > 30, the student t distribution can be approximated by the Normal distribution. Like the
Normal distribution, the t-distribution is symmetrical about the mean = 0. But it is flatter as
compared to the Normal distribution. However, as the sample size increases the t-distribution
losses its flatness and becomes approximately Normal.

The shape of the t-distribution is determined by the degrees of freedom. Degrees of freedom can
be defined as the number of values we can choose freely. Suppose we are dealing with a sample
of size n = 6 and we know the mean of these 6 numbers is 5. Symbolically, we have:
a+b +c + d +e + f
=5
6
Now, we are free to assign any value to a, b, c, d and e,
Say a = 3, b = 2, c = 4, d = 5 and e = 3. But, we are no more free to assign a value to f since:
a+b+c+d+e+f 17 + f
=5 ⇒ = 5 ⇒ 17 + f = 30
6 6
⇒ f =13
That is, in order for the mean of these 6 numbers to be 5, f must be 13. If we assign another
number for f, then the mean will not be equal to 5. Thus, we are free to choose only 5 values and
the 6th one is determined automatically.
Hence, the degree of freedom is:
n–1=6–1=5

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Generally, for a sample of size n, the degree of freedom is n – 1. The values of t a/2 for different
degrees of freedom and different values of X are tabulated. t /2¿ ) denotes the value of t for which
the area under the curve to its right is equal to /2 with (n – 1) degrees of freedom.
Example 1: a) for n = 20 and ¿ 2 = 0.025, find; t /2(n – 1)
Solution:
From the t-distribution table, t0.025 (19) = 2.093 (shaded area = 0.025)
b) If n = 26,  = 0.005
Then t/2 (n – 1) = t0.005 (25) = 2.787
(From the table of t-distribution)
Under such situations, a (1 - ) 100 %. Confidence interval for the population mean  is given by:

X ± t α / 2 (n− 1) S / √ n
Example.2
One measure of a company’s financial health is its debt-to equity ratio. This quantity is defined to
be the ration of the company’s corporate debt to the company’s equity. If this ratio is too high, it
is one indication of financial instability. For obvious reasons, banks often monitor the financial
health of companies to which they have extended commercial loans. Suppose that, in order to
reduce risk, a large bank has decided to initiate a policy limiting the mean debt-to- equity ratio for
its portfolio of commercial loans to 1.5. In order to estimate the mean debt-to-equity ratio of its
loan portfolio, the bank randomly selects a sample of 15 of its commercial loan accounts. Audits
of these companies result in the following debt-to-equity ratios:
1.31 1.05 1.45 1.21 1.19
1.78 1.37 1.41 1.22 1.11
1.48 1.33 1.29 1.32 1.65
A stem-and-leaf display of these ratios is reasonably mound shaped. Furthermore, the sample

mean and standard deviation of these ratios can be calculated to be X = 1.343 and S = 0.192

Suppose that the bank wishes to calculate a 95% confidence interval for a loan portfolio’s mean
debt-to-equity ratio,  since the bank has taken a small sample of size 15, it is appropriate to
calculate an interval based on the t - distribution. We have n – 1 = 15 – 1 = 14 degrees of
freedom, and the level of confidence 100 (1 - ) percent = 95 percent implies that  = 0.05

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significant level. Therefore, we use the t point t /2 = t0.05 / 2 = t 0.025 at degree of freedom 14 = 2.145
(from, the table). It follows that the 95 percent confidence interval for  is

( X ± t . 025
S
√n) [
= 1 .343 ± 2. 145
.192
√15 ( )]
=  1.343  0.106
=  1.237, 1.449
This interval says that the bank is 95 percent confident that the mean debt-to-equity ratio for its
portfolio of commercial loan accounts is between 1.237 and 1449. Based on this interval, the bank
has strong evidence that the portfolio’s mean ratio is less than 1.5 (or that the bank is in
compliance with its new policy).

B) Interval Estimation Of The Population Proportion

The symbol p represents the population proportion of success and q=1-p represents the population

proportion of failure. Hence, sample proportion, p, is an unbiased estimator of a population

proportion,  and here  is unknown and we want to estimate p by p and hence z becomes

 p-Z Q
n √
≤  ≤ +Za/2 n
a/2
Q p
The formula to construct interval estimate for P
√
=
p ±Z α/2 S p
Where p =sample proportion
α =1-c
S p =sample standard error of the proportion
=unknown population proportion
Example: on a certain region a sample of 500 members of the labor force showed that 40 were
unemployed. Find the 95% confidence interval for the proportion unemployed in the region.

40
Given: P = =0.08, q=1-0.08=0.92
500
n = 500 C=0.95 α =1-c = 0.05 Za/2 = Z0.025 = 1.96 (from the table Z=1.96)

ANSWER: 0.08-1.96
√ 0.08× 0.92
500
≤ p ≤ 0.08+1.96
√ 0.08× 0.92
500

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0.05622≤P≤0.10378
EXERCISE: Of 900 consumers surveyed, 414 said they were very enthusiastic about a new
home decor scheme. Construct a 99% confidence interval for the population proportion.

2.2.3. Interval Estimation for the Difference between Two Means

Suppose we have a random sample of nx1 and nx2 observations from normal distributions with

means µ1 and µ2 and variances σ 2 x1 and σ 2

x2 . If the observed sample means are X 1 and
X 2 then a 100 (1- α) % confidence interval for (x1-x2) is given by;

( X 1- X 2) - Z a /2 √ σ 2x1 σ 2x 2
n x1
+
n x2
≤ (1 -2) ≤ ( X 1- X 2) + Z a /2
√ σ 2x1 σ 2x 2
n x1
+
n x2

Or Z= 1−2=(1−2) plus or minus Z a /2

√ σ 2x1 σ 2x 2
n x1
+
n x2
EXAMPLE: A sample of 60 wires of company A has a mean time of 2500 hours and a sample of
120 wires of company B has a mean time of 2000 hours which are selected at random for testing
the life time. Population standard deviation for company A and B are 100 and 150 hours
respectively. Find 90% confidence interval on the difference of the average lifetime of the
population of wires produced by company A and company B
SOLUTION:
A B
X 1 =2500
X 2=2000
n=60 n=120
σ1=100 σ2=150

n x1√ n x2 n x1 n x2 √
→ ( X 1- X 2) - Z a /2 σ 2 x 1 + σ 2 x 2 ≤ (1 -2) ≤ ( X 1- X 2) + Z a /2 σ 2 x 1 + σ 2 x 2

→ (2500-2000) – 1.645
√ 100 ×100 150× 150
60
+
120
≤ (1 -2) ≤ + 1.645
→ 456.24 ≤ (1 -2) ≤543.76
60
+
120 √
100 ×100 150× 150

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C) Interval Estimation of the Difference between Population Proportions

√ n1 n2 √
(P1-p2¿−Z a/ 2 P 1 q 1 + P2 q 2 ≤ (p1-p2) ≤( P 1− p 2 )+ Z a/ 2 P 1q 1 + P 2 q 2
n1 n2
Example: A sample of 100 T- shirts are taken from market ABC and 20 have yellow color and
another sample of 150 are taken from market XYZ and 40 have yellow color. Find the interval of
the difference between two population proportions at 92% confidence level?
Given:
ABC XYZ

n1 =100 n2 =150
p1 =20/100=0.2 p2=40/150=0.267
q1 =1-p-=1-0.2=0.8 q2= 1-0.267=0.733

Population proportions are not known (P1 And P2), so, combined sample proportions are
estimators of population proportions, then

√ n1 n2 √
(P1-p2¿−Z a/ 2 P 1 q 1 + P2 q 2 ≤ (p1-p2) ≤( P 1− p 2 )+ Z a/ 2 P 1q 1 + P 2 q 2
n1 n2
(0.2-0.267) - 1.75×0.0761 ≤ (p1-p2) ≤ (0.2-0.267) +1.75×0.0761
-0.067-0.1332 ≤ (p1-p2) ≤ -0.067+ 0.1332
-0.2002≤ (p1-p2) ≤ 0.0662

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