Managerial Economics in Global Economy (Regression Analysis)

Regression Analysis
Firm ABC wants to determine the relationship between its advertisement expenses and sales. The manger of
marketing department is asking to increase the budget of advertisement He sad that higher advertisement
expense bring increase in sales and in this way firm can earn more profit. Now management wants to test
this hypothesis that “ the higher advertisement expenditures lead to higher sales for firm ” to ensure that
their investment will be beneficial for organization. Management is also interested to know how much sales
increase for each Rupees increase in advertisement Manger collects the data for last 10 years. In this case,
advertisement (X) is independent variable and sales (Y) are dependent variable that manager seeks to
explain.
Sales and Advertisement Expenditures for firm ABC
(In Millions of Rupees)

Years Advertisement Sales

Table 0.1
(X) (Y)

1 20 88

2 18 80

3 22 84

4 24 92

5 22 96

6 24 104

7 26 108

8 26 116

9 28 112

10 30 120

We can draw the following graph with the help of given data. In this graph the independent variable
is measured along with the horizontal axis and sales are measured along the vertical axis. Regression line is

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 Managerial Economics in Global Economy (Regression Analysis)
showing the positive relation between these two variables, now we can also prove this relationship with the
help of statistical formulas.

Graph 0.1
0.1

Different methods can be applied to prove this hypothesis. In this case we will use these methods.
⇒ The Ordinary Least-Squares Methods
⇒ Test of Significance or Parameter Estimates
⇒ T-Test
⇒ Coefficient of determination
⇒ Test of significance
⇒ The Multiple Regression Model

The Ordinary Least-Squares Methods

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 Managerial Economics in Global Economy (Regression Analysis)
This is the most popular method of parameter estimation for coefficients of regression models. It has
well known probability distributions and gives unbiased estimators of regression parameters with the
smallest variance. The objective of regression line is to obtain the estimates of “a” (vertical intercept) and
“b” (the slope) of regression line:
Ŷt = + Xt
Where Ŷt is the estimation of firm’s sales and in the year “t” and Xt is the indicates the level of
advertisement and and are estimation of parameters.

Years X Y X-X Y-Y (X-X)( Y-Y) (X-X)2

Table 0.2 1 20 88 -4 -12 48 16

2 18 80 -6 -20 120 36

3 22 84 -2 -16 32 4

4 24 92 0 -8 0 0

5 22 96 -2 -4 8 4

6 24 104 0 4 0 0

7 26 108 2 8 16 4

8 26 116 2 16 32 4

9 28 112 4 12 48 16

10 30 120 6 20 120 36

X= 24 Y= 100 X-X= 0 Y-Y= 0 = 424 = 120

Estimation Procedure n

∑(X t − X )(Yt − Y )
bˆ= t =1
n =
∑ t
( X −
t =1
X ) 2

ˆ
aˆ= Y − bX

• = 100 - 3.533(24)

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 Managerial Economics in Global Economy (Regression Analysis)
• = 15.20
Thus the equation of regression is….
Ŷt = + Xt
Ŷ= 15.20-3.533(X)
This regression indicates that having the zero value of “X” (advertisement expense) the
level of sales is 15.20 million. If the value of “X” is 20 million as shown in the first year
the level of sales will increase from 15.20 to 85.86 million.
So, we can calculate the increase in sales with each Rupees increase in advertisement
expense….
Ŷ= 15.20-3.533(X)
After putting the values of “X” in different years….
Ŷ= 15.20-3.533(20) = 85.86
Ŷ= 15.20-3.533(18) = 78.79
Ŷ= 15.20-3.533(22) = 92.92
Ŷ= 15.20-3.533(24) = 99.99
Ŷ= 15.20-3.533(22) = 92.92
Ŷ= 15.20-3.533(24) = 99.99
Ŷ= 15.20-3.533(26) = 107.05
Ŷ= 15.20-3.533(26) = 107.05
Ŷ= 15.20-3.533(28) = 114.12
Ŷ= 15.20-3.533(30) = 121.19
Test of Significance Standard Error

Years X Y Ŷ (Y- Ŷ)2

Table 0.3 1 20 88 85.86 4.5796
2 18 80 78.79 1.4641
3 22 84 92.92 79.5664
4 24 92 99.99 63.8401
5 22 96 92.92 9.4864
6 24 104 99.99 16.0801
7 26 108 107.05 0.9025
8 26 116 107.05 80.1025
9 28 112 114.12 4.4944
10 30 120 121.19 1.4161
X= 24 Y= 100 = 261. 9322

Test of Significance Standard Error

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 Managerial Economics in Global Economy (Regression Analysis)
To test the hypothesis that b is significant (advertisement positively affects the sales) we
need to calculate the standard error (deviation) of . The standard error of can be
calculated as…..

Where Yt and Xt are the sample observation of dependent and independent variables and “t”
is the number of years. The “e” is the error term or “n” is the number of observation in
estimation of regression line; “k” is the number of estimated coefficients in the regression.
The value of “n-k” is called degree of freedom (df).

T-Test
After calculation of the ratio of we have to calculate the ratio of . This is called the
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 Managerial Economics in Global Economy (Regression Analysis)
t-statistic or t-ratio. We use t-statistic to check the relationship between two variables.
Two types of hypothesis are used in T-Test that are…
 H 1 = There is a relationship between two variables \

 H 0 = There is no relationship between two variables \

The degree of freedom is (n-k) so it is (10-2) = 8

From statistical table of the book Managerial Economics In Global World at page no 610 we
get the value of t using 8 as a degree of freedom, which is 2.306. The level of significance is
0.05. In this equation the value of “t” that we have calculated lies in the acceptance area. So,
we accept the H 1 which indicates that there is relationship between advertisement and sales.

-2.306
2.306
0 t
-t
Between these negative “-t ” and “ t ” the area is rejection, means that if the value of “t”
falls in this area its mean there is no relationship between the advertisement and sales. The
value that we have calculated lies in out side of the rejection area which reflects that there is
relationship between sales and advertisement expenditures.

Coefficient of Determination

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 Managerial Economics in Global Economy (Regression Analysis)
Years X Y Ŷ (Ŷ-Y) 2 (Y-Y) 2
Table 0.4
1 20 88 85.86 199.9396 144

2 18 80 78.79 449.8641 400

3 22 84 92.92 50.1264 256

4 24 92 99.99 1.04 64

5 22 96 92.92 50.1264 16

6 24 104 99.99 1.04 16

7 26 108 107.05 49.7025 64

8 26 116 107.05 49.7025 256

9 28 112 114.12 199.3744 144

10 30 120 121.19 449.0161 400

X= 24 Y= 100 1500. 08 1760

Explained Variation ∑ (Yˆ− Y )

2

R =
2
=
Total Variation ∑ (Yt − Y )2

1500.08
= = 0.8523
1760

This means that 85% total variation in sales is due to advertisement expenditures. We can graphically
represent this affect with the help of SPSS, which is presented in graph no 0.2.

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 Managerial Economics in Global Economy (Regression Analysis)

Graph 0.2

The above graph is showing the best fit for a straight linear regression line. The
line shows that there is perfect positive relationship between sales and
advertisement expenditures. The value of R2 linear (0.85) is equal to the value of
That we have calculated above with the help of this formula.

R =
2 Explained Variation
=
∑ (Yˆ− Y ) 2

Total Variation ∑ (Y − Y )
t
2

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 Managerial Economics in Global Economy (Regression Analysis)
Test of significance

Decomposition of sum of squares

Total variation = Explained + Unexplained Variation

∑ t
(Y − Y ) 2
= ∑ (Yˆ− Y ) 2
+ ∑ t t
(Y − Yˆ) 2

1760 = 1500 + 261.93122

Coefficient of Correlation:

r = R 2 with the sign of bˆ

r= 0.8523

r= 0.9232

Multiple Regression with the of SPSS

We can calculate the multiple regressions with the help of SPSS (statistical package for the social sciences);
a software package used for conducting statistical analyses, manipulating data, and generating tables and
graphs that summarize data.

Model Summary
Model R R Adjusted R Std. Error of the
Square Square Estimate
a
1 .923 .853 .810 6.08824
a. Predictors: (Constant), promotions, advertisement

a
Model Summary show the value of R square is 923 reflect the multiple correlation coefficients. And the
value of Adjusted R Square is. 81. It indicates that 81% of variance in the dependent variable (sales) can
be predicted from independent variable.

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 Managerial Economics in Global Economy (Regression Analysis)

ANOVAb
Model Sum of df Mean F Sig.
Squares Square
1 Regression 1500.533 2 750.267 20.241 .001a
Residual 259.467 7 37.067
Total 1760.000 9
a. Predictors: (Constant), promotions, advertisement
b. Dependent Variable: sales

The ANOVAb table shows that the F = 20.24 which is statistically significant where the Sig. Level is
. 001 which is less than 0.05 so we will accept H1 which mean that predictors are significantly combine
together to predict dependent variable (sales).

Coefficient

Model Un standardized Standardized t Sig.

Coefficients Coefficients
B Std. Error Beta
1 (Constant) 12.600 16.912 .745 .481
advertisement 4.633 4.359 1.210 1.063 .323
promotions -2.000 7.860 -.290 -.254 .806
a. Dependent Variable: sales

Coefficient table shows the standardized beta coefficient which are interpreted like correlation. The t
value and sig. values indicates whether that variable is significantly contributing to the equation for
predicting dependent variable (sales) in this case the advertisement and promotion are significantly adding
predictions.

As we know that the regression equation is

Dependent Variable = α + β (Independent Variables)

So, we can obtain multiple regression equations from this table of coefficients.

Dependency of Y (sales) on X (advertisement) variable:

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 Managerial Economics in Global Economy (Regression Analysis)
As we know that the regression equation is

Dependent Variable = α + β (Independent Variables)

Y Variable = 12.600 + 4.633(20) = 105.26

Y Variable = 12.600 + 4.633 (18) = 95.994
Y Variable = 12.600 + 4.633 (22) = 114.526
Y Variable = 12.600 + 4.633 (24) = 123.792
Y Variable = 12.600 + 4.633 (22) = 114.526
Y Variable = 12.600 + 4.633 (24) = 123.792
Y Variable = 12.600 + 4.633 (26) = 125.18
Y Variable = 12.600 + 4.633 (26) = 125.18
Y Variable = 12.600 + 4.633 (28) = 142.324
Y Variable = 12.600 + 4.633 (30) = 151.59

Dependence of Y (sales) Variable on Z (promotions)

Y Variable = 12.600 + 4.633(10) = 58.93

Y Variable = 12.600 + 4.633 (8) = 49.66
Y Variable = 12.600 + 4.633 (11) = 63.56
Y Variable = 12.600 + 4.633 (12) = 68.19
Y Variable = 12.600 + 4.633 (11) = 63.56
Y Variable = 12.600 + 4.633 (12) = 68.19
Y Variable = 12.600 + 4.633 (13) = 72.82
Y Variable = 12.600 + 4.633 (13) = 72.82
Y Variable = 12.600 + 4.633 (14) = 77.46
Y Variable = 12.600 + 4.633 (15) = 82.09

Problems in Regression Analysis

Multicollinearity: It occurs when there are high intercorrelations among some set of predictor variables.
In other words Multicollinearity happens when two or more predictors contain the overlapping information.

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 Managerial Economics in Global Economy (Regression Analysis)

(Adapted from: Quantitative Techniques Module, Superior University)

Heteroskedastic: It is an adjective describing a data sample or data-generating process in which the

errors are drawn from different distributions for different values of the independent variables.

Most commonly heteroskedasticity takes the form of changes in variance with the magnitude of X. That is,
in

y = Xb + e

that the e's vary in magnitude with the X's. (An example is that variance of income across individuals is
systematically higher for higher income individuals.)

http://economics.about.com/cs/economicsglossary/g/heteroskedastic.htm

Autocorrelation: Usually autocorrelation means correlation among the data from different time periods.
Spatial autocorrelation means correlation among the data from locations. There could be many dimensions
of spatial autocorrelation, unlike autocorrelation between periods.

http://economics.about.com/b/2007/01/25/economics-term-of-the-afternoon-spatial-autocorrelation.htm

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