Module 3

Regression Models

To accompany
Quantitative Analysis for Management, Eleventh Edition,
by Render, Stair, and Hanna
Power Point slides created by Brian Peterson
 Learning Objectives
After completing this chapter, students will be able to:

1. Identify variables and use them in a regression

model.
2. Develop simple linear regression equations.
from sample data and interpret the slope and
intercept.
3. Compute the coefficient of determination and
the coefficient of correlation and interpret their
meanings.
4. Interpret the F-test in a linear regression model.
5. List the assumptions used in regression and
use residual plots to identify problems.
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 Learning Objectives
After completing this chapter, students will be able to:

6. Develop a multiple regression model and use it

for prediction purposes.
7. Use dummy variables to model categorical
data.
8. Determine which variables should be included
in a multiple regression model.
9. Transform a nonlinear function into a linear
one for use in regression.
10. Understand and avoid common mistakes made
in the use of regression analysis.

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 Chapter Outline

4.1 Introduction
4.2 Scatter Diagrams
4.3 Simple Linear Regression
4.4 Measuring the Fit of the Regression
Model
4.5 Using Computer Software for Regression
4.6 Assumptions of the Regression Model

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 Chapter Outline

4.7 Testing the Model for Significance

4.8 Multiple Regression Analysis
4.9 Binary or Dummy Variables
4.10 Model Building
4.11 Nonlinear Regression
4.12 Cautions and Pitfalls in Regression
Analysis

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 Introduction
 Regression analysis is a very valuable
tool for a manager.
 Regression can be used to:
 Understand the relationship between
variables.
 Predict the value of one variable based on
another variable.
 Simple linear regression models have
only two variables.
 Multiple regression models have more
variables.
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 Introduction
 The variable to be predicted is called
the dependent variable.
variable
 This is sometimes called the response
variable.
 The value of this variable depends on
the value of the independent variable.
 This is sometimes called the explanatory
or predictor variable.
Dependent Independent Independent
variable
= variable
+ variable

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 Scatter Diagram

 A scatter diagram or scatter plot is

often used to investigate the
relationship between variables.
 The independent variable is normally
plotted on the X axis.
 The dependent variable is normally
plotted on the Y axis.

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 Triple A Construction
 Triple A Construction renovates old homes.
 Managers have found that the dollar volume of
renovation work is dependent on the area
payroll.
TRIPLE A’S SALES LOCAL PAYROLL (X)
(Y) ($100,000,000s)
($100,000s)
6 3
8 4
9 6
5 4
4.5 2
9.5 5
Table 4.1
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 Triple A Construction
Scatter Diagram of Triple A Construction Company Data

Figure 4.1
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 Simple Linear Regression
 Regression models are used to test if there is a
relationship between variables.
 There is some random error that cannot be
predicted.
Y  0   1 X  

where
Y = dependent variable (response)
X = independent variable (predictor or explanatory)
0 = intercept (value of Y when X = 0)
1 = slope of the regression line
 = random error

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 Simple Linear Regression

 True values for the slope and intercept are not

known so they are estimated using sample data.

Yˆ b0  b1 X

where
Y^ = predicted value of Y
b0 = estimate of β0, based on sample results
b1 = estimate of β1, based on sample results

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 Triple A Construction

Triple A Construction is trying to predict sales

based on area payroll.

Y = Sales
X = Area payroll
The line chosen in Figure 4.1 is the one that
minimizes the errors.

Error = (Actual value) – (Predicted value)

e Y  Yˆ

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 Triple A Construction
For the simple linear regression model, the values
of the intercept and slope can be calculated using
the formulas below.
Yˆ b0  b1 X

X
 X
average (mean) of X values
n

Y
 Y
average (mean) of Y values
n
b1 
 ( X  X )(Y  Y )
(X  X ) 2

b0 Y  b1 X
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 Triple A Construction
Regression calculations for Triple A Construction

Y X (X – X)2 (X – X)(Y – Y)
6 3 (3 – 4)2 = 1 (3 – 4)(6 – 7) = 1
8 4 (4 – 4)2 = 0 (4 – 4)(8 – 7) = 0
9 6 (6 – 4)2 = 4 (6 – 4)(9 – 7) = 4
5 4 (4 – 4)2 = 0 (4 – 4)(5 – 7) = 0
4.5 2 (2 – 4)2 = 4 (2 – 4)(4.5 – 7) = 5
9.5 5 (5 – 4)2 = 1 (5 – 4)(9.5 – 7) = 2.5
ΣY = 42 ΣX = 24 Σ(X – X)2 = 10 Σ(X – X)(Y – Y) = 12.5
Y = 42/6 = 7 X = 24/6 = 4

Table 4.2

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 Triple A Construction
Regression calculations

X
 X 24
 4
6 6

Y
 Y 42
 7
6 6

b1 
 ( X  X )(Y  Y ) 12.5
 1.25
(X  X ) 10 2

b0 Y  b1 X 7  (1.25 )( 4 ) 2

Therefore Yˆ 2  1.25 X
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 Triple A Construction
Regression calculations

X
 X 24
 4
6 6 sales = 2 + 1.25(payroll)

Y
 Y 42
 7
If the payroll next
year is $600 million
6 6
ˆ
b1 
 ( X  X )(Y  YY

 1.5
) 2 12 .25(6) 9.5 or $ 950,000
1.25
(X  X ) 10 2

b0 Y  b1 X 7  (1.25 )( 4 ) 2

Therefore Yˆ 2  1.25 X
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 Measuring the Fit
of the Regression Model
 Regression models can be developed
for any variables X and Y.
 How do we know the model is actually
helpful in predicting Y based on X?
 We could just take the average error, but
the positive and negative errors would
cancel each other out.
 Three measures of variability are:
 SST – Total variability about the mean.
 SSE – Variability about the regression line.
 SSR – Total variability that is explained by
the model.
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 Measuring the Fit
of the Regression Model
 Sum of the squares total:

SST  (Y  Y )2

 Sum of the squared error:

SSE  e 2  (Y  Yˆ )2

 Sum of squares due to regression:

SSR  (Yˆ  Y )2

 An important relationship:
SST  SSR  SSE
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 Module 3 - ACTIVITY

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 Measuring the Fit
of the Regression Model
Sum of Squares for Triple A Construction

Y X (Y – Y)2 Y^ ^ 2
(Y – Y) (Y^ – Y)2
6 3
8 4
9 6
5 4
4.5 2
9.5 5
^ 2 ∑(Y^ – Y)2 =______
∑(Y – Y)2 =____ ∑(Y – Y) =

Y= SST = SSE = SSR = ________

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Table 4.3
 Measuring the Fit
of the Regression Model
Deviations from the Regression Line and from the Mean

Figure 4.2

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 Coefficient of Determination
 The proportion of the variability in Y explained by
the regression equation is called the coefficient
of determination.
 The coefficient of determination is r2.

SSR
2 SSE
r  1 
SST SST
 For Triple A Construction:
15.625
2
r  0.6944
22.5
 About 69% of the variability in Y is explained by
the equation based on payroll (X).
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 Correlation Coefficient
 The correlation coefficient is an expression of the
strength of the linear relationship.
 It will always be between +1 and –1.
 The correlation coefficient is r.

r  r2

 For Triple A Construction:

r  0.6944 0.8333

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 Four Values of the Correlation
Coefficient
Y Y
*
*
* ** *
*
* ** *
* * *
* *
(a) Perfect Positive X (b) Positive X
Correlation: Correlation:
r = +1 0<r<1
Y Y
*
* ** *
* * * * *
* *
* *** *
*
Figure 4.3 (c) No Correlation: X (d) Perfect Negative X
Correlation:
r=0 r = –1
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 Using Computer Software
for Regression
Accessing the Regression Option in Excel 2010

Program 4.1A
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 Using Computer Software
for Regression
Data Input for Regression in Excel

Program 4.1B
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 Using Computer Software
for Regression
Excel Output for the Triple A Construction Example

Program 4.1C
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 Assumptions of the Regression Model

 If we make certain assumptions about the errors

in a regression model, we can perform statistical
tests to determine if the model is useful.
1. Errors are independent.
2. Errors are normally distributed.
3. Errors have a mean of zero.
4. Errors have a constant variance.
 A plot of the residuals (errors) will often highlight
any glaring violations of the assumption.

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 Copyright

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reproduced, stored in a retrieval system, or transmitted, in
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photocopying, recording, or otherwise, without the prior
written permission of the publisher. Printed in the United
States of America.
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