Introduction to Linear Regression

and Correlation Analysis

 Scatter Plots and Correlation

 A scatter plot (or scatter diagram) is used to show

the relationship between two variables
 Correlation analysis is used to measure strength
of the association (linear relationship) between
two variables
 Only concerned with strength of the
relationship
 No causal effect is implied

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-2

 Scatter Plot Examples
Linear relationships Curvilinear relationships

y y

x x

y y

x x
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-3
 Scatter Plot Examples
(continued)
Strong relationships Weak relationships

y y

x x

y y

x x
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-4
 Scatter Plot Examples
(continued)
No relationship

x
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-5
 Correlation Coefficient
(continued)

 Correlation measures the strength of the

linear association between two variables
 The sample correlation coefficient r is a
measure of the strength of the linear
relationship between two variables, based
on sample observations

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-6

 Features of r
 Unit free
 Range between -1 and 1
 The closer to -1, the stronger the negative
linear relationship
 The closer to 1, the stronger the positive
linear relationship
 The closer to 0, the weaker the linear
relationship

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-7

 Examples of Approximate
r Values
y y y

x x x
r = -1 r = -.6 r=0
y y

x x
r = +.3
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. r = +1 Chap 14-8
 Calculating the
Correlation Coefficient
Sample correlation coefficient:

r
 ( x  x)( y  y)
[ ( x  x ) ][  ( y  y ) ]
2 2

or the algebraic equivalent:

n xy   x  y
r
[n(  x 2 )  (  x )2 ][n(  y 2 )  (  y )2 ]
where:
r = Sample correlation coefficient
n = Sample size
x = Value of the independent variable
y = Value of the dependent variable
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-9
 Calculation Example
Tree Trunk
Height Diameter
y x xy y2 x2
35 8 280 1225 64
49 9 441 2401 81
27 7 189 729 49
33 6 198 1089 36
60 13 780 3600 169
21 7 147 441 49
45 11 495 2025 121
51 12 612 2601 144
=321 =73 =3142 =14111 =713

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-10

 Calculation Example
(continued)

Tree n xy   x  y
Height, r
y 70 [n(  x 2 )  (  x)2 ][n(  y 2 )  (  y)2 ]
60

8(3142)  (73)(321)
50 
40
[8(713)  (73)2 ][8(14111)  (321) 2 ]
30

 0.886
20

10

0
r = 0.886 → relatively strong positive
0 2 4 6 8 10 12 14
linear association between x and y
Trunk Diameter, x

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-11

 Excel Output

Excel Correlation Output

Tools / data analysis / correlation…

Tree Height Trunk Diameter

Tree Height 1
Trunk Diameter 0.886231 1

Correlation between
Tree Height and Trunk Diameter

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-12

 Significance Test for Correlation
 Hypotheses
H0: ρ = 0 (no correlation)
HA: ρ ≠ 0 (correlation exists)
The Greek letter ρ (rho) represents
the population correlation coefficient
 Test statistic
r
t
 1 r 2
(with n – 2 degrees of freedom)

n2
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-13
 Example: Produce Stores
Is there evidence of a linear relationship
between tree height and trunk diameter at
the .05 level of significance?

H0: ρ = 0 (No correlation)

H1: ρ ≠ 0 (correlation exists)
 =.05 , df = 8 - 2 = 6

r .886
t   4.68
1 r 2 1  .886 2
n2 82
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-14
 Example: Test Solution

r .886 Decision:
t   4.68
1 r 2 1  .886 2 Reject H0

n2 82 Conclusion:

There is sufficient
d.f. = 8-2 = 6
evidence of a
linear relationship
/2=.025 /2=.025
at the 5% level of
significance
Reject H0 Do not reject H0 Reject H0
-tα/2 0
tα/2
-2.4469 2.4469
4.68
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-15
 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
Independent variable: the variable used to
explain the dependent variable

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-16

 Simple Linear Regression Model

 Only one independent variable, x

 Relationship between x and y is
described by a linear function
 Changes in y are assumed to be
caused by changes in x

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-17

 Types of Regression Models
Positive Linear Relationship Relationship NOT Linear

Negative Linear Relationship No Relationship

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-18

 Population Linear Regression

The population regression model:

Population Random
Population Independent Error
Slope
y intercept Variable term, or
Coefficient
Dependent residual

y  β0  β1x  ε
Variable

Linear component Random Error

component

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-19

 Linear Regression Assumptions

 Error values (ε) are statistically independent

 Error values are normally distributed for any
given value of x
 The probability distribution of the errors is
normal
 The distributions of possible ε values have
equal variances for all values of x
 The underlying relationship between the x
variable and the y variable is linear

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-20

 Population Linear Regression
(continued)

y y  β0  β1x  ε
Observed Value
of y for xi

εi Slope = β1
Predicted Value
Random Error
of y for xi
for this x value

Intercept = β0

xi x
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-21
 Estimated Regression Model
The sample regression line provides an estimate of
the population regression line

Estimated Estimate of Estimate of the

(or predicted) the regression regression slope
y value
intercept
Independent

ŷ i  b0  b1x variable

The individual random error terms ei have a mean of zero

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-22

 Least Squares Criterion

 b0 and b1 are obtained by finding the values

of b0 and b1 that minimize the sum of the
squared residuals

e 2
  (y ŷ) 2

  (y  (b 0  b1x))
2

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-23

 The Least Squares Equation
 The formulas for b1 and b0 are:

b1 
 (x  x)(y  y) algebraic equivalent for b1:

 (x  x) 2

 xy   x y
b1  n
and (
x  n
2  x ) 2

b0  y  b1x

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-24

 Interpretation of the
Slope and the Intercept

 b0 is the estimated average value of y

when the value of x is zero

 b1 is the estimated change in the

average value of y as a result of a
one-unit change in x

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-25

 Simple Linear Regression
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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-26

 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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-27

 Regression Using Excel
 Data / Data Analysis / Regression

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-28

 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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-29

 Graphical Presentation
 House price model: scatter plot and
regression line
450
400
House Price ($1000s)

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)

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-30
 Interpretation of the
Intercept, b0

house price  98.24833  0.10977 (square feet)

 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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-31

 Interpretation of the
Slope Coefficient, b1

house price  98.24833  0.10977 (square feet)

 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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-32

 Least Squares Regression
Properties
 The sum of the residuals from the least squares
regression line is 0 (  (y yˆ )  0 )
 The sum of the squared residuals is a minimum
(minimized (y yˆ ) 2
) 
 The simple regression line always passes through the
mean of the y variable and the mean of the x
variable
 The least squares coefficients are unbiased
estimates of β0 and β1

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-33

 Explained and Unexplained
Variation
 Total variation is made up of two parts:

SST  SSE  SSR

Total sum of Sum of Squares Sum of Squares
Squares Error Regression

SST   ( y  y )2 SSE   ( y  ŷ )2 SSR   ( ŷ  y )2

where:
y = Average value of the dependent variable
y = Observed values of the dependent variable
ŷ = Estimated value of y for the given x value
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-34
 Explained and Unexplained
Variation
(continued)

 SST = total sum of squares

 Measures the variation of the y i values around their
mean y
 SSE = error sum of squares
 Variation attributable to factors other than the
relationship between x and y
 SSR = regression sum of squares
 Explained variation attributable to the relationship
between x and y

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-35

 Explained and Unexplained
Variation
(continued)
y
yi 
 2
SSE = (yi - yi ) y
_
SST = (yi - y)2

y  _2
_ SSR = (yi - y) _
y y

Xi x
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-36
 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
R  2 where 0 R 1
2

SST
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-37
 Coefficient of Determination, R2
(continued)
Coefficient of determination
SSR sum of squares explained by regression
R  2

SST total sum of squares

Note: In the single independent variable case, the coefficient

of determination is

R r 2 2

where:
R2 = Coefficient of determination
r = Simple correlation coefficient
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-38
 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
R = +1
2

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-39

 Examples of Approximate
R2 Values
(continued)

y
0 < R2 < 1

Weaker linear relationship

between x and y:
x
Some but not all of the
y
variation in y is explained
by variation in x

x
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-40
 Examples of Approximate
R2 Values
(continued)

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)

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-41

 Excel Output
SSR 18934.9348
Regression Statistics
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
  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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-42

 Test for Significance of
Coefficient of Determination
 Hypotheses
H0: The independent variable does not explain a significant
H0: ρ = 0 2
portion of the variation in the dependent variable

HA: ρ2 ≠ 0 HA: The independent variable does explain a significant

portion of the variation in the dependent variable

 Test statistic

SSR/1
F

SSE/(n  2) (with D1 = 1 and D2 = n - 2
degrees of freedom)

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-43

 Excel Output
SSR/1 18934.93/1
Regression Statistics
F   11.085
Multiple R 0.76211 SSE/(n - 2) 13665.57/( 10 - 2)
R Square 0.58082
Adjusted R Square 0.52842 The critical F value from Appendix H for
Standard Error 41.33032  = .05 and D1 = 1 and D2 = 8 d.f. is 5.318.
Observations 10 Since 11.085 > 5.318 we reject H0: ρ2 = 0

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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-44

 Standard Error of Estimate
 The standard deviation of the variation of
observations around the simple regression line
is estimated by

SSE
sε 
n2
Where
SSE = Sum of squares error
n = Sample size

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-45

 The Standard Deviation of the
Regression Slope
 The standard error of the regression slope
coefficient (b1) is estimated by
sε sε
sb1  
 (x  x) 2

x 2

(  x)2

n
where:
sb1 = Estimate of the standard error of the least squares slope
SSE
sε  = Sample standard error of the estimate
n2
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-46
 Excel Output
Regression Statistics sε  41.33032
Multiple R 0.76211
R Square 0.58082
Adjusted R Square 0.52842
Standard Error
Observations
41.33032
10
sb1  0.03297
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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-47

 Comparing Standard Errors
Variation of observed y values Variation in the slope of regression
from the regression line lines from different possible samples
y y

small s x small sb1 x

y y

large s x large sb1 x

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-48
 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)
HA: β1 0 (linear relationship does exist)
 Test statistic
b1  β1 where:

t b1 = Sample regression slope

sb1 coefficient
β1 = Hypothesized slope
sb1 = Estimator of the standard
d.f.  n  2 error of the slope
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-49
 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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-50

 Inferences about the Slope:
t Test Example
Test Statistic: t = 3.329
b1 sb1 t
H0: β1 = 0 From Excel output:
HA: 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

d.f. = 10-2 = 8
Decision:
/2=.025 /2=.025 Reject H0
Conclusion:
Reject H0 Do not reject H0 Reject H
There is sufficient evidence
-tα/2 tα/2 0

0 that square footage affects

-2.3060 2.3060 3.329
house price
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-51
 Regression Analysis for
Description
Confidence Interval Estimate of the Slope:
b1  t /2 sb1 d.f. = n - 2

Excel Printout for House Prices:

  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

At 95% level of confidence, the confidence interval for

the slope is (0.0337, 0.1858)

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-52

 Regression Analysis for
Description
  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

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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-53

 Confidence Interval for
the Average y, Given x
Confidence interval estimate for the
mean of y given a particular xp

Size of interval varies according

to distance away from mean, x

1 (x p  x)
2

ŷ  t /2sε 
n  (x  x) 2

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-54

 Confidence Interval for
an Individual y, Given x
Confidence interval estimate for an
Individual value of y given a particular xp

1 (x p  x)
2

ŷ  t /2 sε 1 
n  (x  x) 2

This extra term adds to the interval width to reflect

the added uncertainty for an individual case

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-55

 Interval Estimates
for Different Values of x

Prediction Interval
for an individual y,
y given xp

Confidence
Interval for
 + b x the mean of
y = b0
1
y, given xp

x
x xp
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-56
 Example: House Prices

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 Predict the price for a house
199 1100 with 2000 square feet
219 1550
405 2350
324 2450
319 1425
255 1700

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-57

 Example: House Prices
(continued)
Predict the price for a house
with 2000 square feet:

house price  98.25  0.1098 (sq.ft.)

 98.25  0.1098(2000)

 317.85
The predicted price for a house with 2000
square feet is 317.85($1,000s) = $317,850
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-58
 Estimation of Mean Values:
Example
Confidence Interval Estimate for E(y)|xp
Find the 95% confidence interval for the average
price of 2,000 square-foot houses

Predicted Price Yi = 317.85 ($1,000s)

1 (x p  x)2
ŷ  t α/2 sε   317.85  37.12
n  (x  x) 2

The confidence interval endpoints are 280.66 -- 354.90,

or from $280,660 -- $354,900
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-59
 Estimation of Individual Values:
Example
Prediction Interval Estimate for y|xp
Find the 95% confidence interval for an individual
house with 2,000 square feet

Predicted Price Yi = 317.85 ($1,000s)

1 (x p  x)2
ŷ  t α/2 sε 1   317.85  102.28
n  (x  x) 2

The prediction interval endpoints are 215.50 -- 420.07,

or from $215,500 -- $420,070
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-60
 Finding Confidence and Prediction
Intervals PHStat

 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

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-61

 Finding Confidence and Prediction
Intervals PHStat
(continued)

Input values

Confidence Interval Estimate for E(y)|xp

Prediction Interval Estimate for y|xp

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-62
 Residual Analysis
 Purposes
 Examine for linearity assumption

 Examine for constant variance for all

levels of x
 Evaluate normal distribution assumption

 Graphical Analysis of Residuals

 Can plot residuals vs. x

 Can create histogram of residuals to

check for normality

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-63

 Residual Analysis for Linearity

y y

x x
residuals

x residuals x

Not Linear
Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc.  Linear
Chap 14-64
 Residual Analysis for
Constant Variance

y y

x x
residuals

x residuals x

Non-constant variance Constant variance

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-65
 Excel Output

RESIDUAL OUTPUT
Predicted House Price Model Residual Plot
House Price Residuals
1 251.92316 -6.923162 80

2 273.87671 38.12329 60
3 284.85348 -5.853484 Residuals 40
4 304.06284 3.937162 20
5 218.99284 -19.99284 0
6 268.38832 -49.38832 0 1000 2000 3000
-20
7 356.20251 48.79749
-40
8 367.17929 -43.17929
-60
9 254.6674 64.33264
Square Feet
10 284.85348 -29.85348

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-66

 Chapter Summary

 Introduced correlation analysis

 Discussed correlation to measure the strength
of a linear association
 Introduced simple linear regression analysis
 Calculated the coefficients for the simple linear
regression equation
 Described measures of variation (R2 and sε)
 Addressed assumptions of regression and
correlation

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-67

 Chapter Summary
(continued)

 Described inference about the slope

 Addressed estimation of mean values and
prediction of individual values
 Discussed residual analysis

Business Statistics: A Decision-Making Approach, 7e © 2008 Prentice-Hall, Inc. Chap 14-68