Managerial Economics

Statistical Analysis of Economic Relations

Coefficient of Variation

Coefficient of variation is the standard deviation divided by mean. The variance and standard

deviation are absolute measures of dispersion that are directly influenced by size and the unit of

measurement. The variance and standard deviation for sales revenue will almost always exceed

those for net profit because net profit (defined as revenue minus cost) is almost always less than

total revenues. In a true economic sense, however, profits tend to be more unpredictable than sales

revenue because profit variation reflects the underlying variability in both sales (demand) and cost

(supply) conditions. As a result, managers often rely on a measure of dispersion that does not

depend on size or the unit of measurement. The coefficient of variation compares the standard

deviation to the mean in an attractive relative measure of dispersion within a population or sample.

For a population, the coefficient of variation equals

Because it is unaffected by size or the unit of measure, the coefficient of variation can be used to

compare relative dispersion across a wide variety of data. In capital budgeting, for example,

managers use the coefficient of variation to compare “risk/reward” ratios for projects of widely

different investment requirements or profitability. Because managers are sometimes only able to

withstand a fixed dollar amount of loss or foregone profit, the coefficient of variation is often used in

conjunction with absolute risk measures such as the variance and standard deviation. Taken

together, absolute and relative measures give managers an especially useful means for assessing

the magnitude of dispersion within a population or sample of data. HYPOTHESIS

TESTING Experiments involving measures of central tendency and measures of dispersion are often

used to provide the information necessary for informed managerial decisions.

A hypothesis test is a statistical experiment used to measure the reasonableness of a given theory

or premise. In hypothesis testing, two different types of experimental error are encountered.
Type I error : Incorrect rejection of a true hypothesis;

Type II error : Incorrect failure to reject a false hypothesis.

Because both can lead to bad managerial decisions, the probability of both types of error must be

quantified and entered into the decision analysis. Although a wide variety of different hypothesis

tests are often employed by managers, the basics of the technique can be illustrated using a simple

means test example.