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Chapter 5

METHOD OF ESTIMATING A
FUNCTION: THE
REGRESSION TECHNIQUE

Learning Objectives
Nature of the managerial problem and use of functions
Method of formulating a function
Estimation of a linear function : A simple regression
technique
Multivariate regression
Tests in multivariate regression estimates

Regression
A statistical technique used to qualify the relationship
between interrelated economic variables.
Used in physical and social studies, where problem of specifying
the relationship between two or more variables is involved.
Estimation of the coefficients
of the independent variables.

Measurement of the
reliability of the estimated
coefficients

Method of Formulating a Function


Formulation of a hypothesis
It is done on the basis of the observed relationship between two
or more facts or events of real life.

Translating the hypothesis into a


function

Suppose a hypothesis, the sales growth is a function of adexpenditure, this hypothesis can be translated into a
mathematical function
Y = A + Bx
where, Y = sales, X = ad-expenditure and A and B are constants.

Estimating a Function by Regression Method

Estimating the error


term

Ordinary Least
Square (OLS)
method

Regression
Method
Testing the
significance of
estimated
parameters

Test of goodness of
fit (the coefficient of
determination)

Estimating a Regression Function


Estimating the error
term:

Deviation of the plotted


points from the straight
line drawn through the
centre of plotted points. It
accounts for the following
kinds of errors:
Sampling error
Specification error
Measurement error

Ordinary Least
Square (OLS)
method:
This method uses the
sum of the square of
the error terms that
regression technique
seeks to minimize and
find the values of a and
b that produce the best
fit line.

Estimating a Regression Function


Testing the
significance of
estimated
parameters:
The level of
significance is
determined on the
basis of the
standard error
(standard deviation
of the estimated
value from the
sample values) and
t-ratio to t statistic.

Test of goodness of fit (the


coefficient of
determination):
It gives the measure of overall
strength of the association
between dependent variable (Y)
and independent variable (X). It
is denoted by R2 and its equation
is:

Explained variation in Y
Total variation in Y

Multivariate Regression

This method is used when dependent variable is the function


of more than one independent or explanatory variable.

Number of
observations

Number of independent
or explanatory variables

Additional Tests in Multivariate


Regression Estimates

Summary
Formulation of a function is required to identify the dependent
and independent variables and to determine the nature and
extent of relationship between them.
Method of Formulating a Function is formulation of a
hypothesis and translating the hypothesis into a function
Regression is a statistical technique used to measure the
Understand
the conceptvariables.
of managerial
relationship between
economic
economics
Regression Function includes estimating the error term,
ordinary least square method, testing the significance of
estimated parameters and test of goodness of fit
In multivariate regression dependent variable is the function
of more than one independent or explanatory variables.
Tests in Multivariate includes coefficients of multiple
determination & adjusted R2 multi-collinearity, Heteroscedasticity and autocorrelation or serial correlation