CORRELATION

Correlation is defined as the relationship between two or more variables. Two variables are said to be
correlated if the change in one variable results in a corresponding change in the other variable.

For example: when price of a commodity rises supply for that commodity also rises.

Different kinds of correlation

1. Positive and negative correlation

Positive correlation:

Two variables are moves in the same direction then the correlation is said to be positive correlation.
That is an increase in the value of one variable causes an increase in the value of other variable or a
decrease in the value of one variable causes a decrease in the value of the other variable.

for example: height, weight

Negative correlation:

Two variables moves in the opposite direction then the correlation is said to be negative correlation.
That is an increase in the value of one variable causes a decrease in the value of the other variable
or a decrease in the value of one variable causes an increase in the value of other variable.

For example: price, demand

2. Linear and non-linear correlation

Linear correlation:

When the amount of change in one variable leads to a constant ratio to the change in the other
variable, then the correlation is said to be linear

x 5 10 15 20
y 10 20 30 40

Ratio 1:2

Graph of linear correlation will be a straight line.

Non-linear correlation (curve linear correlation)_

When the amount of change in one variable does not leads to a constant ratio to the change in the
other variable, then the correlation is said to be non- linear.
x 5 10 15 20
y 12 23 8 25

Graph of non-linear correlation will be a curve.

3. Simple, partial and multiple correlation

Simple correlation

In the study of relationship between variables , if there are only two variables, the correlation is
said to be simple.

Example: price, demand

Partial correlation

In partial correlation we study the relationship between any two variables , and the third variable
remains constant, if there are three variables.

Example: pressure, volume and temperature

Multiple correlation

In multiple correlation we study the relationship between one variable on one side and the
remaining variables on the other side.

Example: yield, rainfall and temperature

METHODS OF STUDYING CORRELATION

1. Scatter diagram

This is a graphical method of studying correlation between two variables. One of the variables is
shown on the X – axis and the other on the Y- axis. Each pair of value is plotted on the graph by
means of a dot mark. After all the items are plotted we get as many dots on the graph paper as the
number of points. If this points show some upward trend ( left bottom to right top) , then the
correlation is said to be positive. If this points show some downward trend (left top to right
bottom) then the correlation is said to be negative. If the plotted point do not show any trend then
there is no correlation.
 supply
60
40
20 supply

0
0 10 20 30

Positive correlation

Y-Values
4

2
Y-Values
0
0 1 2 3

No correlation

demand
100
50
demand
0
0 10 20 30

Negative correlation

2. Coefficient of correlation

Correlation coefficient is denoted by ‘r’. the value of correlation coefficient lies between -1 and+1.

When r= +1 , There is perfect positive correlation.

When r =-1, T here is perfect negative correlation.

When r=0, There is No correlation.

 Methods of measuring correlation coefficient

1. Karl pearson’s coefficient of correlation

Correlation coefficient=r=

n xy − ( x y )
n x 2 − (  x ) n y 2 − (  y )
2 2

n dxdy − ( dx dy )
r=
n dx 2 − (  dx ) n dy 2 − (  y )
2 2

cov( x, y)
Karl Pearson’s correlation co.efficient=  x   y ,

 ( x − x )( y − y )
Product moment correlation coefficient = n x   y

2. Spearman’s Rank correlation coefficient

6 D 2
1−
Spearman’s rank correlation coefficient = n(n 2 − 1)

m3 − m
6[ D 2 + ( )]
1− 12
In case of tied ranks, Spearman’s rank correlation coefficient = n(n2 − 1)

2. Concurrent deviation method

2C − N
 ( )
Concurrent deviation is N
1. Karl person’s co. efficient of correlation

Ex. Calculate co. efficient of correlation

X 2 3 4 5 6 7 8

Y 4 5 6 12 9 5 4

Solution:

X Y XY X2 Y2

2 4 8 4 16

3 5 15 9 25

4 6 24 16 36

5 12 60 25 144

6 9 54 36 81

7 5 35 49 25

8 4 32 64 16

35 45 228 203 343

 n XY − (  X . Y )

n ( X 2 ) − ( X ) n (Y 2 ) − (Y )
2 2

r=

7  228 − (35  45)

= 7  203 − ( 35 ) 7  343 − ( 45 )
2 2

1596 − 1575
= 1421 − 1225 2401 − 2025

21
= 196 376
21
= 196 376

Correlation co. efficient ‘r’=0.077

2).Spearman’s rank correlation co. efficient

6 D 2
1−
Spearman’s rank correlation coefficient = n(n 2 − 1)

Ex.1. The ranking of 10 individuals at the start and at the finish of a course of training are as follows.

Individuals : A B C D E F G H I J

Rank before : 1 6 3 9 5 2 7 10 8 4

Rank after : 6 8 3 2 7 10 5 9 4 1

Rank Before Rank after Rank Difference (D) D2

1 6 5 25

6 8 2 4
 3 3 0 0

9 2 7 49

5 7 2 4

2 10 8 64

7 5 2 4

10 9 1 1

8 4 4 16

4 1 3 9

Sum=176

6 D 2
1−
Rank correlation coefficient =
n ( n 2 − 1)

6 176
1−
= 10 (100 − 1)
=1 - 1.07

Rank correlation co efficient= -0.07

Ex2. Ten competitors in a beauty contest are ranked by three judges in the following order.

First judge :1 6 5 10 3 2 4 9 7 8

Second judge :3 5 8 4 7 10 2 1 6 9

Third judge :6 4 9 8 1 2 3 10 5 7

First judge Second judge Rank difference (D) D2

1 3 2 4
 6 5 1 1

5 8 3 9

10 4 6 36

3 7 4 16

2 10 8 64

4 2 2 4

9 1 8 64

7 6 1 1

8 9 1 1

TOTAL 200

6 D 2
1−
Rank correlation coefficient =
n ( n 2 − 1)

6  200
1−
= 10(100 − 1)

=1-1.21

Rank correlation coefficient , r = -0.21

First judge Third judge Rank difference (D) D2

1 6 5 25

6 4 2 4

5 9 4 16

10 8 2 4

3 1 2 4

2 2 0 0
 4 3 1 1

9 10 1 1

7 5 2 4

8 7 1 1

TOTAL 60

6 D 2
1−
Rank correlation coefficient =
n ( n 2 − 1)

6  60
1−
= 10(100 − 1)

=1-0.364

Rank correlation co.efficient , r = 0.636

Second judge Third judge Rank difference (D) D2

3 6 3 9

5 4 1 1

8 9 1 1

4 8 4 16

7 1 6 36

10 2 8 64

2 3 1 1

1 10 9 81

6 5 1 1

9 7 2 4

TOTAL 240
 6 D 2
1−
Rank correlation coefficient =
n ( n 2 − 1)

6  214
1−
= 10(100 − 1)

= 1-1.30

Rank correlation co.efficient , r = -0.30

The rank correlation coefficient in the case of first and third judges is greater than other two pairs.
There for first and third judges have highest similarity of thought and have the nearest approach in
common taste in beauty.

REPEATED RANK

m3 − m
6[ D + ( 2
)]
1− 12
In case of tied ranks, Spearman’s rank correlation coefficient = n(n2 − 1)

Obtain the rank correlation coefficient for the following data

X 68 64 75 50 64 80 75 40 55 64

Y 62 58 68 45 81 60 68 48 50 70

Solution:

X Rank of X Y Rank of Y D2

68 4 62 5 1

64 6 58 7 1

75 2.5 68 3.5 1

50 9 45 10 1

64 6 81 1 25

80 1 60 6 25

75 2.5 68 3.5 1
 40 10 48 9 1

55 8 50 8 0

64 6 70 2 16

TOTAL 72

75 Occurs 2 times , m = 2 m3 − m = 6

64 occurs 3 times , m= 3 m3 − m = 24

68 Occurs two times, m = 2 m3 − m = 6

m3 − m
6[ D 2 + ( )]
1− 12
Spearman’s rank correlation coefficient = n(n2 − 1)

 36 
6   72 + 
1− 
12 
= 10(100 − 1)

 6  75 
1−  
=  990 

Rank correlation coefficient , r = 0.54

2. Concurrent deviation method

2C − N
 ( )
Concurrent deviation is r= N

Ex. Calculate the co.efficient of concurrent deviation from the following data.

X: 20 25 30 15 28 32 35 17 29

Y: 30 18 25 10 30 25 15 30 27

X Y Direction of Direction of Dx DY
change (Dx) change of Y(Dy)
20 30 ................ ……… ………
 25 18 + - -
30 25 + + +
15 10 - - +
28 30 + + +
32 25 + - -
35 15 + - -
17 30 - + -
29 27 + - -

C= no. of positive signs in Dx.DY column=3

N = No .of pairs compared= 8

2C − N
 ( )
Concurrent deviation is r= N

=-.5

Note:

When 2C>N, r is +ve

When 2C<N , r is –ve

Properties of correlation coefficient.

1).correlation coefficient has a well defined formula

2).It lies between -1 and +1

3).it is a pure number and is independent of the units of measurement.

4).correlation co .efficient does not change with reference to change of origin or change of scale.

5).coefficient of correlation between X and Y is same as that of Y and X.

Probable error

Probable error is used to measure the reliability and dependability of the value of correlation
coefficient . If probable error is added or subtracted from the value of correlation coefficient , we get 2
limits within which the value of correlation coefficient may expected to lie.
 0.6745(1 − r 2 )
=
P.E= Probable error = n

(1 − r 2 )
S.E = n

Coefficient of determination = explained variance/ total variance

MEASURES OF CORRELATION
Points to remember
Meaning of correlation: Correlation is a statistical tool which studies the relationship between two
variables e.g. change in price leads to change in quantity demanded.
Correlation studies and measures the direction and intensity of relationship among variables. It
measures co-variation not causation. It does not imply cause and effect relation.
Type of Correlation
Correlation is classified into positive and negative correlation. The correlation is said to be positive when
the variables move together in the same direction. e.g. sale of lce cream and temperature move in same
direction.
The correlation is said to be negative when the variables move in opposite direction. e.g. When you
spend more time in studying chances of your failure decline.
Examples of positive correlation are:
1. Price and supply of a commodity.
2. Increase in Height and Weight.
3. Age of husband and age of wife.
4. The family income and expenditure on luxury items.
Examples of negative correlation are:
1. Sale of woollen garments and day temperature.
2. Price and Demand of a commodity.
3. Yield of crops and price.
Degree of Correlation:

Degree Positive Negative

Perfect +1 -1

High Between +0.75 and +1 Between -0.75 and -1

Moderate Between +0.25 and +0.75 Between -0.25 and -0.75

Low Between 0 and +0.25 Between 0 and -0.25

Zero 0 0

Methods of estimating correlation:

(a) Scatter diagram
(b) Karl person’s coefficient of correlation.
(c) Spearman’s rank correlation.
Scatter diagram offers a graphic expression of the direction and degree of correlation. To construct a
scatter diagram, x variables taken on X-axis and y variable is taken on Y-axis. The cluster of points,
plotted is referred to as a scatter diagram. In this, the degree of closeness of scatter points and their
overall direction enables us to examine the relationship.
Karl person’s coefficient of correlation is a quantitative method of calculating correlation. It gives a
precise numerical value of the degree of linear relationship between two variables.
Karl person’s coefficient of correlation is also known as product moment correlation.

Formula:
Here,
r = Coefficient of correlation

= Standard deviation of X-series.

= Standard deviation of Y-series.

N = Number of observations
Karl Person’s coefficient of correlation is calculated by following methods:

(a) Actual mean method:

Here,
r = Coeff. Of correlation

(b) Assumed Mean method:

Here,
dx = Deviations of x-series from assumed mean = (X – A)
dy = Deviation of Y-series from assumed mean = (Y – A)

= Sum of multiple of dx and dy.

= Sum of the square of dx.

= Sum of the square of dy

= Sum of the deviation of x-series

= Sum of the deviation of Y-series

N = Number of pairs of observations
When value of the variables are large, we use step deviation method to reduce the burden of
calculation.
(c) Step deviation method
Here,

dx = deviation of X-series from assumed mean = (X-A)

dy = deviation of Y-series from assumed mean = (Y-A)

= Sum of multiple of dx and dy.

= Sum of the square of dx.

= Sum of the square of dy

= Sum of the deviation of x-series

= Sum of the deviation of Y-series

N = Number of pairs of observations
C1 is common factor for series -x
C2 is common factor for series -y
Properties of correlation coefficient(r)
(i) Correlation coefficient (r) has no unit.
(ii) A negative value of r indicates an inverse relation.
(iii) If r is positive then two variables move in the same direction.
(iv) The value of r lies between minus – 1 and +1, i.e.
(v) If r is zero, the two variables are uncorrelated.
(vi) If r = + 1 or r = – 1, the correlation is perfect.
(vii) A high value of r indicates strong linear relationship and a low value or indicates a weak linear
relationship.
(viii) The value of r is unaffected by the change of origin and change of scale.
Given two variables x and y let us define two new variables

Here A and C are assumed means of X and V respectively. B and D are common factors. They rxy = ruv.
Spearman’s rank correlation method is used to calculate coefficient of correlation of qualitative
variables such as beauty, bravery, wisdom, ability virtue etc. It was developed by British Psychologist
C.E. spearman.

Here,
When ranks are repeated the formula is:

Where are number of repetitions of rank

INTRODUCTION TO INDEX NUMBER

Introduction to index number:

An index number is a statistical device for measuring changes in the magnitude of a group of related
variables.
Features of Index Number

1. Index numbers are expressed in terms of percentages. However, percentage sign (%) is never
used.

2. Index numbers are relative measurement of group of data.

3. Index numbers offer a precise measurement of the quantitative change in the concerned
variables over time.

4. Index number show changes in terms of averages.

5. They are expressed in numbers.

6. Index number facilitates the comparative study over different time period.

Importance of Index number

1. It serves as a barometer for measuring the value of money.

2. Gives knowledge about change in standard of living.

 3. It helps the business community in planning their decision.

4. Helpful to determine the rate of premium.

Limitation of Index Number

1. Limited applicability

2. International comparison is not possible

3. Limited coverage

4. Difficulty in the construction of index number

Types of Index numbers:

(i) Wholesale price index (WPI)
(ii) Consumer price index (CPI) or Cost of living index
(iii) Index of industrial production (IIP)
(iv) Index of Agricultural production (IAP)
(v) Sensex
Methods of constructing index numbers:
1. Construction of Simple Index numbers
a. Simple Aggregative Method
b. Simple Average of Price Relatives Method
2. Construction of weighted Index numbers
a. weighted Average of Price Relative Method
b. Weighted Aggregative Method
Simple aggregative method:

Here, = Price index of the current year.

= Sum of the prices of the commodities in the current year

= Sum of the prices of the commodities in the base year

Current year: Current year is the year for which average change is to be measured or index of index
number is to be calculated.
Base year: Base year is the year of reference from which we want measure extent of change in the
current year. The index number of base year is generally assumed to be 100.
Simple average of price Relatives method:
Here, = Price index of the current year

= Price relatives
N = Number of commodities
Weighted average of price relative method:

Here, = Index number for the current year in relation to base year

W = Weight, R = Price relatives i.e.

Weighted Aggregative method:
(i) Laspeyre’s method :- P01 = ∑p1q0∑p0q0×100∑p1q0∑p0q0×100
(ii) Pasche’s method :- P01 = ∑p1q1∑p0q1×100∑p1q1∑p0q1×100
(iii) Fisher’s Method :- P01
= ∑p1q0∑p0q0×∑p1q1∑p0q1−−−−−−−−−−−−√×100∑p1q0∑p0q0×∑p1q1∑p0q1×100
Some Important index numbers:
(i) Consumer price index (CPI): CPI is also known as the cost of living index, measures the average
change in retail prices.
Methods of constructing CPI:
Here,

W = Weights
(B) Aggregative expenditure method: P01 = ∑p1q0∑p0q0×100∑p1q0∑p0q0×100
(ii) Wholesale price index (WPI): WPI Indicates the change in the general price level.
(iii) Index of industrial production (IIP): IIP is used to measure the relative increase or decrease in the
level of industrial production.
IIP= ∑[q1q0×100]W∑W∑q1q0×100W∑W

Here, = Level of Production in the current year

= Level of production in the base year

W = Weight
(iv) Index of agriculture production (IAP)
IAP is used to study the rise and fall of the yield of principle crops from one period to other period.
(v) Sensex: Sensex is the short form of Bombay stock exchange sensitive index with 1978-79 as base. It
is the benchmark index for the Indian stock market.
It consists or 30 stocks which represent 13 sectors of the economy and the companies are the leaders
in their respective industries.
Problems in construction of index numbers:
(i) Purpose of index number.
(ii) Selection of base year.
(iii) Selection of items.
(iv) Selection of the prices of items.
(v) Selection of method of weighting
(vi) Selection of sources of data
(vii) Choice of an average.
(viii) Choice of method.
Uses of index numbers:
(i) To measure the purchasing power of money.
(ii) Knowledge of change in standard of living.
(iii) Adjustment in salaries and allowances.
(iv) Help in framing suitable policies.
(v) As economic barometers.
Inflation and index numbers:
Inflation is described a situation characterised by a sustained increase in the general price level.
Generally, inflation is measured in terms of wholesale price index.

Rate of inflation

Here, = WPI for week first (1)

= WPI for week second (2)