CORRELATION ANALYSIS

When changes in the values of one variable are accompanied by changes in the values of the other variable,
we say that the two variables are correlated. Thus correlation is the amount of relationship or association
between two or more variables.

Types of Correlation

The different types of correlation are

1) Positive and negative correlation

2) Linear and non-linear correlation
3) Simple, multiple and partial correlation

Positive Correlation

The correlation between two variables is said to be positive (direct) when both the variables move in the
same direction. In other words, in case of positive correlation we can always see that an increase or decrease
in the value of one variable will always be followed by an increase or decrease in the values of the other
variable.

Eg: Income and expenditure are positively correlated. We can see that an increase in income is followed by
an increase in expenditure. Similarly a decrease in income is followed by decrease in expenditure.

Negative Correlation

The correlation between two variables is said to be negative (inverse) when both the variables move in the
opposite direction.

Eg: Price and demand are negatively correlated. We can see that an increase in price is followed by a
decrease in demand. Similarly a decrease in price is followed by an increase in demand.

Linear Correlation

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

Eg: If price goes up by 10%, it leads to a rise in supply by 15% each time, then there is linear correlation
between price and supply.

Price: 20 25 30 35 40
Supply: 30 37.5 45 52.5 60

Non linear Correlation

Correlation is said to be non linear when the amount of change in one variable is not in constant ratio to the
change in the other variable. In this case, the ratio of change fluctuates and is never constant.
Simple Correlation

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

Eg: The correlation between price and demand is simple.

Multiple Correlation

In this case, we measure the degree of association between one variable on one side and all other variables on
the other side.

Eg: The relationship between yield with both rainfall and temperature together is multiple correlation.

Partial Correlation

Here we study the relationship of one variable with one of the other variables presuming that the other
variables remain constant.

Eg: Let there be three variables viz. yield, rainfall and temperature. Each is related with the other. Then the
relationship between yield and rainfall (assuming that temperature is constant) is the partial correlation.

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 is plotted on the graph by means of a dot mark. If these
points show some trend either upward or downward, the two variables are said to be correlated.

When the plotted points show an upward trend from the left bottom to the right top, we can conclude that
there is positive correlation between the variables. On the other hand, when the plotted points show a
downward trend from the left top to the right bottom, we can conclude that there is negative correlation
between the variables. If the plotted points do not show any trend, there is no correlation between the
variables.

Uses of Correlation

1) It helps to study the association between two variables. Eg: we can examine whether there is any
relation between sale and profit with the help of correlation.
2) Correlation measures degree of relation between two variables. Karl Pearson’s coefficient of
correlation provides a formula for finding the degree of relation between two variables.
3) Correlation analysis helps to estimate the future values. Eg: from the correlation coefficient between
income and investment, one can predict the possible quantum of investment for a particular amount
of income.

Importance of correlation in Business activities

Correlation study is useful in estimating the likely change in a variable with a particular amount of change in
another variable. Eg: Advertisement expenditure and sales. Prediction of values of variables based on
correlation analysis is more reliable and near to reality. Therefore in business forecasting, the correlation
analysis is very useful.
 REGRESSION ANALYSIS

Regression analysis is a mathematical measure of the average relationship between two or more variables in
terms of the original units of the data. Regression analysis, in general sense, means estimation or prediction
of unkown value of one variable from known value of the other variable.

Dependent and Independent variables

The variable whose value is to be predicted is called dependent variable and the variable which is used for
prediction is called independent variable.

Suppose we are dealing with a bivariate data (x,y). While estimating the value of y for any given value of x,
we take y as dependent variable and x as independent variable. Then we get line of regression of y on x.
Similarly for estimating x for any given value of y, we use the regression line of x and y. Here x is dependent
variable and y is an independent variable. Thus there are two regression lines. The two regression equations
are not reversible or interchangeable because of the simple reason that the basis and assumption for deriving
these equations are quite different.

Usefulness of study of regression

The study of regression is very useful in many types of analysis. By its study, we can obtain most probable
values of one series for given values of the other related series. If we know that two series relating to price
and supply are correlated we can find out what would be the effect on price if the supply of commodity were
increased or decreased to a particular level. The utility of regression is very great in physical sciences where
the data are generally in functional relationship. Therefore, it is always possible to exactly calculate the value
of one variable for a given value of the other variable by studying their regression.

Distinction between correlation and regression

1. In correlation analysis we study degree of relationship between the variables whereas in regression
analysis we study the nature of relationship.
2. In correlation analysis, the choice of dependent and independent variables is purely a personal choice
and is of no practical significance. In regression analysis, one has to decide which variable shall be
taken as dependent and which as independent.
3. Correlation analysis is not for the purpose of prediction where as regression analysis is basically
used for prediction purposes.