RESEARCH METHODOLOGY
LESSON 17:
PRINCIPLES OF STATISTICAL INFERENCE AND CONFIDENCE INTERVALS
In this chapter we shall learn to apply techniques of statistical
inference to business situations. I will first introduce the basic idea
underlying statistical inference and hypothesis testing. Our focus
will be more on understanding key concepts intuitively and less
on formulas and calculations, which can be done easily on
computers.
A business manager in a typical managerial situation needs to
determine whether results based on samples can be generalized to
a population. Different management situations require different
statistical techniques to carryout tests regarding the applicability of
sample statistics to a population.
By the end of this unit you should be able to
• Understand the nature of statistical inference
• Understand types of statistical inference
• Understand the theory behind statistical inference
• Apply sampling theory concepts to confidence intervals and
estimation
Nature of Statistical Inference
What is Statistical Inference?
We have seen that all managerial/ business situations involve
decision making in situations with incomplete information. When
a particular finding emerges from data analysis the manager asks
whether the empirical findings represent the true picture or have
occurred as a result of sampling accident.
Statistical inference is the process where we generalize from sample
results to a population from which the sample has been drawn.
Thus statistical inference is the process where we extend our
knowledge obtained from a random sample which is only a small
part of the population to the whole population.
Where do we use Statistical Inference?
Let us think of a typical managerial situation: Imagine you are a
purchase manager. Your basic problem is to ensure that a
consignment of Aluminum sheets supplied to you by a supplier
correspond to the required specification of .04 inch thickness.
How do you go about ensuring this?
One way would be to accept blindly what ever your suppliers
claim. Another option would be to audit each and every item.
Clearly this would be both very time consuming and expensive
and would result in an unacceptably low level of productivity.
Another option is for the manger to choose a random sample of
100 aluminum and measures them for their thickness. He finds
for example that the sheets in the sample have an average thickness
of .048 inches. On tzhe basis of past experience with the supplier
the manager believes that the sheets come from a population with
a standard deviation of .004inches. On the basis of this data he
has to make a decision whether the to accept or reject a consignment
of 10,000 sheets.
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To solve problems such as this we have to learn how to use
characteristics of samples to test an assumption about the
population from which the sample comes from. This in effect is
the process of statistical inference.
The issue facing the manager in the above example is:
• Could a sample of 100 aluminum sheets with average
thickness of .048 inches have come from a population with a
average thickness of .04 inches?
• Does the sample estimate of thickness differ from the
population estimate due to sampling error or is it because
our fundamental assumption about the mean thickness of
the underlying population is not correct?
• Suppose he believes it to be the first case and accepts the
consignment, what is the risk that he runs that the
consignment is flawed and does not conform to quality
standards of .04 inches?
This is just one example of a very typical managerial situation
where the principles of statistical inference can be put to use to
solving the manager’s dilemma.
Types of Statistical Inference
Broadly statistical inference falls into two major categories:
estimation and hypothesis testing. Both are actually two sides of
the same coin and can be regarded as representing different aspects
of a technique.
Below I briefly explain each of them.
1. Estimation
This is concerned with how we use sample statistics to estimate
population parameters. It is not necessary that an estimate be
based on statistical data. All managers make quick estimates based
on incomplete information, gut feel and intuition. Thus an estimate
of sales for the next quarter can be based on gut feel or on an
analysis of past sales data for the quarter. Both represent estimates.
The difference between a estimate based on intuition and one
based on a random sample is that we can apply the principles of
probability allows us to calculate percentage of error variation in
an estimate attributable to sampling variation.
The sample mean for example can be used as an estimate of the
population mean. Similarly the percentage of occurrence in a sample
of an attribute or event can be used to estimate the population
proportion . To explain the concept a little more clearly we can
look at a few examples of estimation:
• University departments make estimates of next years
enrollments on the basis of last years enrollments in the
same courses.
• Credit managers make estimates about whether a purchaser
will pay his bills on the basis of past behaviour of
customers with similar characteristics or their past repayment
record
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2. Hypotheses Testing
If we find a difference between two samples, we would like to
know, is this a “real” difference (i.e., is it present in the population)
or just a “chance” difference (i.e. it could just be the result of
random sampling error).
Hypothesis begins with an assumption called a hypothesis that
we make about a population parameter. We then collect sample
data and calculate sample statistics such as mean, standard deviation
to decide how likely it is that our hypothesized population
parameter is correct. Essentially the process involves judging
whether a difference between a sample and assumed population
value is significant or not. The smaller the difference the greater
the chance that our hypothesized value for the mean is correct.
Some examples of real world situations where we might want to
test hypotheses:
• A random sample of 100 south Indian families finds that
they consume more of a particular brand of Assam tea per
family than a random sample of 100 North Indian families.
It could be that the observed difference was caused by
sampling accident and that there is actually no difference
between the two populations. However if the results are not
caused by pure sampling fluctuations then we have a case for
the firm to take some further marketing action based on
sampling finding.
• Colgate Palmolive have decided that a new TV ad campaign
can only be justified if more than 55% of viewers see the
ads. In this case the company requests a marketing research
company to carryout a survey to assess viewership. The
agency comes back with a ad penetration of 50% for a
random sample of 1000. It is now the company’s problem
to assess whether the sample viewing proportion is
representative of the hypothesized level of viewership that
the company desires, i.e 55%. Can differences between the
two proportions be attributed to sampling error or is the
ads true viewership actually lower.
In the next section we shall look at the theory behind statistical
inference. The basis of inference remains the same irrespective of
whether the managerial objective is to obtain a point or interval
estimate of a population parameter or to test whether a particular
hypotheses is supported by sample data or not.
Activities
1. What is statistical inference? What are the different types of
inference?
2. Why do decision makers measure samples rather than entire
population? What are the disadvantages of sampling?
Theory behind Statistical Inference
We now look at the underlying theoretical basis of statistical
inference. The underlying basis of statistical inference is the theory
of sampling distributions.
Now we shall briefly review some concepts, which have been dealt
with in more detail in the earlier chapter on sampling.
What is a Sample?
A sample is a representative subset of the underlying population.
For each sample that is taken from a population we can calculate
various sample statistics such as mean and variance. We can take
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many such samples from a population and calculate their mean
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and standard deviations. Given the existence of sampling variation
it is likely that there is also going to be some variability in the
different estimates of mean and standard deviations. This can be
explained best with the help of an example:
Suppose there is a store which sells CDS . We assume it has a
regular customer base. A random sample of 100 customers is
taken and we find the sample mean age of customers was equal
to 42years, with a standard deviation of 5 years. However this is
only one possible sample, which could have been taken. A second
different sample may have had a result where mean was equal to
45 years and standard deviation of 6 years. To change a sample we
need only change one of the customers. We would expect samples
taken from a population to generate similar if not identical sample
means. If we take repeated samples such that all possible samples
are taken then we are likely to obtain a sampling distribution of
means.
What does this Distribution Look Like?
Logically we can conceive that there is only one sample which will
contain the youngest possible customers and its mean will have
the lowest sample mean. Similarly there will be another couple of
samples having the lowest 99 customers. These samples will have
means, which are slightly higher than the lowest mean. A
somewhat higher number will contain the youngest 98 customers
and so on.
The majority of the samples will have a cross section of all age
groups and therefore there would be a clustering of sample means
around what is likely to be the true population mean. The
distribution of sample means will look like the normal
distribution as shown in the figure1 below.
Sampling distribution of sample mean values
µ
Figure 1
This result follows from the Central Limit theorem : if we take
random samples of size n from a population, the distribution of
sample means will approach that of a normal probability
distribution. This approximation is closer the larger is n.
We do not actually know what form our population distribution
takes: it could be normal or it could be skewed. However it doesn’t
matter, as the sampling distribution will approximate a normal
distribution as long as sufficiently large samples are taken.
Normal Distribution
We now look briefly at some of the key characteristics of the
normal distribution.
The normal sampling distribution can be summarized by its two
statistics:
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 • Mean F
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• standard deviation
Logically we can see that the mean of the sampling distribution
should equal the mean of the population. The standard deviation
of the sampling distribution is given by / ”n, where is the
population standard deviation and n is the sample size. Thus the
sampling distribution of the mean can be defined in terms of its
mean and standard deviation.
However we should be clear We are talking about three different
statistics:
Mean Standard
Deviation
Sample x s population mean lies outside this range. This is illustrated in
Population µ s
Sampling distribution of mean µ
The three distributions are illustrated below:
Sampling distribution of the Population
The two distributions are illustrated in figure2 below. As can be
seen the sampling distribution of the sample mean is far more
concentrated than the population distribution. However both
distributions have the same mean m.
Figure 2
Application of sampling theory concepts to confidence
intervals.Once we have calculated our sample mean we need to
know where it lies in the sampling distribution of the mean in
relation to the true mean of the sampling distribution or the
population mean. It might be higher than the population mean
or lower, or it might be identical with the population mean. While
we cannot know for certain where the sample mean lies in relation
to the population mean we can use probability to assess its likely
position vis a vis the population mean.
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102
From our earlier classes we know that irrespective of the values of
and , for a normal probability distribution, the total area under
the normal curve is 1.00. Further specific portions of the normal
curve lie between plus/ minus any given number of standard
deviations from the mean.
These results are summarized below:
• Approx 68% of all values in a normally distributed
population lie within ±1 standard deviation from the mean.
Approximately 16% of the area lies on either side of of the
population mean lies outside this range. This is illustrated in
the figure 3.
• Approx 95.5% of all values in a normally distributed
population lie within ± 2 standard deviation from the mean.
Approximately 2.25% of area on either side of the
the figure4.
• Approx 99.7% of all values in a normally distributed
population lie within ±3 standard deviation from the mean .
This is illustrated in the figure5. Only .15% of the area under
the curve on either side of the mean lies outside this range.
Figure 3,4,5
Standard Normal Distribution
However we rarely need intervals involving only one, two or three
standard deviations. Statistical tables provide areas under the
normal curve that are contained by any number of standard
deviations (plus/ minus ) from the mean. We do this by
constructing the standard normal distribution which is
standardized .Thus all normal distributions with mean and
standard deviation can be transformed into a standard normal
distribution with µ =0 and s =1. This transformation is done
using the z statistic where
Z= x - µ/ s
s
The distribution of the z statistic represents the standard normal
distribution with mean µ =0 and standard deviation s =1.
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With the normal table we can determine the probability that the

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sample mean c lies within a certain distance from the population
mean.. The distance from the mean is defined in terms of number
of standard deviations away from the mean.
How do we do this?
This follows from the result that, irrespective of the shape of the
normal curve, the area under the normal curve for a distance of
one ,two or three or any given number of standard deviations is
the same across all curves. Therefore all intervals containing the
same number of standard deviations from the mean contain the
same proportion of the total area under the curve. Hence we can
make use of only one standard normal distribution.
Using the Standard normal probability distribution
The figure 6 below shows the raw scale and the standard normal
transformation. The standardized normal variable is z= x-FII/
s
As can be seen from the figure5 below, z actually represents a
transformation or change in measurement scale on the horizontal
axis. Thus in the raw scale the m=50. In the standard normal scale
this value is transformed to m=0.

Figure 5
The Standard normal probability table is organized in terms of z
values . It only gives the z values for half the area under the curve.
Because the distribution is symmetric: values which hold for one
half of the distribution are true for the other.
So far we have tried to understand the theory of sampling
underlying confidence intervals. We now turn to defining what
exactly is a confidence interval.
References
Aaker D A , Kumar V & Day G S - Marketing Research (John
Wiley &Sons Inc, 6th ed.)
Diamantopoulos A and Schlegelmilch A- Taking the fear out of
Data Analysis (Dryden Press, 1997)
Communication Service
Kothari C R – Quantitative Techniques (Vikas Publishing House
3rd ed.)
Levin R I & Rubin DS - Statistics for Management (Prentice Hall
of India, 2002)
Notes

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