Chapter 2

Statistical Inference Methods

 1. Point Estimation

 2. Interval Estimation
Goal: How can we use sample data to estimate values
of population parameters?

Point estimate: A single statistic value that is the

“best guess” for the parameter value

Interval estimate: An interval of numbers around the

point estimate, that has a fixed “confidence level” of
containing the parameter value. Called a
confidence interval.
(Based on sampling distribution of the point estimate)
 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

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 Point Estimators – Most common to
use sample values

 Sample mean estimates population mean m

ˆ  y   y i

n
• Sample std. dev. estimates population std. dev. s

ˆ s   i
( y  y ) 2

n 1
 Point Estimates

We can estimate a with a Sample

Population Parameter … Statistic
(a Point Estimate)

Mean μ X
Proportion π p

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 Properties of good estimators

 Unbiased: Sampling distribution of the estimator

centers around the parameter value

ex. Biased estimator: sample range. It cannot be larger

than population range.

 Efficient: Smallest possible standard error, compared

to other estimators

Ex. If population is symmetric and approximately normal

in shape, sample mean is more efficient than sample
median in estimating the population mean and median.
 2. Confidence Interval

 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

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 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

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 Confidence Interval Example

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?
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 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

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 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.

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 Estimation Process

Random Sample I am 95%

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

Sample

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 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
population parameter of interest

• 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

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

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 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

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 Confidence Intervals

Confidence
Intervals

Population Population
Mean Proportion

σ Known σ Unknown

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

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 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

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 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

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 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
to constructed
σ contain μ;
X  Zα / 2
n ()x100% do
not.
Confidence Intervals
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 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.

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 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.

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

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 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

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 Confidence Intervals

Confidence
Intervals

Population Population
Mean Proportion

σ Known σ Unknown

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 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.

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 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

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 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 t α / 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)
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 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

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 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)
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 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
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 Student’s t Table

Upper Tail Area

Let: n = 3
df .10 .05 .025 df = n - 1 = 2
 = 0.10
1 3.078 6.314 12.706 /2 = 0.05

2 1.886 2.920 4.303

3 1.638 2.353 3.182 /2 = 0.05

The body of the table

contains t values, not 0 2.920 t
probabilities
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 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
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 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

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 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

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 Confidence Intervals

Confidence
Intervals

Population Population
Mean Proportion

σ Known σ Unknown

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 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 )

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 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
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 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

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 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

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 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

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 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.

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 Determining Sample Size

Determining
Sample Size

For the For the

Mean Proportion

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 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

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 Determining Sample Size

Determining
Sample Size

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

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 Determining Sample Size
(continued)

Determining
Sample Size

For the
Mean

σ 2
Zα / 2 σ 2
e Z α / 2 Now solve
n
for n to get 2
n e
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 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

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 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)

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 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

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 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

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 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)

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 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)

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 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
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 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.

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 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 is often 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.

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 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

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 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

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 Estimation & Sample Size
Determination For Finite
Populations

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 Use A fpc When Sampling More Than
5% Of The Population (n/N > 0.05)
Confidence Interval For µ with a fpc
S N n
X t / 2
n N1 A fpc simply
reduces the
standard error
Confidence Interval For π with a fpc of either the
sample mean or
p (1  p ) N n the sample proportion
p z / 2
n N1

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 Confidence Interval for µ with a fpc

Suppose N 1000, n 100, x 50, s 10

s N n
95% CI for  : x t / 2 
n N1
10 1000  100
50 1.984 
100 1000  1
50 1.88 (48.12, 51.88)

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 Determining Sample Size with a fpc

 Calculate the sample size (n0) without a fpc

z2 / 2 2
 For µ: n0 
e2
z2 / 2 (1   )
 For π: n0 
e2
 Apply the fpc utilizing the following formula to
arrive at the final sample size (n).
 n = n0N / (n0 + (N-1))

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