Statistics for

Business and Economics

6th Edition

Chapter 12

Simple Regression

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-1
 Correlation Analysis

§ 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
§ Correlation was first presented in Chapter 3

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-2
 Correlation Analysis
§ The population correlation coefficient is
denoted ρ (the Greek letter rho)
§ The sample correlation coefficient is
s xy
r=
sxsy
where

s xy =
å (x - x)(y - y) i i

n -1
Statistics for Business and Economics, 6e © 2007 Pearson Education, 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 explain
(also called the endogenous variable)
Independent variable: the variable used to explain
the dependent variable
(also called the exogenous variable)

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-4
 Linear Regression Model

§ The relationship between X and Y is

described by a linear function
§ Changes in Y are assumed to be caused by
changes in X
§ Linear regression population equation model

Yi = β0 + β1x i + ε i

§ Where b0 and b1 are the population model

coefficients and e is a random error term.

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-5
 Simple Linear Regression
Model
The population 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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-6
 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
Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-7
 Simple Linear Regression
Equation
The simple linear regression equation provides an
estimate of the population regression line
Estimated Estimate of Estimate of the
(or predicted) the regression regression slope
y value for intercept
observation i
Value of x for

yˆ i = b0 + b1x i observation i

The individual random error terms ei have a mean of zero

ei = ( y i - yˆ i ) = y i - (b0 + b1x i )

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-8
 Least Squares Estimators

§ 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 SSE = min å ei2

= min å (y i -yˆ i )2

= min å [y i - (b0 + b1x i )]2

Differential calculus is used to obtain the

coefficient estimators b0 and b1 that minimize SSE
Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-9
 Least Squares Estimators
(continued)

§ The slope coefficient estimator is

n

å (x - x)(y - y)
i i
sY
b1 = i=1
n
= rxy
sX
å i
(x
i=1
- x) x
2

§ And the constant or y-intercept is

b0 = y - b1x

§ The regression line always goes through the mean x, y

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-10
 Finding the Least Squares
Equation

§ The coefficients b0 and b1 , and other

regression results in this chapter, will be
found using a computer
§ Hand calculations are tedious
§ Statistical routines are built into Excel
§ Other statistical analysis software can be used

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-11
 Linear Regression Model
Assumptions

§ The true relationship form is linear (Y is a linear function

of X, plus random error)
§ The error terms, εi are independent of the x values
§ The error terms are random variables with mean 0 and
constant variance, σ2
(the constant variance property is called homoscedasticity)
2
E[ε i ] = 0 and E[ε i ] = σ 2 for (i = 1, !, n)
§ The random error terms, εi, are not correlated with one
another, so that
E[ε iε j ] = 0 for all i ¹ j

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-12
 Interpretation of the
Slope and the Intercept

§ 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)

§ b1 is the estimated change in the

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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-13
 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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-14
 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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-15
 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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-16
 Regression Using Excel
§ Tools / Data Analysis / Regression

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-17
 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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-18
 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)

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-19
 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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-20
 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

Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-21
 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(200 0)

= 317.85
The predicted price for a house with 2000
square feet is 317.85($1,000s) = $317,850
Statistics for Business and Economics, 6e © 2007 Pearson Education, Inc. Chap 12-22