Introduction to simple linear

regression
ASW, 12.1-12.2

Economics 224 – Notes for November 5, 2008

 Regression model
• Relation between variables where changes in some
variables may “explain” or possibly “cause” changes
in other variables.
• Explanatory variables are termed the independent
variables and the variables to be explained are
termed the dependent variables.
• Regression model estimates the nature of the
relationship between the independent and
dependent variables.
– Change in dependent variables that results from changes
in independent variables, ie. size of the relationship.
– Strength of the relationship.
– Statistical significance of the relationship.
 Examples
• Dependent variable is retail price of gasoline in Regina –
independent variable is the price of crude oil.
• Dependent variable is employment income – independent
variables might be hours of work, education, occupation, sex,
age, region, years of experience, unionization status, etc.

• Price of a product and quantity produced or sold:

– Quantity sold affected by price. Dependent variable is
quantity of product sold – independent variable is price.
– Price affected by quantity offered for sale. Dependent
variable is price – independent variable is quantity sold.
600 160

140

500

120

400

100

300 80

60

200

40

100

20

0 0
1981M01

1982M01

1984M01

1985M01

1986M01

1987M01

1988M01

1991M01

1992M01

1993M01

1994M01

1995M01

1997M01

1998M01

1999M01

2000M01

2001M01

2002M01

2004M01

2005M01

2007M01

2008M01
1983M01

1989M01

1990M01

1996M01

2003M01

2006M01
Crude Oil price index, 1997=100, left axis Regular gasoline prices, regina, cents per litre, right axis

Source: CANSIM II Database (Vector v1576530 and v735048

respectively)
 Bivariate and multivariate models
Bivariate or simple regression model
(Education) x y
(Income)
Multivariate or multiple regression model

(Education) x1
y (Income)
(Sex) x2
(Experience) x3
(Age) x4 with simultaneous relationship
Model
Price of wheat Quantity of wheat produced
Bivariate or simple linear regression (ASW, 466)
• x is the independent variable
• y is the dependent variable
• The regression model is
y   0  1 x  
• The model has two variables, the independent or explanatory
variable, x, and the dependent variable y, the variable whose
variation is to be explained.
• The relationship between x and y is a linear or straight line
relationship.
• Two parameters to estimate – the slope of the line β1 and the
y-intercept β0 (where the line crosses the vertical axis).
• ε is the unexplained, random, or error component. Much
more on this later.
 Regression line
• The regression model is y   0  1 x  
• Data about x and y are obtained from a sample.
• From the sample of values of x and y, estimates b0 of
β0 and b1 of β1 are obtained using the least squares or
another method.
• The resulting estimate of the model is
yˆ  b0  b1 x
• The symbol ŷ is termed “y hat” and refers to the
predicted values of the dependent variable y that are
associated with values of x, given the linear model.
 Relationships
• Economic theory specifies the type and structure of
relationships that are to be expected.
• Historical studies.
• Studies conducted by other researchers – different
samples and related issues.
• Speculation about possible relationships.
• Correlation and causation.
• Theoretical reasons for estimation of regression
relationships; empirical relationships need to have
theoretical explanation.
 Uses of regression
• Amount of change in a dependent variable that results
from changes in the independent variable(s) – can be
used to estimate elasticities, returns on investment in
human capital, etc.
• Attempt to determine causes of phenomena.
• Prediction and forecasting of sales, economic growth,
etc.
• Support or negate theoretical model.
• Modify and improve theoretical models and
explanations of phenomena.
Income hrs/week Income hrs/week
8000 38 8000 35
6400 50 18000 37.5
2500 15 5400 37
3000 30 15000 35
6000 50 3500 30
5000 38 24000 45
8000 50 1000 4
4000 20 8000 37.5
11000 45 2100 25
25000 50 8000 46
4000 20 4000 30
8800 35 1000 200
5000 30 2000 200
7000 43 4800 30
 Summer Income as a Function of Hours Worked

30000

25000

20000
Income

15000

10000

5000

0
0 10 20 30 40 50 60
Hours per Week
yˆ  2461  297 x

R2 = 0.311
Significance = 0.0031
 Outliers
• Rare, extreme values may distort the
outcome.
– Could be an error.
– Could be a very important observation.
• Outlier: more than 3 standard deviations from
the mean.

15
 GPA vs. Time Online

12

10

8
Time Online

0
50 55 60 65 70 75 80 85 90 95 100
GPA
 GPA vs. Time Online

6
Time Online

0
50 55 60 65 70 75 80 85 90 95 100
GPA
 160

140
Regular gasoline prices, regina, cents per litre

120

100

80

60

Correlation =
40
0.8703
20

0
0 100 200 300 400 500 600
Crude Oil Price Index (1997=100)

Source: CANSIM II Database (Vector v1576530 and v735048

respectively)
 U-Shape d Re lationship

12

10

6
Y

0
0 2 4 6 8 10 12
X

Correlation = +0.12.
19
 Next Wednesday, November 12
• Least squares method (ASW, 12.2)
• Goodness of fit (ASW, 12.3)
• Assumptions of model (ASW, 12.4)

• Assignment 5 will be available on UR Courses

by late afternoon Friday, November 7.
• No class on Monday, November 10 but I will
be in the office, CL247, from 2:30 – 4:00 p.m.