CORRELATION

K.K. SOOD
P.G.T. ECONOMICS
J.N.V. CHANDIGARH
 Correlation
• Introduction:- In the previous chapter we have learnt
how to construct summary measures out of a mass of data
and changes among similar variables.
• Now we will learn how to examine the relationship
between two variables.
• As a summer heat rises, hill stations, are crowed with
more and more visitors. Ice cream sales become more
brisk.
• Thus , the temperature is related to number of visitors and
sale of ice creams
 Definition of correlation
• Correlation analysis studies the relation between two
variables.
• It deals with questions such as:
• Is there any relationship between two variables?
• It the value of one variable changes, does the value of the
other also changes?
• Do both the variables move in the same direction?
• How strong is the relationship?
 Types of relationship
• 1) Cause and effect relationship:-
• Low agricultural productivity is related to low rainfall.
• 2) Coincidence:-
• The relation between the arrival of migratory birds in a
sanctuary and the birth rate in the locality cannot be
given any cause and effect interpretation.
 Types of relationship
• 3) Third variable’s impact on two variables:-
• Brisk sale of ice-creams may be related to higher number
of deaths due to drowning. The victims are not drowned
due to eating of ice creams. Rising temperature leads to
brisk sale of ice cream. Moreover, large number of people
start going to swimming pools to beat the heat. This might
have raised the number of deaths by drowning.
 What does correlation
measures?
• Correlation studies and measures the direction and intensity of
relationship among variables.
• Correlation measures covariation, not causation.
• Correlation should never be interpretated as implying cause
and effect relation.
• The presence of correlation between two variables X and Y
simply means that when the value of one variable is found to
change in one direction, the value of other variable is found to
change either in same direction(ie positive change) or in the
opposite direction(ie negative change)
 Types of correlation
• Positive correlation:-
• When two variable move in the same direction, that is,
when one increases the other also increases and when one
decreases
X the other Yalso decreases.
X Y
10 100 50 250
20 150 40 200
30 200 30 150
40 250 20 100
 Types of Correlation
Negative correlation –
• When two variables changes in different directions, it is
called negative correlation. Relationship between price
and demandPrice Demand
1 40
2 30
3 20
4 10
 Linear and Non-Linear
Correlation
Linear Correlation:-
• When two variables change in a constant proportion, it is
called linear correlation.
• If two sets of data bearing fixed proportion to each other
are shown on a graph paper, their relationship will be
indicated by a straight line.
• Thus linear correlation implies a straight line relationship.
(a) 2 4 6 8 10 12 14
(b) 5 10 15 20 25 30 35
 Linear and Non-Linear
Correlation
Non – linear Correlation
• When the two variables do not change any constant
proportion, the relationship said to be non linear.
• Such a relationship does not form a straight line
relationship.
(a) 2 4 6 8 10 12 14
(b) 3 7 12 18 25 35 45
Simple and Multiple Correlation
1. Simple Correlation
• It implies the study of two variables only. Like the relationship
between price and demand.
2. Multiple Correlation
• When the relationship among three or more than three
variables is studied simultaneously, it is called multiple
correlation.
• In case of such correlation the entire set of independent and
dependent variables is simultaneously studied.
 Degrees of Correlation
• Degree of Correlation refers to the Coefficient of
correlation .
• Perfect correlation: When two variables are changes in the
same proportion it is called perfect correlation. It may be two
kinds:
(i) Perfect Positive:- Correlation is perfectly positive when
proportional change in two variables is in the same direction.
• In this case, Coefficient of correlation is positive(+1)
(ii) Perfect Negative :- Correlation is perfectly negative when
proportional change in two variables is in the opposite direction.
• In this case, Coefficient of correlation is negative(+1)
 Degrees of Correlation
• Absence of correlation :- If there is no relation between
two series or variables, that is, change in one has no effect
on the change in other, than those series and variables
lack any correlation between them.
• Limited Degree of Correlation :- Between perfect
correlation and absence of correlation there is a situation
of limited degree of correlation.
• In real life, one mostly finds limited degree of correlation.
Its coefficient(r) is more than zero and less than one(r>0
but <1).
The degree of correlation between 0
and 1 may be rated as
• High: When correlation of two series is close to one, it is
called high degree of correlation. Its coefficient lies
between 0.75 and 1.
• Moderate: When correlation of two series is neither large
nor small, it is called moderate degree of correlation. Its
coefficient lies between 0.25 and 0.75.
• Low: When correlation of two series is very small, it is
called low degree of correlation. Its coefficient lies
between 0 and 0.25.
 Degree of Correlation

Degree Positive Negative

Perfect +1 -1
High Between +0.75 and +1 Between -0.75 and -1
Moderate Between +0.25 and +0.75 Between -0.25 and -0.75

Low Between 0 and +0.25 Between 0 -0.25 and -1

Zero 0 0
 Methods of estimating
correlation
• Scattered Diagram Method.
• Karl Pearson’s Coefficient of correlation.
• Spearman Rank Correlation
 Scattered Diagram
• To make scattered diagram, data are plotted on a graph
paper. A dot is marked for each value. The course of these
dots would indicate direction and closeness of the
variable.
 Karl Pearson’s Coefficient of
Correlation
• Karl Pearson's has given a quantitative method of
calculating correlation. It is an important and widely used
method of studying correlation .
• Karl Pearson’s Coefficient of Correlation is generally
written as ‘r’
Numerical by direct method
Short-cut method
Numerical on Short-cut method
Step-deviation method
 Numerical on Step-deviation
Method
Calculate the coefficient of Correlation between the price
and quanitiy demanded-

Price (Rs.) 5 10 15 20 25
Demand(k 40 35 30 25 20
g)
 Properties of Correlation
Coefficient
• R has no units. It is a pure number.
• A negative value of r indicates an inverse relation, and if r
is positive, the two variables moves in a same direction.
• If r = 0, the two variables are uncorrelated. There is no
linear relationship between them.
• If r = 1 or r = -1, the correlation is perfect or
proportionate.
• The value of correlation coefficient lies between -1 and +1
ie -1< r < +1.
 Spearman’s Rank Correlation
Coefficient
• In 1904, Charles Edward Spearman developed a
formula to calculate, coefficient of correlation of
qualitative variables.
• It is popularly known as Spearman’s Rank Difference
Formula or Method.
• There are some variables whose qualitative measurement
is not possible.
• These variables are known as qualitative variables such as
beauty, bravery, wisdom, ability, virtue, etc.
FORMULA
 Rank correlation in three different
situations
i) When Ranks are given
ii) When Ranks are not given.
iii) When the values of the series are the same.
When ranks are given
When Ranks are not given
When the values of the series
are the same
Numerical
 Importance of correlation
• Formation of laws and concepts.
• Cause and Effect relationship
• Business Decisions
• Policy formulation