Basic Business Statistics

11th Edition

Chapter 8

Confidence Interval Estimation

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc. Chap 8-1

 Learning Objectives

In this chapter, you learn:

 To construct and interpret confidence interval estimates
for the mean and the proportion
 How to determine the sample size necessary to
develop a confidence interval for the mean or
proportion
 How to use confidence interval estimates in auditing

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-2

 Chapter Outline

Content of this chapter

 Confidence Intervals for the Population

Mean, μ
 when Population Standard Deviation σ is Known
 when Population Standard Deviation σ is Unknown
 Confidence Intervals for the Population
Proportion, π
 Determining the Required Sample Size

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-3

 Point and Interval Estimates

 A point estimate is a single number,

 a confidence interval provides additional
information about the variability of the estimate

Lower Upper
Confidence Confidence
Point Estimate
Limit Limit

Width of
confidence interval

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-4

 Point Estimates

We can estimate a with a Sample

Population Parameter … Statistic
(a Point Estimate)

Mean μ X
Proportion π p

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-5

 Confidence Intervals

 How much uncertainty is associated with a

point estimate of a population parameter?

 An interval estimate provides more

information about a population characteristic
than does a point estimate

 Such interval estimates are called confidence

intervals

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-6

 Confidence Interval Estimate
 An interval gives a range of values:
 Takes into consideration variation in sample
statistics from sample to sample
 Based on observations from 1 sample
 Gives information about closeness to
unknown population parameters
 Stated in terms of level of confidence
 e.g. 95% confident, 99% confident
 Can never be 100% confident

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-7

 Confidence Interval Example

Cereal fill example

 Population has µ = 368 and σ = 15.

 If you take a sample of size n = 25 you know

 368 ± 1.96 * 15 / 25 = (362.12, 373.88) contains 95% of

the sample means
 When you don’t know µ, you use X to estimate µ
 If X = 362.3 the interval is 362.3 ± 1.96 * 15 / 25 = (356.42, 368.18)
 Since 356.42 ≤ µ ≤ 368.18 the interval based on this sample makes a
correct statement about µ.

But what about the intervals from other possible samples

of size 25?
Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-8
 Confidence Interval Example
(continued)
Lower Upper Contain
Sample # X
Limit Limit µ?
1 362.30 356.42 368.18 Yes

2 369.50 363.62 375.38 Yes

3 360.00 354.12 365.88 No

4 362.12 356.24 368.00 Yes

5 373.88 368.00 379.76 Yes

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-9
 Confidence Interval Example
(continued)
 In practice you only take one sample of size n
 In practice you do not know µ so you do not
know if the interval actually contains µ
 However you do know that 95% of the intervals
formed in this manner will contain µ
 Thus, based on the one sample, you actually
selected you can be 95% confident your interval
will contain µ (this is a 95% confidence interval)
Note: 95% confidence is based on the fact that we used Z = 1.96.

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-10

 Estimation Process

Random Sample I am 95%

confident that
Population μ is between
Mean 40 & 60.
(mean, μ, is X = 50
unknown)

Sample

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-11

 General Formula
 The general formula for all confidence
intervals is:
Point Estimate ± (Critical Value)(Standard Error)
Where:
• Point Estimate is the sample statistic estimating the
W population parameter of interest
h
• Critical Value is a table value based on the sampling
distribution of the point estimate and the desired confidence
level

• Standard Error is the standard deviation of the point estimate

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-12
 Confidence Level

 Confidence Level
 Confidence the interval will contain
the unknown population parameter
 A percentage (less than 100%)

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-13

 Confidence Level, (1-)
(continued)
 Suppose confidence level = 95%
 Also written (1 - ) = 0.95, (so  = 0.05)
 A relative frequency interpretation:
 95% of all the confidence intervals that can be
constructed will contain the unknown true
parameter
 A specific interval either will contain or will
not contain the true parameter
 No probability involved in a specific interval

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-14

 Confidence Intervals

Confidence
Intervals

Population Population
Mean Proportion

σ Known σ Unknown

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-15

 Confidence Interval for μ
(σ Known)
 Assumptions
 Population standard deviation σ is known

 Population is normally distributed

 If population is not normal, use large sample

 Confidence interval estimate:

σ
X  Z α/2
n
where X is the point estimate
Zα/2 is the normal distribution critical value for a probability of /2 in each tail
σ/ n is the standard error

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-16

 Finding the Critical Value, Zα/2
Z α/2  1.96
 Consider a 95% confidence interval:
1  α  0.95 so α  0.05

α α
 0.025  0.025
2 2

Z units: Zα/2 = -1.96 0 Zα/2 = 1.96

Lower Upper
X units: Confidence Point Estimate Confidence
Limit Limit

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-17

 Common Levels of Confidence
 Commonly used confidence levels are 90%,
95%, and 99%
Confidence
Confidence
Coefficient, Zα/2 value
Level
1 
80% 0.80 1.28
90% 0.90 1.645
95% 0.95 1.96
98% 0.98 2.33
99% 0.99 2.58
99.8% 0.998 3.08
99.9% 0.999 3.27

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-18

 Intervals and Level of Confidence
Sampling Distribution of the Mean

/2 1  /2
x
Intervals μx  μ
extend from x1
σ x2 (1-)x100%
X  Zα / 2
n of intervals
constructed
to
σ contain μ;
X  Zα / 2
n ()x100% do
not.
Confidence Intervals
Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-19
 Example
 A sample of 11 circuits from a large normal
population has a mean resistance of 2.20
ohms. We know from past testing that the
population standard deviation is 0.35 ohms.

 Determine a 95% confidence interval for the

true mean resistance of the population.

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-20

 Example
(continued)
 A sample of 11 circuits from a large normal
population has a mean resistance of 2.20
ohms. We know from past testing that the
population standard deviation is 0.35 ohms.

 Solution: σ
X  Z α/2
n
 2.20  1.96 (0.35/ 11 )
 2.20  0.2068
1.9932  μ  2.4068

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-21

 Interpretation
 We are 95% confident that the true mean
resistance is between 1.9932 and 2.4068
ohms
 Although the true mean may or may not be
in this interval, 95% of intervals formed in
this manner will contain the true mean

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-22

 Confidence Intervals

Confidence
Intervals

Population Population
Mean Proportion

σ Known σ Unknown

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-23

 Do You Ever Truly Know σ?

 Probably not!

 In virtually all real world business situations, σ is not

known.

 If there is a situation where σ is known then µ is also

known (since to calculate σ you need to know µ.)

 If you truly know µ there would be no need to gather a

sample to estimate it.

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-24

 Confidence Interval for μ
(σ Unknown)
 If the population standard deviation σ is
unknown, we can substitute the sample
standard deviation, S
 This introduces extra uncertainty, since
S is variable from sample to sample
 So we use the t distribution instead of the
normal distribution

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-25

 Confidence Interval for μ
(σ Unknown)
(continued)
 Assumptions
 Population standard deviation is unknown
 Population is normally distributed
 If population is not normal, use large sample
 Use Student’s t Distribution
 Confidence Interval Estimate:

S
X  tα / 2
n
(where tα/2 is the critical value of the t distribution with n -1 degrees of
freedom and an area of α/2 in each tail)

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-26

 Student’s t Distribution

 The t is a family of distributions

 The tα/2 value depends on degrees of
freedom (d.f.)
 Number of observations that are free to vary after
sample mean has been calculated

d.f. = n - 1

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-27

 Degrees of Freedom (df)
Idea: Number of observations that are free to vary
after sample mean has been calculated

Example: Suppose the mean of 3 numbers is 8.0

Let X1 = 7 If the mean of these three

Let X2 = 8 values is 8.0,
What is X3? then X3 must be 9
(i.e., X3 is not free to vary)
Here, n = 3, so degrees of freedom = n – 1 = 3 – 1 = 2
(2 values can be any numbers, but the third is not free to vary
for a given mean)
Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-28
 Student’s t Distribution
Note: t Z as n increases

Standard
Normal
(t with df = ∞)

t (df = 13)
t-distributions are bell-
shaped and symmetric, but
have ‘fatter’ tails than the t (df = 5)
normal

0 t
Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-29
 Student’s t Table

Upper Tail Area

Let: n = 3
df .25 .10 .05 df = n - 1 = 2
 = 0.10
1 1.000 3.078 6.314 /2 = 0.05

2 0.817 1.886 2.920

3 0.765 1.638 2.353 /2 = 0.05

The body of the table

contains t values, not 0 2.920 t
probabilities
Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-30
 Selected t distribution values
With comparison to the Z value

Confidence t t t Z
Level (10 d.f.) (20 d.f.) (30 d.f.) (∞ d.f.)

0.80 1.372 1.325 1.310 1.28

0.90 1.812 1.725 1.697 1.645
0.95 2.228 2.086 2.042 1.96
0.99 3.169 2.845 2.750 2.58

Note: t Z as n increases

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-31

 Example of t distribution
confidence interval

A random sample of n = 25 has X = 50 and

S = 8. Form a 95% confidence interval for μ

 d.f. = n – 1 = 24, so t α/2  t 0.025  2.0639

The confidence interval is

S 8
X  t α/2  50  (2.0639)
n 25

46.698 ≤ μ ≤ 53.302

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-32

 Example of t distribution
confidence interval
(continued)

 Interpreting this interval requires the

assumption that the population you are
sampling from is approximately a normal
distribution (especially since n is only 25).
 This condition can be checked by creating a:
 Normal probability plot or
 Boxplot

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-33

 Confidence Intervals

Confidence
Intervals

Population Population
Mean Proportion

σ Known σ Unknown

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-34

 Confidence Intervals for the
Population Proportion, π

 An interval estimate for the population

proportion ( π ) can be calculated by
adding an allowance for uncertainty to
the sample proportion ( p )

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-35

 Confidence Intervals for the
Population Proportion, π
(continued)
 Recall that the distribution of the sample
proportion is approximately normal if the
sample size is large, with standard deviation

 (1  )
σp 
n
 We will estimate this with sample data:

p(1 p)
n
Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-36
 Confidence Interval Endpoints
 Upper and lower confidence limits for the
population proportion are calculated with the
formula

p(1  p)
p  Z α/2
n
 where
 Zα/2 is the standard normal value for the level of confidence desired
 p is the sample proportion
 n is the sample size
 Note: must have np > 5 and n(1-p) > 5

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-37

 Example

 A random sample of 100 people

shows that 25 are left-handed.
 Form a 95% confidence interval for
the true proportion of left-handers

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-38

 Example
(continued)
 A random sample of 100 people shows
that 25 are left-handed. Form a 95%
confidence interval for the true proportion
of left-handers.

p  Z α/2 p(1  p)/n

 25/100  1.96 0.25(0.75)/100
 0.25  1.96 (0.0433)
0.1651  π  0.3349

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-39

 Interpretation

 We are 95% confident that the true

percentage of left-handers in the population
is between
16.51% and 33.49%.

 Although the interval from 0.1651 to 0.3349

may or may not contain the true proportion,
95% of intervals formed from samples of
size 100 in this manner will contain the true
proportion.

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-40

 Determining Sample Size

Determining
Sample Size

For the For the

Mean Proportion

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-41

 Sampling Error
 The required sample size can be found to reach a
desired margin of error (e) with a specified level of
confidence (1 - )

 The margin of error is also called sampling error

 the amount of imprecision in the estimate of the
population parameter
 the amount added and subtracted to the point estimate to
form the confidence interval

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-42

 Determining Sample Size

Determining
Sample Size

For the
Mean Sampling error
(margin of error)
σ σ
X  Zα / 2 e  Zα / 2
n n

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-43

 Determining Sample Size
(continued)

Determining
Sample Size

For the
Mean

σ 2
Zα / 2 σ 2
e  Zα / 2 Now solve
n
for n to get 2
n e
Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-44
 Determining Sample Size
(continued)

 To determine the required sample size for the

mean, you must know:

 The desired level of confidence (1 - ), which

determines the critical value, Zα/2
 The acceptable sampling error, e
 The standard deviation, σ

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-45

 Required Sample Size Example

If  = 45, what sample size is needed to

estimate the mean within ± 5 with 90%
confidence?

2 2 2 2
Z σ (1.645) (45)
n 2
 2
 219.19
e 5

So the required sample size is n = 220

(Always round up)

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-46

 If σ is unknown

 If unknown, σ can be estimated when

using the required sample size formula
 Use a value for σ that is expected to be
at least as large as the true σ
 Select a pilot sample and estimate σ with
the sample standard deviation, S

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-47

 Determining Sample Size
(continued)

Determining
Sample Size

For the
Proportion

π (1 π ) Now solve Z 2 π (1 π )

eZ for n to get n 2
n e

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-48

 Determining Sample Size
(continued)

 To determine the required sample size for the

proportion, you must know:

 The desired level of confidence (1 - ), which determines the

critical value, Zα/2
 The acceptable sampling error, e
 The true proportion of events of interest, π
 π can be estimated with a pilot sample if necessary (or
conservatively use 0.5 as an estimate of π)

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-49

 Required Sample Size Example

How large a sample would be necessary

to estimate the true proportion defective in
a large population within ±3%, with 95%
confidence?
(Assume a pilot sample yields p = 0.12)

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-50

 Required Sample Size Example
(continued)

Solution:
For 95% confidence, use Zα/2 = 1.96
e = 0.03
p = 0.12, so use this to estimate π

Z α/2 2 π (1  π ) (1.96) 2 (0.12)(1  0.12)

n   450.74
e2 (0.03) 2
So use n = 451

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-51

 Applications in Auditing
 Six advantages of statistical sampling in
auditing

 Sampling is less time consuming and less costly

 Sampling provides an objective way to calculate the
sample size in advance
 Sampling provides results that are objective and
defensible.
 Because the sample size is based on demonstrable
statistical principles, the audit is defensible before one’s
superiors and in a court of law.

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-52

 Applications in Auditing
(continued)
 Sampling provides an estimate of the sampling error
 Allows auditors to generalize their findings to the population
with a known sampling error.
 Can provide more accurate conclusions about the
population
 Sampling isoften more accurate for drawing
conclusions about large populations.
 Examining every item in a large population is subject to
significant non-sampling error
 Sampling allows auditors to combine, and then
evaluate collectively, samples collected by different
individuals.

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-53

 Confidence Interval for
Population Total Amount
 Point estimate for a population of size N:
Population total  NX

 Confidence interval estimate:

S N n
N X  N (t α / 2 )
n N 1
(This is sampling without replacement, so use the finite population
correction in the confidence interval formula)

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-54

 Confidence Interval for
Population Total: Example

A firm has a population of 1000 accounts and wishes

to estimate the total population value.

A sample of 80 accounts is selected with average

balance of $87.6 and standard deviation of $22.3.

Find the 95% confidence interval estimate of the total

balance.

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-55

 Example Solution
N  1000, n  80, X  87.6, S  22.3

S N n
N X  N (t α / 2 )
n N 1
22.3 1000  80
 (1000)(87.6)  (1000)(1.9905)
80 1000  1
 87,600  4,762.48

The 95% confidence interval for the population total

balance is $82,837.52 to $92,362.48

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-56

 Confidence Interval for
Total Difference
 Point estimate for a population of size N:
Total Difference  ND

 Where the average difference, D, is:

n

D i
D i1
n
where Di  audited value - original value

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-57

 Confidence Interval for
Total Difference
(continued)

 Confidence interval estimate:

SD N n
N D  N (t α / 2 )
n N 1

where n
 ( Di  D) 2
S D  i 1
n 1

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-58

 One-Sided Confidence Intervals
 Application: find the upper bound for the
proportion of items that do not conform with
internal controls

p(1  p) N  n
Upper bound  p  Z α
n N 1
 where
 Zα is the standard normal value for the level of confidence desired
 p is the sample proportion of items that do not conform
 n is the sample size
 N is the population size

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-59

 Ethical Issues

 A confidence interval estimate (reflecting

sampling error) should always be included
when reporting a point estimate
 The level of confidence should always be
reported
 The sample size should be reported
 An interpretation of the confidence interval
estimate should also be provided

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-60

 Chapter Summary
 Introduced the concept of confidence intervals
 Discussed point estimates
 Developed confidence interval estimates
 Created confidence interval estimates for the mean (σ
known)
 Determined confidence interval estimates for the
mean (σ unknown)
 Created confidence interval estimates for the
proportion
 Determined required sample size for mean and
proportion settings

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-61

 Chapter Summary
(continued)

 Developed applications of confidence interval

estimation in auditing
 Confidence interval estimation for population total

 Confidence interval estimation for total difference

in the population
 One-sided confidence intervals for the proportion

nonconforming
 Addressed confidence interval estimation and ethical
issues

Basic Business Statistics, 11e © 2009 Prentice-Hall, Inc.. Chap 8-62