Probability and Statistics

LECTURE 11
SIMPLE LINEAR REGRESSION

Adapted from http://www.prenhall.com/mcclave

 OUTLINE
1. Simple Linear Regression Model
2. Least Squares Method
3. Coefficient of Determination
4. Model Assumptions
5. Testing for Significance
Simple Linear Regression

 Managerial decisions often are based on the

relationship between two or more variables.

 Regression analysis can be used to develop an

equation showing how the variables are related.

 The variable being predicted is called the dependent

variable and is denoted by y.
 The variables being used to predict the value of the
dependent variable are called the independent
variables and are denoted by x.
Simple Linear Regression

 Simple linear regression involves one independent

variable and one dependent variable.

 The relationship between the two variables is

approximated by a straight line.

 Regression analysis involving two or more

independent variables is called multiple regression.
 SIMPLE LINEAR REGRESSION
MODEL
 The equation that describes how y is related to x and
an error term is called the regression model.
 The simple linear regression model is:

Y = b0 + b1X +e
where:
b0 and b1 are called parameters of the model,
e is a random variable called the error term.
 ASSUMPTIONS ABOUT THE ERROR
TERM

1. The error e is a random variable with mean of zero.

2. The variance of e , denoted by  2, is the same for

all values of the independent variable.

3. The values of e are independent.

4. The error e is a normally distributed random

variable.
 Simple Linear Regression
Equation
 The simple linear regression equation is:

E(Y) = b0 + b1X
• Graph of the regression equation is a straight line.
• b0 is the y intercept of the regression line.
• b1 is the slope of the regression line.
• E(y) is the expected value of y for a given x value.
Simple Linear Regression
Equation
 Positive Linear Relationship
E(y)

Regression line

Intercept Slope b1
b0 is positive

x
Simple Linear Regression
Equation
 Negative Linear Relationship

E(y)

Intercept Regression line

b0
Slope b1
is negative
x
Simple Linear Regression
Equation
 No Relationship
E(y)

Intercept Regression line

b0
Slope b1
is 0

x
Estimated Simple Linear
Regression Equation
 The estimated simple linear regression equation

• The graph is called the estimated regression line.

• b0 is the y intercept of the line.
• b1 is the slope of the line.
• is the estimated value of y for a given x value.
 ESTIMATION PROCESS

Regression Model
Sample Data:
y = b0 + b1x +e x y
Regression Equation x1 y1
E(y) = b0 + b1x . .
Unknown Parameters . .
b0, b1 xn yn

Estimated
b0 and b1 Regression Equation
provide estimates of ŷ  b0 b1x
b0 and b1 Sample Statistics
b0, b1
 LEAST SQUARES METHOD

Least Squares Criterion

where:
yi = observed value of the dependent variable
for the ith observation
y^i = estimated value of the dependent variable
for the ith observation
 LEAST SQUARES METHOD

 Slope for the Estimated Regression Equation

b1  (x x)(y y)

i i

where:
(x x)
i
2

xi = value of independent variable for ith

observation
yi = value of dependent variable for ith
_ observation
x = mean value for independent variable
_
y = mean value for dependent variable
 Least Squares Method
 y-Intercept for the Estimated Regression Equation
Simple Linear Regression

 Example: Reed Auto Sales

Reed Auto periodically has a special week-long sale.
As part of the advertising campaign Reed runs one or
more television commercials during the weekend
preceding the sale. Data from a sample of 5 previous
sales are shown on the next slide.
Simple Linear Regression
 Example: Reed Auto Sales

Number of Number of
TV Ads (x) Cars Sold (y)
1 14 Note that in
3 24 practice, the
2 18 sample size
1 17 should be
3 27 larger than this.
Sx = 10 Sy = 100
 Scatterplot

30
Reed Auto Sales Estimated Regression Line

25
20
Cars Sold

y = 5x + 10
15
10
5
0
0 1 2 3 4
TV Ads
 ESTIMATED REGRESSION
EQUATION
 Slope for the Estimated Regression Equation

 y-Intercept for the Estimated Regression Equation

 Estimated Regression Equation

COEFFICIENT OF DETERMINATION
 Relationship Among SST, SSR, SSE
SST = SSR + SSE

 i
(y  y)2
  i
(yˆ  y)2
 i i
(y  ˆ
y )2

where:
SST = total sum of squares
SSR = sum of squares due to regression
SSE = sum of squares due to error
Coefficient of Determination

 The coefficient of determination is:

R2 = SSR/SST

where:
SSR = sum of squares due to regression
SST = total sum of squares
Coefficient of Determination

R2 = SSR/SST = 100/114 = .8772

The regression relationship is very strong; 87.72%

of the variability in the number of cars sold can be
explained by the linear relationship between the
number of TV ads and the number of cars sold.
 SAMPLE CORRELATION
COEFFICIENT

rxy  (sign of b1) Coefficient of Determination

where:
b1 = the slope of the estimated regression
equation
 SAMPLE CORRELATION
COEFFICIENT

rxy  (sign of b1) r2

The sign of b1 in the equation is “+”.

 ASSUMPTIONS ABOUT THE ERROR
TERM

1. The error e is a random variable with mean of zero.

2. The variance of e , denoted by  2, is the same for

all values of the independent variable.

3. The values of e are independent.

4. The error e is a normally distributed random

variable.
 TESTING FOR SIGNIFICANCE

To test for a significant regression relationship, we

must conduct a hypothesis test to determine whether
the value of b1 is zero.

Two tests are commonly used:

t Test and F Test

Both the t test and F test require an estimate of  2,

the variance of e in the regression model.
 TESTING FOR SIGNIFICANCE

 An Estimate of s 2
The mean square error (MSE) provides the estimate
of  2, and the notation s2 is also used.
s 2 = MSE = SSE/(n  2)
where:

SSE  (yi  y
ˆi )2  (yi b0 b1xi )2
 TESTING FOR SIGNIFICANCE

 An Estimate of 
• To estimate  we take the square root of  2.
• The resulting s is called the standard error of
the estimate.

SSE
s  MSE 
n2
 TESTING FOR SIGNIFICANCE
t test
 Hypotheses

H0: b1  0
Ha: b1  0
 Test Statistic

b1 s
t where sb1 
sb1 2
S(xi x)
 Testing for Significance:
t Test
 Rejection Rule

Reject H0 if p-value < 

or t < -t or t > t

where:
t is based on a t distribution
with n - 2 degrees of freedom

In this example, use α = 0.05.

 Testing for Significance:
t Test
1. Determine the hypotheses.

2. Specify the level of significance.  = .05

3. Select the test statistic.

𝟏

4. State the rejection rule. Reject H0 if p-value < α = .05

or |t| > 3.182 (with
3 degrees of freedom)
 Testing for Significance:
t Test
5. Compute the value of the test statistic.

6. Determine whether to reject H0.

t = 4.541 provides an area of .01 in the upper
tail. Hence, the p-value is less than .02. (Also,
t = 4.63 > 3.182.) We can reject H0.
Conclusion: there is enough evidence at 0.05 level
of significance to conclude that a linear relationship
exists between the number of TV Ads and the number
of cars sold.
Running simple linear regression
using R

Suppose that the data have been inputted into

the reed data frame

> fit <- lm(CarsSold ~ TVAds, data = reed)

> summary(fit)
 Reading R Outputs
Required for Exam
Call:
lm(formula = CarsSold ~ TVAds, data = reed)

Residuals:
1 2 3 4 5
-1 -1 -2 2 2
Coefficients:
Estimate Std. Error t value
Pr(>|t|)
(Intercept) 10.000 2.366 4.226 0.0242
*
TVAds 5.000 1.080 4.629 0.0190
*
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
Residual standard error: 2.16 on 3 degrees of freedom
Multiple R-squared: 0.8772,Adjusted R-squared: 0.8363
F-statistic: 21.43 on 1 and 3 DF, p-value: 0.01899
 SOME CAUTIONS ABOUT THE
INTERPRETATION OF SIGNIFICANCE TESTS

 Rejecting H0: b1 = 0 and concluding that the

relationship between x and y is significant does
not enable us to conclude that a cause-and-effect
relationship is present between x and y.
 SELF-STUDY:
CHECKING MODEL’S ASSUMPTIONS
CONCLUSION
 Simple Linear Regression Model
 Least Squares Method
 Coefficient of Determination
 Model Assumptions
 Testing for Significance