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Regression Models
To accompany
Quantitative Analysis for Management, Eleventh Edition, Global Edition
by Render, Stair, and Hanna
Power Point slides created by Brian Peterson
Learning Objectives
After completing this chapter, students will be able to:
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
Figure 4.1
Copyright © 2012 Pearson Education 4-10
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 1X e
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
e = random error
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
Y = Sales
X = Area payroll
The line chosen in Figure 4.1 is the one that
minimizes the errors.
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
Copyright © 2012 Pearson Education 4-14
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
X
X 24
4
6 6
Y
Y 42
7
6 6
b1
( X X )(Y Y ) 12.5
1.25
(X X ) 2
10
b0 Y b1 X 7 (1.25)(4) 2
Therefore Yˆ 2 1.25 X
Copyright © 2012 Pearson Education 4-16
Triple A Construction
Regression calculations
X
X 24
4 sales = 2 + 1.25(payroll)
6 6
Y
Y 42
7
If the payroll next
year is $600 million
6 6
b1
ˆ
( X X )(Y YY 1..525(6) 9.5 or $ 950,000
) 2 12
1.25
(X X ) 2
10
b0 Y b1 X 7 (1.25)(4) 2
Therefore Yˆ 2 1.25 X
Copyright © 2012 Pearson Education 4-17
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.
Copyright © 2012 Pearson Education 4-18
Measuring the Fit
of the Regression Model
Sum of the squares total:
SST (Y Y )2
An important relationship:
SST SSR SSE
Copyright © 2012 Pearson Education 4-19
Measuring the Fit
of the Regression Model
Sum of Squares for Triple A Construction
^ ^ ^
Y X (Y – Y)2 Y (Y – Y)2 (Y – Y)2
6 3 (6 – 7)2 = 1 2 + 1.25(3) = 5.75 0.0625 1.563
SST = 22.5
Sum of the squared error SSE = 6.875
SSRˆ=215.625
SSE e (Y Y )
2
An important relationship
SST SSR SSE
Copyright © 2012 Pearson Education 4-21
Measuring the Fit
of the Regression Model
Deviations from the Regression Line and from the Mean
Figure 4.2
r r2
r 0.6944 0.8333
* *
* * *
* * * * *
* *
* *** *
*
Figure 4.3 (c) No Correlation: X (d) Perfect Negative X
r=0 Correlation:
r = –1
Copyright © 2012 Pearson Education 4-25
Using Computer Software
for Regression
Accessing the Regression Option in Excel 2010
Program 4.1A
Copyright © 2012 Pearson Education 4-26
Using Computer Software
for Regression
Data Input for Regression in Excel
Program 4.1B
Copyright © 2012 Pearson Education 4-27
Using Computer Software
for Regression
Excel Output for the Triple A Construction Example
Program 4.1C
Copyright © 2012 Pearson Education 4-28
Assumptions of the Regression Model
Figure 4.4A
X
Figure 4.4B
Figure 4.4C
SSE
s MSE
2
n k 1
where
n = number of observations in the sample
k = number of independent variables
0.05
F = 7.71 9.09
Figure 4.5
Copyright © 2012 Pearson Education 4-43
Analysis of Variance (ANOVA) Table
DF SS MS F SIGNIFICANCE
Regression k SSR MSR = SSR/k MSR/MSE P(F >
MSR/MSE)
Residual n-k-1 SSE MSE =
SSE/(n - k - 1)
Total n-1 SST
Copyright © 2012 Pearson Education 4-44
Table 4.4
ANOVA for Triple A Construction
Program 4.1C
(partial)
P(F > 9.0909) = 0.0394
Because this probability is less than 0.05, we reject
the null hypothesis of no linear relationship and
conclude there is a linear relationship between X
and Y.
Copyright © 2012 Pearson Education 4-45
Multiple Regression Analysis
Multiple regression models are
extensions to the simple linear model
and allow the creation of models with
more than one independent variable.
Y = 0 + 1X1 + 2X2 + … + kXk + e
where
Y = dependent variable (response variable)
Xi = ith independent variable (predictor or explanatory
variable)
0 = intercept (value of Y when all Xi = 0)
i = coefficient of the ith independent variable
k = number of independent variables
e = random error
Copyright © 2012 Pearson Education 4-46
Multiple Regression Analysis
To estimate these values, a sample is taken the
following equation developed
Yˆ b0 b1 X 1 b2 X 2 ... bk X k
where
Ŷ = predicted value of Y
b0 = sample intercept (and is an estimate of 0)
bi = sample coefficient of the ith variable (and is
an estimate of i)
Yˆ b0 b1 X1 b2 X 2
where
Ŷ = predicted value of dependent variable (selling
price)
b0 = Y intercept
X1 and X2 = value of the two independent variables (square
footage and age) respectively
b1 and b2 = slopes for X1 and X2 respectively
Program 4.2A
Copyright © 2012 Pearson Education 4-50
Jenny Wilson Realty
Output for the Jenny Wilson Realty Multiple
Regression Example
SST /( n 1)
* * * *
*
** * * ** *
*
*** * ** *
Linear relationship Nonlinear relationship
Figure 4.6A
Figure 4.6B
X 2 ( weight)2
This gives us a model that can be solved with
linear regression software:
Yˆ b0 b1 X 1 b2 X 2
Program 4.5
A better model with a
smaller F-test for
significance and a larger
Copyright © 2012 Pearson Education
adjusted r2 value 4-68
Cautions and Pitfalls