Chapter 6

Correlation Analysis

Definition of correlation
Correlation is a statistical measure that indicates the extent to which two or more variables
fluctuate together. A positive correlation indicates the extent to which those variables increase or
decrease in parallel; a negative correlation indicates the extent to which one variable increases as
the other decreases.
A correlation coefficient is a statistical measure of the degree to which changes to the value of
one variable predict change to the value of another. When the fluctuation of one variable reliably
predicts a similar fluctuation in another variable, there’s often a tendency to think that means that
the change in one causes the change in the other. However, correlation does not imply causation.
There may be, for example, an unknown factor that influences both variables similarly.
Types of Correlation:
1. Positive Correlation:
If the weight of an individual increases in proportion to increase in his height, the relation
between this increase of height and weight is called as positive correlation. It ranges from 0 to +
1. If it is 0 then there is no relation at all. When it is + 1, then there is perfect positive correlation.
2. Negative Correlation:
It is just the opposite of positive correlation. If the weight of an individual does not increase in
proportion to increase in his height or if the weight of an individual decreases with an increase in
height, then it is said to be negative correlation, also ranges from 0 to -1. -1 is perfect negative
correlation.
3. Zero Correlation:
Zero correlation is a correlation showing no relationship, or a correlation having a correlation
coefficient of zero.
4. Linear and Non-Linear (Curvilinear) Correlation: Whether the correlation between the
variables is linear or non-linear depends on the constancy of ratio of change between the
variables. The correlation is said to be linear when the amount of change in one variable to the
amount of change in another variable tends to bear a constant ratio. For example, from the
values of two variables given below, it is clear that the ratio of change between the variables is
the same:
X: 10 20 30 40 50
Y: 20 40 60 80 100
The correlation is called as non-linear or curvilinear when the amount of change in one
variable does not bear a constant ratio to the amount of change in the other variable. For
example, if the amount of fertilizers is doubled the yield of wheat would not be necessarily be
doubled.
5. SIMPLE, PARTIAL OR MULTIPLE CORRELATION.

The distinction between simple, partial and multiple correlation is based upon the number of
variables studied. When only two variables are studied it is a problem of simple correlation.
When three or more variables are studied it is a problem of either multiple or partial correlation.
In multiple correlation three or more variables are studied simultaneously. For example, when
one studies the relationship between the yield of rice per acre and both the amount of rainfall and
the amount of fertilizers used, it is a problem of multiple correlation. On the other hand, in partial
correlation we recognize more than two variables, but consider only two variables to be
influencing each other, the effect of other influencing variables being kept constant. For
example, in the price problem taken above if we limit our correlation analysis of yield and
rainfall to periods when a certain average daily temperature existed, it becomes a problem
relating to partial correlation only.

SIGNIFICANCE OF THE STUDY OF CORRELATION

1. Most of the variables show some kind of relationship. For example, there is relationship
between price and supply, income and expenditure, etc. with the help of correlation analysis we
can measure in one figure the degree of relationship existing between the variables.
2. Once we know that two variables are closely related, we can estimate the value of one variable
given the value of another. This is done with help of regression analysis.
3. Correlation analysis contributes to the understanding of economic behavior, aids in locating
the critically important variables on which others depend, may reveal to the economist the
connection by which disturbances spread and suggest to him the paths through which stabilizing
forces may become effective. In business, correlation analysis enables the executive to estimate
costs, prices and other variables on the basis of some other series with which these costs, sales,
or prices may be functionally related. However, it should be noted that coefficient of correlation
is one of the most widely used and also one of the most widely abused statistical measures. It is
abused in the sense that one sometimes overlooks the fact that correlation measures nothing but
the strength of linear relationship and that it does not necessarily imply a cause- effect
relationship.
4. Progressive development in the methods of science and philosophy has been characterized by
increase in the knowledge of relationships or correlations. In nature also one finds multiplicity in
interrelated-forces.
5. The effect of correlation is to reduce the range of uncertainty. The prediction based on
correlation analysis is likely to be more reliable and near to reality.
Method of studying correlation:
1. Scatter Diagram Method
2. Karl Pearson’s co-efficient of correlation
3. Spearman’s Rank Correlation
4. Method of least squares

Correlation Mathematical Problem

1. Find correlation coefficient between the sales and expenses from the data given.

Firm 1 2 3 4 5 6 7 8 9 10
Sales 50 50 55 60 65 65 65 60 60 50
Expenses 11 13 14 16 16 15 15 14 13 13

2. Find coefficient of correlation by Karl Pearson’s method between X and Y and interpret its value.

X 57 42 40 33 42 45 42 42 44 56 44 43
Y 10 60 30 41 29 27 27 19 18 19 31 29

3. Find coefficient of correlation between price and sales from the following data:

Price 103 98 85 92 90 84 88 90 93 95
sales 500 610 700 630 670 800 800 750 700 680

4. A panel of men and a panel of women were asked by a consumer testing organization to rank 8
brands of tea according to taste. A rank of 1 was given to the best testing tea and a rank of 8 to the
worst.

Brand A B C D E F G H
Panel of 5 4 3 6 7 8 1 2
women
Panel of 4 5 6 3 8 7 2 1
men
5. Calculate rank correlation coefficient from the following two tests given below:

Preliminary 92 89 87 86 83 77 71 63 53 50
test
Final test 86 83 91 77 68 85 52 82 37 57