ASSOCIATIVE/CAUSAL/EXPLANATORY MODELS

Linear Regression Analysis

Slope-Intercept Form of a Linear Equation: 𝒚 = 𝒂 + 𝒃𝒙

Where:
𝒚 = dependent variable; demand or sales
𝒙 = independent variable; any variable that affects demand or sales;
e.g. time, price, population, household income, advertising exp.
𝒂 = y-intercept of the line; value of 𝒚 when 𝒙 = 0.
∆𝒚
𝒃 = slope of the line =
∆𝒙

Step 1: Gather data

x y
x1 y1
x2 y2
x3 y3
: :
xn yn

Step 2: Confirm that there’s indeed a strong linear relationship between 𝒙 and𝒚.
Calculate the correlation coefficient, 𝒓.

n xy   x y
r ; if 𝒓 ≥ 𝟎. 𝟕𝟎, there’s strong linear
n x   x   n y   y  
       
2 2 2 2
relationship between 𝒙 and𝒚 and
Linear Regression Analysis may be
Step 3: Calculate the slope, 𝒃: used to forecast 𝒚 given 𝒙.

n xy   x y
b
n x 2    x 
2

Step 4: Calculate the y-intercept, 𝒂:

a
y  b x
n

Step 5: Derive the Linear Regression Equation Step 6. Forecast 𝒚 given 𝒙.

𝒚 = 𝒂 + 𝒃𝒙