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# Statistics for

6th Edition

Chapter 12
Simple Regression

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-1

Chapter Goals
After completing this chapter, you should be
able to:
Explain the correlation coefficient and perform a
hypothesis test for zero population correlation
Explain the simple linear regression model
Obtain and interpret the simple linear regression
equation for a set of data
Describe R2 as a measure of explanatory power of the
regression model
Understand the assumptions behind regression
analysis
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-2

Chapter Goals
(continued)

## After completing this chapter, you should be

able to:
Explain measures of variation and determine whether
the independent variable is significant
Calculate and interpret confidence intervals for the
regression coefficients
Use a regression equation for prediction
Form forecast intervals around an estimated Y value
for a given X
Use graphical analysis to recognize potential problems
in regression analysis
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-3

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 12-4

Correlation Analysis
The population correlation coefficient is
denoted (the Greek letter rho)
The sample correlation coefficient is

r
where

s xy

s xy
sxsy

(x x)(y y)

n 1

Chap 12-5

## Hypothesis Test for Correlation

To test the null hypothesis of no linear
association,

H0 : 0

## the test statistic follows the Students t

distribution with (n 2 ) degrees of freedom:

r (n 2)
(1 r )

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-6

Decision Rules
Hypothesis Test for Correlation
Lower-tail test:

Upper-tail test:

Two-tail test:

H0: 0
H1: < 0

H0: 0
H1: > 0

H0: = 0
H1: 0

-t

Where t

r (n 2)
(1 r )
2

/2
-t/2

/2
t/2

## Reject H0 if t < -tn-2,

or t > tn-2,

has n - 2 d.f.
Chap 12-7

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)

Chap 12-8

## 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 0 1x i i
Where 0 and 1 are the population model
coefficients and is a random error term.
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-9

## Simple Linear Regression

Model
The population regression model:
Population
Y intercept
Dependent
Variable

Population
Slope
Coefficient

Independent
Variable

Random
Error
term

Yi 0 1Xi i
Linear component

Random Error
component

Chap 12-10

## Simple Linear Regression

Model
(continued)

Yi 0 1Xi i

Observed Value
of Y for Xi

Predicted Value
of Y for Xi

Slope = 1
Random Error
for this Xi value

Intercept = 0

Xi
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

X
Chap 12-11

## Simple Linear Regression

Equation
The simple linear regression equation provides an
estimate of the population regression line
Estimated
(or predicted)
y value for
observation i

Estimate of
the regression

Estimate of the
regression slope

intercept

y i b0 b1x i

Value of x for
observation i

## The individual random error terms ei have a mean of zero

ei ( y i - y i ) y i - (b0 b1x i )
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-12

## 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 y :
min SSE min ei2
min (y i y i )2
min [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 12-13

(continued)

n

b1

(x x)(y y)
i 1

x
2
(x

x
)
i

rxy

sY
sX

i 1

## 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 12-14

## 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

Chap 12-15

## Linear Regression Model

Assumptions
The true relationship form is linear (Y is a linear function
of X, plus random error)
The error terms, i are independent of the x values
The error terms are random variables with mean 0 and
constant variance, 2
(the constant variance property is called homoscedasticity)
2

E[ i ] 0 and E[ i ] 2

for (i 1, , n)

## The random error terms, i, are not correlated with one

another, so that
E[ i j ] 0
for all i j
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-16

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 12-17

## 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

Chap 12-18

## Sample Data for House Price

Model
House Price in \$1000s
(Y)

Square Feet
(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 12-19

Graphical Presentation
House price model: scatter plot

Chap 12-20

## Regression Using Excel

Tools / Data Analysis / Regression

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-21

Excel Output
Regression Statistics
Multiple R

0.76211

R Square

0.58082

0.52842

Standard Error

41.33032

Observations

ANOVA

10

df

SS

MS

F
11.0848

Regression

18934.9348

18934.9348

Residual

13665.5652

1708.1957

Total

32600.5000

Coefficients
Intercept
Square Feet

Standard Error

t Stat

P-value

Significance F
0.01039

Lower 95%

Upper 95%

98.24833

58.03348

1.69296

0.12892

-35.57720

232.07386

0.10977

0.03297

3.32938

0.01039

0.03374

0.18580

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-22

Graphical Presentation
House price model: scatter plot and
regression line
Slope
= 0.10977

Intercept
= 98.248

## house price 98.24833 0.10977 (square feet)

Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-23

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 12-24

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 oneunit 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 12-25

Measures of Variation
Total variation is made up of two parts:

SST

SSR

SSE

Total Sum of
Squares

Regression Sum
of Squares

Error Sum of
Squares

SST (y i y)2

SSR (y i y)2

SSE (y i y i )2

where:

## yi = Observed values of the dependent variable

y = Predicted value of y for the given x value
i
i

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-26

Measures of Variation
(continued)

## SST = total sum of squares

Measures the variation of the yi values around their
mean, y
SSR = regression sum of squares
Explained variation attributable to the linear
relationship between x and y
SSE = error sum of squares
Variation attributable to factors other than the linear
relationship between x and y

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-27

Measures of Variation
(continued)

Y
yi

2
SSE = (yi - yi )

## SST = (yi - y)2

_2
SSR = (yi - y)

_
y

xi
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

_
y

X
Chap 12-28

Coefficient of Determination, R2
The coefficient of determination is the portion
of the total variation in the dependent variable
that is explained by variation in the
independent variable
The coefficient of determination is also called
R-squared and is denoted as R2
SSR regression sum of squares
R

SST
total sum of squares
2

note:

0 R 1

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-29

Examples of Approximate
r2 Values
Y
r2 = 1

r2 = 1

## 100% of the variation in Y is

explained by variation in X

r =1
2

between X and Y:

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-30

Examples of Approximate
r2 Values
Y
0 < r2 < 1

## Weaker linear relationships

between X and Y:
Some but not all of the
variation in Y is explained
by variation in X

X
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-31

Examples of Approximate
r2 Values
r2 = 0

No linear relationship
between X and Y:

r2 = 0

## The value of Y does not

depend on X. (None of the
variation in Y is explained
by variation in X)

Chap 12-32

Excel Output
Multiple R

0.76211

R Square

0.58082

0.52842

Standard Error

## 58.08% of the variation in

house prices is explained by
variation in square feet

41.33032

Observations

ANOVA

SSR 18934.9348
R

0.58082
SST 32600.5000
2

Regression Statistics

10

df

SS

MS

F
11.0848

Regression

18934.9348

18934.9348

Residual

13665.5652

1708.1957

Total

32600.5000

Coefficients
Intercept
Square Feet

Standard Error

t Stat

P-value

Significance F
0.01039

Lower 95%

Upper 95%

98.24833

58.03348

1.69296

0.12892

-35.57720

232.07386

0.10977

0.03297

3.32938

0.01039

0.03374

0.18580

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-33

Correlation and R2
The coefficient of determination, R2, for a
simple regression is equal to the simple
correlation squared

R r
2

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

2
xy

Chap 12-34

Estimation of Model
Error Variance
An estimator for the variance of the population model
error is
n

2
e
i

SSE
s

n2 n2
2

2
e

i1

## Division by n 2 instead of n 1 is because the simple regression

model uses two estimated parameters, b0 and b1, instead of one

## se s2e is called the standard error of the estimate

Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-35

Excel Output
Regression Statistics
Multiple R

0.76211

R Square

0.58082

0.52842

Standard Error

41.33032

Observations

ANOVA

s e 41.33032

10

df

SS

MS

F
11.0848

Regression

18934.9348

18934.9348

Residual

13665.5652

1708.1957

Total

32600.5000

Coefficients
Intercept
Square Feet

Standard Error

t Stat

P-value

Significance F
0.01039

Lower 95%

Upper 95%

98.24833

58.03348

1.69296

0.12892

-35.57720

232.07386

0.10977

0.03297

3.32938

0.01039

0.03374

0.18580

Chap 12-36

## Comparing Standard Errors

se is a measure of the variation of observed y
values from the regression line
Y

small se

large se

## The magnitude of se should always be judged relative to the size

of the y values in the sample data
i.e., se = \$41.33K is moderately small relative to house prices in
the \$200 - \$300K range
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-37

Regression Model
The variance of the regression slope coefficient
(b1) is estimated by
2
2
s
s
e
e
s 2b1

2
2
(xi x) (n 1)s x

where:

sb1

SSE
se
n2

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-38

Excel Output
Regression Statistics
Multiple R

0.76211

R Square

0.58082

0.52842

Standard Error
Observations

ANOVA

sb1 0.03297

41.33032
10

df

SS

MS

F
11.0848

Regression

18934.9348

18934.9348

Residual

13665.5652

1708.1957

Total

32600.5000

Coefficients
Intercept
Square Feet

Standard Error

t Stat

P-value

Significance F
0.01039

Lower 95%

Upper 95%

98.24833

58.03348

1.69296

0.12892

-35.57720

232.07386

0.10977

0.03297

3.32938

0.01039

0.03374

0.18580

Chap 12-39

## Comparing Standard Errors of

the Slope
Sb1 is a measure of the variation in the slope of regression

Y

small Sb1

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

large Sb1

Chap 12-40

t Test
t test for a population slope
Is there a linear relationship between X and Y?

H0: 1 = 0
H1: 1 0

## (no linear relationship)

(linear relationship does exist)

Test statistic

b1 1
t
sb1
d.f. n 2
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

where:
b1 = regression slope
coefficient
1 = hypothesized slope
sb1 = standard
error of the slope
Chap 12-41

t Test
(continued)
House Price
in \$1000s
(y)

Square Feet
(x)

245

1400

312

1600

279

1700

308

1875

199

1100

219

1550

405

2350

324

2450

319

1425

255

1700

## Estimated Regression Equation:

house price 98.25 0.1098 (sq.ft.)

## The slope of this model is 0.1098

Does square footage of the house
affect its sales price?

Chap 12-42

t Test Example
H0: 1 = 0

H1: 1 0

Coefficients
Intercept
Square Feet

b1
Standard Error

sb1
t Stat

P-value

98.24833

58.03348

1.69296

0.12892

0.10977

0.03297

3.32938

0.01039

b1 1 0.10977 0
t

3.32938
t
sb1
0.03297

Chap 12-43

t Test Example
(continued)

H0: 1 = 0

## From Excel output:

H1: 1 0

Coefficients
Intercept
Square Feet

d.f. = 10-2 = 8
t8,.025 = 2.3060
/2=.025

Reject H0

/2=.025

Do not reject H0

-tn-2,/2
-2.3060

Reject H0

tn-2,/2
2.3060 3.329

b1
Standard Error

sb1

t Stat

P-value

98.24833

58.03348

1.69296

0.12892

0.10977

0.03297

3.32938

0.01039

Decision:
Reject H0
Conclusion:
There is sufficient evidence
that square footage affects
house price

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-44

t Test Example
(continued)

P-value = 0.01039
H0: 1 = 0

H1: 1 0

Coefficients
Intercept
Square Feet

## This is a two-tail test, so

the p-value is
P(t > 3.329)+P(t < -3.329)
= 0.01039
(for 8 d.f.)

P-value
Standard Error

t Stat

P-value

98.24833

58.03348

1.69296

0.12892

0.10977

0.03297

3.32938

0.01039

## Decision: P-value < so

Reject H0
Conclusion:
There is sufficient evidence
that square footage affects
house price

Chap 12-45

## Confidence Interval Estimate

for the Slope
Confidence Interval Estimate of the Slope:

d.f. = n - 2

Coefficients
Intercept
Square Feet

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

98.24833

58.03348

1.69296

0.12892

-35.57720

232.07386

0.10977

0.03297

3.32938

0.01039

0.03374

0.18580

## At 95% level of confidence, the confidence interval for

the slope is (0.0337, 0.1858)
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-46

for the Slope
(continued)
Coefficients
Intercept
Square Feet

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

98.24833

58.03348

1.69296

0.12892

-35.57720

232.07386

0.10977

0.03297

3.32938

0.01039

0.03374

0.18580

## Since the units of the house price variable is

\$1000s, we are 95% confident that the average
impact on sales price is between \$33.70 and
\$185.80 per square foot of house size
This 95% confidence interval does not include 0.
Conclusion: There is a significant relationship between
house price and square feet at the .05 level of significance
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-47

Prediction
The regression equation can be used to
predict a value for y, given a particular x
For a specified value, xn+1 , the predicted
value is

y n1 b0 b1x n1

## Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-48

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 12-49

## Relevant Data Range

When using a regression model for prediction,
only predict within the relevant range of data
Relevant data range

Risky to try to
extrapolate far
beyond the range
of observed Xs
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

Chap 12-50

## Multiple Regression Analysis

Extensions to the simple linear model
Models with more than one independent
variable
Y = 0 + 1X1 + 2X2 + + kXk +
where
Y=
dependent variable (response variable)
Xi =
ith independent variable (predictor or explanatory
variable)
0 =
intercept (value of Y when all Xi = 0)
i =
coefficient of the ith independent variable
k=
number of independent variables
=
random error
Education, Inc.

4 51

## Multiple Regression Analysis

To estimate these values, a sample is taken
the following equation developed
Y b0 b1 X1 b2 X 2 ... bk X k
Y
bi =

Where
=
predicted value of Y
b0 = sample intercept (an estimate of 0)
sample coefficient of the ith variable (an estimate
of i)

Education, Inc.

4 52

## Jenny Wilson Realty

Develop a model to determine the suggested
listing price for houses based on the size and
age of the house
Y b0 b1 X1 b2 X 2

where
=
predicted value of dependent variable
(selling price)
b0 =
Y intercept
X1 and X2 =
value of the two independent
variables (square footage and age) respectively
b1 and b2 =
slopes for X1 and X2
respectively
a sample of houses
that have sold

Selects
recently and records the data
Education, Inc.

4 53

TABLE 4.5

SELLING
PRICE (\$)

SQUARE
FOOTAGE

AGE

95,000

1,926

30

Good

119,000

2,069

40

Excellent

124,800

1,720

30

Excellent

135,000

1,396

15

Good

142,000

1,706

32

Mint

145,000

1,847

38

Mint

159,000

1,950

27

Mint

165,000

2,323

30

Excellent

182,000

2,285

26

Mint

183,000

3,752

35

Good

200,000

2,300

18

Good

211,000

2,525

17

Good

215,000

3,800

40

Excellent

1,740

12

Mint

Pearson
219,000
Education, Inc.

CONDITION

4 54

## Jenny Wilson Realty

PROGRAM 4.2A Input Screen for the Jenny Wilson Realty Multiple Regression Example

Education, Inc.

4 55

## Jenny Wilson Realty

Program 4.2B Excel Output

Y b0 b1 X1 b2 X 2
146,630.89 43.82X1 2898.69X 2
Education, Inc.

4 56

Evaluating Multiple
Regression Models
Similar to simple linear regression models
The p-value for the F test and r2 interpreted
the same
The hypothesis is different because there is
more than one independent variable
The F test is investigating whether all the
coefficients are equal to 0 at the same time

Education, Inc.

4 57

Evaluating Multiple
Regression Models
To determine which independent variables are
significant, tests are performed for each
variable
H 0 : 1 0
H1 : 1 0

The test statistic is calculated and if the pvalue is lower than the level of significance
(), the null hypothesis is rejected
Education, Inc.

4 58

## Jenny Wilson Realty

Full model is statistically significant
Useful in predicting selling price
p-value for F test = 0.002

r2 = 0.6719

## Are both variables significant?

For X1 (square footage)
For = 0.05, p-value = 0.0013

H 0 : 1 0
H1 : 1 0

## null hypothesis is rejected

For X1 (age)
For = 0.05, p-value = 0.0039
Education, Inc.

4 59

## Both square footage

Jenny Wilson Realty

in predicting the
Full model is statistically significant
selling price
Useful in predicting selling price
p-value for F test = 0.002

r2 = 0.6719

## Are both variables significant?

For X1 square footage
For = 0.05, p-value = 0.0013

H 0 : 1 0
H1 : 1 0

## null hypothesis is rejected

For X1 age
For = 0.05, p-value = 0.0039
Education, Inc.

4 60

## Binary or Dummy Variables

Binary (or dummy or indicator) variables are
special variables created for qualitative data
A dummy variable is assigned a value of 1 if a
particular condition is met and a value of 0
otherwise
The number of dummy variables must equal
one less than the number of categories of the
qualitative variable
Education, Inc.

4 61

## Jenny Wilson Realty

A better model can be developed if
information about the condition of the property
is included
X3 = 1 if house is in excellent condition
= 0 otherwise
X4 = 1 if house is in mint condition
= 0 otherwise

## Two dummy variables are used to describe

the three categories of condition
No variable is needed for good condition
since if both X3 and X4 = 0, the house must be
in good condition
Education, Inc.

4 62

## Jenny Wilson Realty

PROGRAM 4.5A Excel Input Screen with Dummy Variables

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4 63

## Jenny Wilson Realty

PROGRAM 4.5B Excel Output with Dummy Variables

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4 64

## Jenny Wilson Realty

PROGRAM 4.5B Excel Output with Dummy Variables

Coefficient of
determination,
r2 = 0.898

## Y 121,658 + 56.43X1 3,962X 2 + 33,162X 3 + 47,369X 4

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4 65

Nonlinear Regression
In some situations, variables are not linear
Transformations may be used to turn a
nonlinear model into a linear model

*
** *
***
*
Linear relationship
Education, Inc.

*
* **
* **

*
*
*

Nonlinear relationship
4 66

Colonel Motors
Use regression analysis to improve fuel
efficiency
Study the impact of weight on miles per gallon (MPG)
TABLE 4.6

MPG

WEIGHT
(1,000 LBS.)

MPG

WEIGHT
(1,000 LBS.)

12

4.58

20

3.18

13

4.66

23

2.68

15

4.02

24

2.65

18

2.53

33

1.70

19

3.09

36

1.95

19

3.11

42

1.92

Education, Inc.

4 67

Colonel Motors
FIGURE 4.6A Linear Model for MPG Data
45
40
35
30
MPG

25
20
15
10
5
0

1.00

2.00

3.00

4.00

5.00

## Weight (1,000 lb.)

Education, Inc.

4 68

Colonel Motors
model
PROGRAM 4.6 Excel Output for Linear Regression Model withUseful
MPG Data

Good r2 value

Y 47.6 8.2X1
Education, Inc.

or

## MPG 47.6 8.2 (weight in 1,000 lb.)

4 69

Colonel Motors
FIGURE 4.6B Nonlinear Model for MPG Data
45
40
35
30
MPG

25
20
15
10
5
0

1.00

2.00

3.00

4.00

5.00

## Weight (1,000 lb.)

Education, Inc.

4 70

Colonel Motors
The nonlinear model is a quadratic model
The easiest approach develop a new variable
X 2 (weight)2

New model
Y b0 b1 X1 b2 X 2

Education, Inc.

4 71

Colonel Motors
Improved
PROGRAM 4.7 Excel Output for Nonlinear Regression Model
with MPGmodel
Data

## Small F test for significance

Adjusted r2 and r2 both increased