UNIT THREE

Simple Linear Regression Models

Content……
Simple Linear Regression Models
3.1. Basic Concepts and Assumptions
3.2. Least Squares Criteria
3.3. Normal Equations of OLS
3.4. Coefficient of Correlation and Determination
3.5. Hypothesis Testing
 LEARNING OUTCOME
 After studying this chapter, you will be able to:
 Determine the significance of the predictor variable in
explaining variability in the dependent variable;
 Predict values of the dependent variable for given values
of the explanatory variable;
 Use linear regression methods to estimate empirical
relationships;
 Critically evaluate simple econometric analyses.
 Introduction

. According to Conner

“if two or more quantities vary in sympathy, so that

movement in one tend to be accompanied by
corresponding movements in the other , then they said
to be correlated.”
A relationship exists when changes in one variable tend to be
accompanied by consistent and predictable changes in the
other variable.
 2.1. Basic concepts of Correlation

 Two variables are correlated if changes in one variable,

correspond to changes in the other
 Correlation in general refers to the statistical
association between two variables
 This statistical association allows us to make estimates
for the one variable based on the value of the other
 While we usually examine linear relationships, between
variables, non-linear might exist too
• .
 2.1. ….
 The degree of relationship between the variables under
consideration is measure through the correlation analysis.
The measure of correlation called the correlation coefficient
The degree of relationship is expressed by coefficient which
range from correlation ( -1 ≤ r ≥ +1)
The direction of change is indicated by a sign.
The correlation analysis enables us to have an idea about the
degree & direction of the relationship between the two
variables under study.
 Basic concept
 Correlation :is there a relationship between 2
variables?
 Regression: how well a certain independent variable
predict dependent variable?
 CORRELATION  CAUSATION
 In order to infer causality: manipulate independent variable
and observe effect on dependent variable
 Basic concept…..
 A correlation typically evaluates three aspects of the
relationship:
 the direction
 the form
 the degree
 The direction of the relationship is measured by the
sign of the correlation (+ or -).
 2.2. Coefficient of Linear Correlation
There are three methods of measuring correlation. These are:
a. The Scattered Diagram or Graphic Method
b. The Simple Linear Correlation coefficient
c. The coefficient of Rank Correlation

 The most common form of relationship is a straight line or

linear relationship which is measured by the Pearson
correlation.
 Scatter Diagram Method
 The scatter diagram is a rectangular diagram which can
help us in visualizing the relationship between two
phenomena.
30

It puts the data into X-Y plane

by moving from the lowest 20

data set to the highest data

Openness to computing

set. 10

0
20 40 60 80 100 120 140 160 180

Computer Self-efficacy
 The Simple Linear Correlation coefficient

 Pearson‟s „r‟ is the most common correlation coefficient.

 Karl Pearson‟s Coefficient of Correlation denoted by- „r‟ The
coefficient of correlation „r‟ measure the degree of linear
relationship between two variables say x and y.
 Karl Pearson‟s Coefficient of Correlation denoted by- r

-1 ≤ r ≥ +1
 Degree of Correlation is expressed by a value of Coefficient
 Direction of change is Indicated by sign ( - ve) or ( + ve)
 Cont.….
 For a precise quantitative measurement of the degree of
correlation between Y and X we use a parameter which is
called the correlation coefficient and is usually designated
by the Greek letter r. Sample correlation coefficient is
defined by the formula.
 Sample correlation coefficient is defined by the formula

Or
Example: The following table shows the quantity supplied for a commodity with the
corresponding price values. Determine the type of correlation that exists between
these two variables

Time period(in Quantity supplied Price Xi (in shillings

days) Yi (in tons)
1 10 2
YX
2 20 4
3 50 6
4 40 8
5 50 10
6 60 12
7 80 14
8 90 16
9 90 18
10 120 20
Example: The following table shows the quantity supplied for a commodity with the
corresponding price values. Determine the type of correlation that exists between
these two variables
Y X xi=Xi- Xˉ yi=Yi- Yˉ x2 y2 xiyi XY X2 Y2
10 2 -9 -51 81 2601 459 20 4 100
20 4 -7 -41 49 1681 287 80 16 400
50 6 YX -5 -11 25 121 55 300 36 2500
40 8 -3 -21 9 441 63 320 64 1600
50 10 -1 -11 1 121 11 500 100 2500
60 12 1 -1 1 1 -1 720 144 3600
80 14 3 19 9 361 57 1120 196 6400
90 16 5 29 25 841 145 1440 256 8100
90 18 7 29 49 841 203 1620 324 8100
120 20 9 59 81 3481 531 2400 400 14400
Sum=610 110 0 0 330 10490 1810 8520 1450 47700
Mean=61 11
This result shows that there is a strong positive correlation between the quantity
supplied and the price of the commodity under consideration.
 C. Spearman rank correlation:
 Spearman rank correlation is a non-parametric test that is used to measure
the degree of association between two variables.
 Spearman rank correlation test does not assume any assumptions about the
distribution of the data and is the appropriate correlation analysis when the
variables are measured on a scale that is at least ordinal.

The following formula is used to calculate the Spearman rank

correlation coefficient:

Where: 𝜌 = Spearman rank correlation coefficient

di= the difference between the ranks of
corresponding values Xi and Yi
n= number of value in each data set.
 C. Spearman rank correlation:
 The Spearman correlation coefficient, 𝜌, can take values from +1 to -1. A 𝜌 of
+1 indicates a perfect association of ranks, a 𝜌 of zero indicates no
association between ranks and a 𝜌 of -1 indicates a perfect negative
association of ranks. .

Example: A market researcher asks experts to express their

preference for twelve different brands of soap. Their replies
are shown in the following table.
Brands of soap A B C D E F G H I J K L

Person I 9 10 4 1 8 11 3 2 5 7 12 6

Person II 7 8 3 1 10 12 2 6 5 4 11 9
The figures in this table are ranks but not quantities. We have to
use the rank correlation coefficient to determine the type of
association between the preferences of the two persons.
This can be done as follows.
Brands of soap A B C D E F G H I J K L sum

Person I 9 10 4 1 8 11 3 2 5 7 12 6

Person II 7 8 3 1 10 12 2 6 5 4 11 9

Di 2 2 1 0 -2 -1 1 -4 0 3 1 -3

Di2 4 4 1 0 4 1 1 16 0 9 1 9 50

Slide 17
This figure, 0.827, shows a marked similarity of preferences of
the two persons for the various brands of soap.
 2.3. Types of Correlation Coefficient

There are three types of correlation:

1.Positive, negative, and zero correlation
2.Linear and non-linear correlation
3.Simple, multiple, and partial correlation

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 Positive correlation
A positive relationship exists when both
variables increase or decrease at the same time.

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