Business Statistics, A First Course

4th Edition

Chapter 12

Simple Linear Regression

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-1
 Learning Objectives
In this chapter, you learn:
 How to use regression analysis to predict the value of
a dependent variable based on an independent
variable
 The meaning of the regression coefficients b0 and b1
 How to evaluate the assumptions of regression
analysis and know what to do if the assumptions are
violated
 To make inferences about the slope and correlation
coefficient
 To estimate mean values and predict individual values
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-2
 Correlation vs. Regression
 A scatter diagram can be used to show the
relationship between two variables
 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
 Scatter diagrams were first presented in Ch. 2
 Correlation was first presented in Ch. 3

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-3
 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 predict
or explain
Independent variable: the variable used to explain
the dependent variable

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-4
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-5
 Types of Relationships
Linear relationships Curvilinear relationships

Y Y

X X

Y Y

X X
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-6
 Types of Relationships
(continued)
Strong relationships Weak relationships

Y Y

X X

Y Y

X X
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-7
 Types of Relationships
(continued)
No relationship

X
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-8
 Simple Linear 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

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-9
 Simple Linear Regression
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
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-10
 Simple Linear Regression
Equation (Prediction Line)
The simple linear regression equation provides an
estimate of the population regression line

Estimated
(or predicted) Estimate of Estimate of the
Y value for the regression regression slope
observation i
intercept
Value of X for

Ŷi  b0  b1Xi
observation i

The individual random error terms ei have a mean of zero

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-11
 Least Squares Method

 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  (Yi Ŷi )  min  (Yi  (b0  b1Xi )) 2 2

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-12
 Finding the Least Squares
Equation

 The coefficients b0 and b1 , and other

regression results in this chapter, will be
found using Excel or Minitab

Formulas are shown in the text for those

who are interested

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-13
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-14
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-15
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-16
 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

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-17
 Regression Using Excel
 Tools / Data Analysis / Regression

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-18
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-19
 Graphical Presentation

 House price model: scatter plot and

regression
450
line
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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-20
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-21
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-22
 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(2000)

 317.85
The predicted price for a house with 2000
square feet is 317.85($1,000s) = $317,850
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-23
 Interpolation vs. Extrapolation
 When using a regression model for prediction,
only predict within the relevant range of data
Relevant range for
interpolation

450
400
House Price ($1000s)

350
300
250
200
150 Do not try to
100
extrapolate
50
0
beyond the range
0 500 1000 1500 2000 2500 3000 of observed X’s
Square Feet
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-24
 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   ( Ŷi  Y )2 SSE   ( Yi  Ŷi )2

where:
Y = Average value of the dependent variable
Yi = Observed values of the dependent variable
Ŷ = Predicted value of Y for the given X value
i i
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-25
 Measures of Variation
(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 relationship
between X and Y
 SSE = error sum of squares
 Variation attributable to factors other than the
relationship between X and Y

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-26
 Measures of Variation
(continued)
Y
Yi  
SSE = (Yi - Yi )2 Y
_
SST = (Yi - Y)2

Y  _
_ SSR = (Yi - Y)2 _
Y Y

Xi X
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-27
 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

2SSR regression sum of squares

r  
SST total sum of squares

2
note: 0 r 1
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-28
 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-29
 Examples of Approximate
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
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-30
 Examples of Approximate
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)

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-31
 Excel Output
2 SSR 18934.9348
Regression Statistics
r    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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-32
 Standard Error of Estimate
 The standard deviation of the variation of
observations around the regression line is
estimated by
n

SSE  i i
( Y  Ŷ ) 2

S YX   i1
n2 n2
Where
SSE = error sum of squares
n = sample size

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-33
 Excel Output
Regression Statistics
Multiple R 0.76211 S YX  41.33032
R Square 0.58082
Adjusted R Square 0.52842
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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-34
 Comparing Standard Errors
SYX is a measure of the variation of observed
Y values from the regression line
Y Y

small s YX X large s YX X

The magnitude of SYX should always be judged relative to the

size of the Y values in the sample data
i.e., SYX = $41.33K is moderately small relative to house prices in
the $200 - $300K range
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-35
 Assumptions of Regression
Use the acronym LINE:
 Linearity
 The underlying relationship between X and Y is linear
 Independence of Errors
 Error values are statistically independent
 Normality of Error
 Error values (ε) are normally distributed for any given value of
X
 Equal Variance (Homoscedasticity)
 The probability distribution of the errors has constant variance

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-36
 Residual Analysis
ei  Yi  Ŷi
 The residual for observation i, ei, is the difference
between its observed and predicted value
 Check the assumptions of regression by examining the
residuals
 Examine for linearity assumption
 Evaluate independence assumption
 Evaluate normal distribution assumption
 Examine for constant variance for all levels of X
(homoscedasticity)

 Graphical Analysis of Residuals

 Can plot residuals vs. X
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-37
 Residual Analysis for Linearity

Y Y

x x
residuals

x residuals x

Not Linear
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc.
 Linear
Chap 12-38
 Residual Analysis for
Independence

Not Independent
 Independent
residuals

residuals
X
residuals

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-39
 Residual Analysis for Normality
 A normal probability plot of the residuals can
be used to check for normality:

Percent
100

0
-3 -2 -1 0 1 2 3
Residual

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-40
 Residual Analysis for
Equal Variance

Y Y

x x
residuals

x residuals x

Non-constant variance
 Constant variance

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-41
 Excel Residual Output

RESIDUAL OUTPUT House Price Model Residual Plot

Predicted
House Price Residuals 80
1 251.92316 -6.923162 60
2 273.87671 38.12329
40
3 284.85348 -5.853484 Residuals
20
4 304.06284 3.937162
0
5 218.99284 -19.99284
0 1000 2000 3000
6 268.38832 -49.38832 -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
Does not appear to violate
any regression assumptions
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-42
 Measuring Autocorrelation:
The Durbin-Watson Statistic
 Used when data are collected over time to
detect if autocorrelation is present
 Autocorrelation exists if residuals in one
time period are related to residuals in
another period

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-43
 Autocorrelation
 Autocorrelation is correlation of the errors
(residuals) over time
Time (t) Residual Plot

15
 Here, residuals show a 10

Residuals
5
cyclic pattern, not
0
random. Cyclical
-5 0 2 4 6 8
patterns are a sign of -10
positive autocorrelation -15
Time (t)

 Violates the regression assumption that

residuals are random and independent
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-44
 The Durbin-Watson Statistic
 The Durbin-Watson statistic is used to test for
autocorrelation
H0: residuals are not correlated
H1: positive autocorrelation is present

n  The possible range is 0 ≤ D ≤ 4

 (e  e i i 1 ) 2

 D should be close to 2 if H0 is true

D i 2
n

 i
e 2
 D less than 2 may signal positive
i1 autocorrelation, D greater than 2 may
signal negative autocorrelation

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-45
 Testing for Positive
Autocorrelation
H0: positive autocorrelation does not exist
H1: positive autocorrelation is present
 Calculate the Durbin-Watson test statistic = D
(The Durbin-Watson Statistic can be found using Excel or Minitab)

 Find the values dL and dU from the Durbin-Watson table

(for sample size n and number of independent variables k)

Decision rule: reject H0 if D < dL

Reject H0 Inconclusive Do not reject H0

0 dL dU 2
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-46
 Testing for Positive
Autocorrelation
(continued)

 Suppose we have the following time series data:

160

140

120

100
Sales

80 y = 30.65 + 4.7038x
2
60 R = 0.8976
40

20

0
0 5 10 15 20 25 30
 Is there autocorrelation? Tim e

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-47
 Testing for Positive
Autocorrelation
(continued)
160
 Example with n = 25: 140

120
Excel/PHStat output: 100

Durbin-Watson Calculations

Sales
80 y = 30.65 + 4.7038x
2
Sum of Squared 60 R = 0.8976
Difference of Residuals 3296.18 40

Sum of Squared 20

Residuals 3279.98 0
0 5 10 15 20 25 30
Durbin-Watson Tim e
Statistic 1.00494

 (e  e i i1 )2
3296.18
D i 2
n
  1.00494
3279.98
 ei
2

i 1
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-48
 Testing for Positive
Autocorrelation
(continued)
 Here, n = 25 and there is k = 1 one independent variable
 Using the Durbin-Watson table, dL = 1.29 and dU = 1.45
 D = 1.00494 < dL = 1.29, so reject H0 and conclude that
significant positive autocorrelation exists
 Therefore the linear model is not the appropriate model
to forecast sales
Decision: reject H0 since
D = 1.00494 < dL

Reject H0 Inconclusive Do not reject H0

0 dL=1.29 dU=1.45 2
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-49
 Inferences About the Slope

 The standard error of the regression slope

coefficient (b1) is estimated by

S YX S YX
Sb1  
SSX  (X  X)
i
2

where:
Sb1 = Estimate of the standard error of the least squares slope

SSE
S YX  = Standard error of the estimate
n2
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-50
 Excel Output
Regression Statistics
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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-51
 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

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-52
 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
where:
b1  β1
t b1 = regression slope
Sb1 coefficient
β1 = hypothesized slope
Sb 1= standard
d.f.  n  2 error of the slope
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-53
 Inference about the Slope:
t Test
(continued)

House Price Simple Linear 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-54
 Inferences about the Slope:
t Test Example

b1 Sb1
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

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-55
 Inferences about the Slope:
t Test Example
(continued)
Test Statistic: t = 3.329
b1 Sb1 t
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

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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-56
 Inferences about the Slope:
t Test Example
(continued)
P-value = 0.01039
P-value
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

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
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-57
 F Test for Significance
 F Test statistic: MSR
F
where
MSE

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)

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-58
 Excel Output
Regression Statistics
Multiple R 0.76211
MSR 18934.9348
R Square 0.58082 F   11.0848
Adjusted R Square 0.52842 MSE 1708.1957
Standard Error 41.33032
Observations 10 With 1 and 8 degrees P-value for
of freedom the F Test
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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-59
 F Test for Significance
(continued)

H0: β1 = 0 Test Statistic:

H1: β1 ≠ 0 MSR
F  11.08
 = .05 MSE
df1= 1 df2 = 8
Decision:
Critical Reject H0 at  = 0.05
Value:
F = 5.32
 = .05 Conclusion:
There is sufficient evidence that
0 F house size affects selling price
Do not Reject H0
reject H0
F.05 = 5.32
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-60
 Confidence Interval Estimate
for the Slope
Confidence Interval Estimate of the Slope:
b1  t n2Sb1 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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-61
 Confidence Interval Estimate
for the Slope
(continued)

  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 First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-62
 t Test for a Correlation Coefficient
 Hypotheses
H0: ρ = 0 (no correlation between X and Y)
H1: ρ ≠ 0 (correlation exists)

 Test statistic
r -ρ
 t (with n – 2 degrees of freedom)
2
1 r where

n2 r   r 2 if b1  0

r   r 2 if b1  0
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-63
 Example: House Prices
Is there evidence of a linear relationship
between square feet and house price at
the .05 level of significance?

H0: ρ = 0 (No correlation)

H1: ρ ≠ 0 (correlation exists)
 =.05 , df = 10 - 2 = 8

r ρ .762  0
t   3.329
1 r 2 1 .762 2
n2 10  2
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-64
 Example: Test Solution

r ρ .762  0 Decision:
t   3.329
1 r 2 1 .762 2 Reject H0

n2 10  2 Conclusion:
There is
d.f. = 10-2 = 8
evidence of a
linear association
/2=.025 /2=.025
at the 5% level of
significance
Reject H0 Do not reject H0 Reject H0
-tα/2 0
tα/2
-2.3060 2.3060
3.329
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-65
 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 Y 
the mean of Y
Y, given Xi

Y = b0+b1Xi

Prediction Interval
for an individual Y,
given Xi Xi
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc.
X
Chap 12-66
 Confidence Interval for
the Average Y, Given X
Confidence interval estimate for the
mean value of Y given a particular Xi
Confidence interval for μY|X Xi :

Ŷ  t n2S YX hi
Size of interval varies according
to distance away from mean, X

1 (Xi  X)2 1 (Xi  X)2

hi    
n SSX n  (Xi  X)2
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-67
 Prediction Interval for
an Individual Y, Given X
Confidence interval estimate for an
Individual value of Y given a particular Xi
Confidence interval for YX  Xi :

Ŷ  t n2S YX 1  hi

This extra term adds to the interval width to reflect

the added uncertainty for an individual case

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-68
 Estimation of Mean Values:
Example
Confidence Interval Estimate for μY|X=X
i

Find the 95% confidence interval for the mean price

of 2,000 square-foot houses

Predicted Price Yi = 317.85 ($1,000s)

1 (Xi  X)2
Ŷ  t n-2S YX   317.85  37.12
n  (Xi  X) 2

The confidence interval endpoints are 280.66 and 354.90,

or from $280,660 to $354,900
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-69
 Estimation of Individual Values:
Example
Prediction Interval Estimate for YX=X
i

Find the 95% prediction interval for an individual

house with 2,000 square feet

Predicted Price Yi = 317.85 ($1,000s)

1 (Xi  X)2
Ŷ  t n-1S YX 1   317.85  102.28
n  (Xi  X) 2

The prediction interval endpoints are 215.50 and 420.07,

or from $215,500 to $420,070
Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-70
 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

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-71
 Finding Confidence and
Prediction Intervals in Excel
(continued)

Input values


Y

Confidence Interval Estimate for μY|X=Xi

Prediction Interval Estimate for YX=Xi

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-72
 Pitfalls of Regression Analysis
 Lacking an awareness of the assumptions
underlying least-squares regression
 Not knowing how to evaluate the assumptions
 Not knowing the alternatives to least-squares
regression if a particular assumption is violated
 Using a regression model without knowledge of
the subject matter
 Extrapolating outside the relevant range

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-73
 Strategies for Avoiding
the Pitfalls of Regression
 Start with a scatter diagram of X vs. Y to
observe possible relationship
 Perform residual analysis to check the
assumptions
 Plot the residuals vs. X to check for violations of
assumptions such as homoscedasticity
 Use a histogram, stem-and-leaf display, box-and-
whisker plot, or normal probability plot of the
residuals to uncover possible non-normality

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-74
 Strategies for Avoiding
the Pitfalls of Regression
(continued)

 If there is violation of any assumption, use

alternative methods or models
 If there is no evidence of assumption violation,
then test for the significance of the regression
coefficients and construct confidence intervals
and prediction intervals
 Avoid making predictions or forecasts outside
the relevant range

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-75
 Chapter Summary

 Introduced types of regression models

 Reviewed assumptions of regression and
correlation
 Discussed determining the simple linear
regression equation
 Described measures of variation
 Discussed residual analysis
 Addressed measuring autocorrelation

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-76
 Chapter Summary
(continued)

 Described inference about the slope

 Discussed correlation -- measuring the strength
of the association
 Addressed estimation of mean values and
prediction of individual values
 Discussed possible pitfalls in regression and
recommended strategies to avoid them

Business Statistics, A First Course (4e) © 2006 Prentice-Hall, Inc. Chap 12-77