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Introduction

1. The Analysis of Variance should

enable you to conduct and interpret the
statistical tests competently.

2. The Index numbers is useful for

managers and is a must for anyone
who frequently reads financial
magazines and journals.

Analysis of Variance

Many business applications involve

comparing the means of one given
attribute across several different
populations (products, consumers,
locations etc.).
 here we compare a given characteristic(s)
over several different groups.

When we are only interested in a single

attribute of the different groups then we
shall be conducting a one-way analysis of
variance that falls into the category of the
completely randomised design
experiments.

Parametric Methods - ANOVA

One‐Way Analysis Of Variance

We have discussed how to estimate

confidence intervals and test hypotheses
involving the difference between two
populations means.
 We now discuss a method that is used to
compare the means of samples drawn
from 3 or more populations to determine
if their differences are statistically
significant.

This procedure is known as 'Analysis Of

Variance' or ‘ANOVA’. It is used
extensively in controlled 'experiments'
when, for instance, a firm wants to
determine if the shelf level on which a
product is placed affects its sales.
in this case, the researcher would need to
compare at least three samples drawn from
3 different populations (e.g. knee level,
waist level and eye level) and test whether
the mean sales of each of these samples
were the same.
What exactly does ANOVA do?
The ANOVA procedure compares the
variance within each sample group with
the variance between the groups (3 or
more).
The ratio of the variance between groups
to the variance within groups produces an
‘F-statistic’.

The distribution of this statistic is called

the F-distribution and can be used to
determine whether the variability in
samples differs significantly.

If the computed statistic is greater than the

critical value at the 5% level of
significance, the hypothesis that there are
no significant differences in the means
of the sample groups can be rejected.
 An example of this method in action -
adapted from Zikmund (1994 p. 527) -
may be found below.

Suppose that a breakfast cereal producer

performs a market test to determine if the
promotion appearing on the cereal box has
an impact on sales volume.
For this purpose, four samples are drawn
from four comparable supermarkets in
which the same cereals are sold in boxes
announcing three different promotions:
A='nothing', B='gift', C='discount on
future purchases'.
Sales data is collected and presented in
Table 1 below.

Table
Note that nj is the number of items in the
jth group but in this example all groups
have n=4.

Hence SS(between)= 1 800.68, while

SS(within)= 4148.25 as shown in the table.
You will have gathered that c is the
number of samples: 3 in this case.

The problem with this calculation is that

the F-statistic is calculated by taking the
ratio of the mean sum of squares between
groups to the mean sum of squares within
groups.

To find the mean of SS(within) we need to

divide it by the appropriate degrees of
freedom, which is cn-c.

The mean square deviations within group

becomes:
MS(within)=SS(within)/(cn-c).
Since c=3 and n=4, df=9, and

4148.25
MS(within) = 9 = 460.91.
The degrees of freedom that are
appropriate to find the mean of
SS(between) , are simply c-1, df=2 in this
case. Hence the

SS (between) 1800.68
MS (between)    900.34
(C  1) 2

The F-statistic is then:

F=MS(between)/MS(within)=900.34/460.91=1.95
with 2 degrees of freedom for the
numerator and 9 for the denominator.
Using the F-tables, we find that at a .05
level of significance, the critical value of
F is 4.26. Since 1.95<4.26, we cannot
reject the null hypothesis that the means
of the four groups are equal. In other
words, in this experiment we can safely
argue that the 'promotions' appear to have
little impact on sales.
Working With ANOVA
ANOVA is usually one of the options
offered by basic statistical packages so
many of its calculations can be avoided,
although computing a few pen and paper
exercises can help you come to terms with
this procedure and how it should correctly
be interpreted. The information provided
by most packages resembles the ANOVA
table displayed in Table 10.2.

Since the information in the table is easily

available on a standard computer
printouts, ANOVA only requires the
researcher to compare the F-ratio with the
F - Tables.
Points to Bear in Mind when Using
ANOVA
procedures are based on the assumption
that the samples are drawn from
populations that are normally distributed.

Index Numbers
The aim of this section is to examine how
various indices can and should be
constructed depending on their intended
use. It also highlights how to correctly
interpret published indices. After the
subject explanation we examine the
simple price index and, through examples,
work our way up to the more complex
aggregate weighted indices.
Explanation
How are Index Numbers used?
Time-Series Data is often used to
construct index numbers and this provides
us with another way of measuring changes
in prices or quantities over time.
Index numbers are always designed to be
compared to a base period, usually
designated as 100 - implying that an index
value of less (more) than 100 indicates a
decrease (increase) relative to the base
period.
Index numbers may be used in the
following ways:
to measure differences in the magnitude of
a single variable or a group of related
variables over time (e.g. Retail Price
Index)
to measure differences in the magnitude of
a single variable or a group of related
variables over space (e.g. average house
prices in Wales and England at a given
period in time).

Management relies a great deal on indices,

both those published by the government,
such as the RPI, and those constructed by
industrial organisations and analysts
inside organisations.
The Simple Price Index
How is a simple Price Index
constructed?
To construct a simple price index (or price
relative), a base year must be specified
and as is denoted P0 - the annual price
level in the base year - while P1 denotes
the annual price level in the year you wish
to compare it with. If just one item is in
the index, the index is calculated as
(P1/P0)100.
For example if the price of a child's
cinema ticket was £2.80 in 1993 and £3.50
in 2003, the price index is
 (3.50/2.80)x100= 125. To obtain the
percentage increase in cinema prices for
children over the last decade, you must
subtract 100 from the index (25%).

Weighted aggregate price index

the iw, or Weighted Aggregate Price
Index, uses the quantities sold of each item
as weights, as opposed to using any other
type of weights Wi.

More Complex Cases

Often, however, one needs to calculate an
index comparing the average price of
several items in one year with the average
prices of those in a base year.
For instance, a more general index of
'children's entertainment' prices, which
includes the prices of attending a theme
park, a cinema and a football match, may
 be required. In this case, a composite price
index needs to be constructed.
Constructing a Composite Price Index
The simplest way to do this would be to
calculate the average index of each of the
items of interest. The problem with this is
that equal weights are given to all the
different forms of entertainments
although it is likely to be the case that
children go to the movies more often then
they attend football matches.
Composite price indices therefore require
taking weighted averages in order to
account for the relative importance of
each of the categories.
Although this all seems relatively simple,
there are several different methods to
calculate these weighted averages, each
producing composite indices that are used
for different purposes.
In the next sub-section we start with the
weighted averages of simple price indices
and then consider the weighted aggregate
price index. To do this, we will be using
various manipulations of the data
presented in Table 10.4.

Notes:
(i) Base period '0' =1993; Current Period
'1'=2003.
(ii) Prices are quoted in £/Tickets columns
b and c; quantities are quoted in millions
of tickets columns e and f.

Weighted Averages of Simple Price

Indices
The weighted averages of simple price
indices is calculated by applying the
following formula:

The term Wi represents the weight given to

item i in the basket of goods. As the name
suggests, it requires that we multiply the
simple price indexes for each item by their
respective weight. These values are then
summed and the total is divided by the
sum total of all weights.

Assigning Weights
Although many weights can be used, in
business and economics it is common
practice to weight each item in a basket of
goods by the total value of expenditure on
this good (price P x quantity sold Q).
Determining Expenditure Year
Even if we are happy with the notion that
the value of expenditures will determine
the ‘importance’ of each item in the index,
we still have to determine whether we use
the value of expenditure in the base year
(P0Q0) or in the current year (P1Q1):
by choosing the first of these options, we
obtain a base-weighted average of simple
price indices (BWASP)
by choosing the second, we obtain a
current-weighted average of simple price
indices (CWASP).

In many cases the scale of the difference

between the two indices will have little or
no impact on the decision-making process
but this is by no means always the case.
When small perturbations matter, care
should be taken in informing the reader of
the business report as to which index
formula has been used.
In our example, the base-weighted average
of simple price indices is calculated as:

Weighted Aggregate Price Index

What is the Weighted Aggregate Price
Index?
An alternative type of index, the iw, or
Weighted Aggregate Price Index, uses the
quantities sold of each item as weights, as
opposed to using any other type of
weights Wi.
 Again these indices can be calculated
using base weights or current weights. A
closer look at the formulae will clarify the
difference between these indexes and the
ones discussed previously.
Studying Patterns of Expenditure
If one desires to give more importance to
the pattern of expenditure in the base year,
then the following formula should be used
- this is known as the Laspeyres Index:

(You will probably have noticed that the

Laspeyres and the BWASP produce the
same result. This is because the P0 figures
cancel out in the BWASP!)
If on the other hand, it is more important to
consider the current pattern of
expenditure, then the following formula
should be used - this is known as the
Paasche Index:

Useful Tips for Computing and

Interpreting Index Numbers
Choosing Between Base and Current
Weighted Formulae
The base-weighted and current-weighted
formulae produce different index
numbers. Care is therefore required when
interpreting indices particularly when
patterns of expenditure in the base and
current year differ considerably. The
choice of formula to use will depend on
the nature of the question. For most
practical purposes, base-weighted indexes
are used since they can be recalculated
each period without requiring the
 determination of new weights each time.
They are, for this reason, more convenient
and less costly to produce.
Choosing the Base Period
It is always desirable to choose as the base
or 'reference' period for the index, a period
of time that is not in some sense abnormal,
otherwise the index can give a misleading
impression:
if, for example, you use a base year in
which floods were extremely bad to
measure carpet sales, then any comparison
with that particular year is bound to
understate the true change in carpet sales
(if a quantity index is used as opposed to a
price index)
the same is true with regard to the dangers
of choosing base years during which the
economy was in a recession or at the peak
of a business cycle (think of the
components of the time-series discussed in
Topic 7).
The Purpose of Measurement
This must also be clear before the items of
the basket are chosen. One cannot
suggest, for instance, that the
entertainment indices computed above
show that less people can afford
'entertainment' because prices have
increased.
We have shown that in general,
entertainment prices have increased since
1993, but nothing has been said about
what happened to other prices in the
economy (including wages). It may well
be that wages and the price of other goods
have increased by much more, suggesting
that the cost of entertainment has
decreased in real terms since 1993. (In
order to measure the real increase or
decrease in the weighted prices of
entertainment, we would need to convert
 the 2003 prices to their 1993 equivalents,
using the R.P.I.)
Selection of Basket Items
Care should also be taken when deciding
which items to include in the basket, and
this decision should be revised regularly to
take into account changes, for instance, in
the products available to consumers (e.g. it
may well be that women football matches
become a very popular form of
entertainment although they were
practically unheard of in the 90's).

Adjusting the Base Year

It is also a good idea to change the base
year so that the indices are within the 0
and 200 range. The reason is that it is
relatively easy to interpret an index of 155
in terms of percentage – e.g. it indicates
that prices have increased by 55% since
1993 - but it is not so easy when the index
is 345.
Note that if the RPI for 2002 is 217.4 and
the RPI for 2003 is 195.4 then it is correct
to say that the RPI has increased by 22
points between 2002 and 2003 but it is
incorrect to state that prices have
increased by 22% since 2002. In order to
interpret this change, you need to know
the base year. Suppose for example that
the base year is 1960 - then prices in 2003
are 22% higher than they were in 2002 in
terms of 1960 prices.