Point and Interval Estimation

Arun Kumar, Ravindra Gokhale, and Nagarajan

Krishnamurthy
Quantitative Techniques-I, Term I, 2012
Indian Institute of Management Indore
Leasing
An auto manufacturer leases cars to small businesses for use in
visiting clients and other business travel. The contracted lease
does not specify a mileage limit and instead includes a
depreciation fee of $0.30 per mile. The contract includes other
origination, maintenance, and damage fees in addition to the
fee that covers the mileage. These leases run for a year. A
sample of 150 cars (all were a particular model of four-door
sedan) returned to their dealers early in this program averaged
21,000 miles, with standard deviation s = 2,352 miles.
Currently this manufacturer has leased approximately 10,000
of these vehicles. When the program was launched, the
planning budget projected that the company would earn (in
depreciation fees) $6,500 on average per car.
Leasing
Motivation:
a. Should the manufacturer assume that if it were to check
every leased car, the average would be 21,000 miles driven?
b. Can the manufacturer use a condence interval to check on
the claim of $6,500 earnings in depreciation fees?
Method:
c. Are the conditions using a 95% condence interval for the
mean number of miles driven per year satised?
d. Does the method of sampling raise any concerns?
e. Can the manufacturer estimate, with a range, the amount it
can expect to earn in depreciation fees per leased vehicle, on
average?
Leasing
Mechanics:
f. Construct the 95% condence interval for the number of
miles driven per year on average for leased cars of this type.
g. Construct the 95% condence interval for earnings over the
one-year period of the lease, in a form suitable for presentation.
Message:
h. Interpret the 95% condence interval for the number of
miles driven over the one year period of the lease.
i. Interpret the 95% condence interval for the average
amount earned per vehicle. What is the implication fee for the
budget claim?
j. Communicate a range for the total earnings of this program,
assuming 10,000 vehicles.
Case: Leasing
Auto manufacturer leases cars to small businesses.
For each mile car has traveled, manufacturer gets $0.30.
Lease runs for one year.
Manufacturer is expecting to earn $6500 on an average
per car.
Currently the manufacturer has leased approximately
10000 cars of a particular model.
Case: Leasing
Auto manufacturer leases cars to small businesses.
For each mile car has traveled, manufacturer gets $0.30.
Lease runs for one year.
Manufacturer is expecting to earn $6500 on an average
per car.
Currently the manufacturer has leased approximately
10000 cars of a particular model.
Case: Leasing
Auto manufacturer leases cars to small businesses.
For each mile car has traveled, manufacturer gets $0.30.
Lease runs for one year.
Manufacturer is expecting to earn $6500 on an average
per car.
Currently the manufacturer has leased approximately
10000 cars of a particular model.
Case: Leasing
Auto manufacturer leases cars to small businesses.
For each mile car has traveled, manufacturer gets $0.30.
Lease runs for one year.
Manufacturer is expecting to earn $6500 on an average
per car.
Currently the manufacturer has leased approximately
10000 cars of a particular model.
Case: Leasing
Auto manufacturer leases cars to small businesses.
For each mile car has traveled, manufacturer gets $0.30.
Lease runs for one year.
Manufacturer is expecting to earn $6500 on an average
per car.
Currently the manufacturer has leased approximately
10000 cars of a particular model.
Case: Leasing
Auto manufacturer leases cars to small businesses.
For each mile car has traveled, manufacturer gets $0.30.
Lease runs for one year.
Manufacturer is expecting to earn $6500 on an average
per car.
Currently the manufacturer has leased approximately
10000 cars of a particular model.
Business question
Are we going to make prots as expected?
Business question
Are we going to make prots as expected?
Case: Leasing
A sample of 150 cars returned to the dealers early in this
program averaged 21,000 miles with standard deviation 2352
miles.
Statistical problem?
What will be the average mileage for all the 10000 cars leased?
Let x denote mileage for a leased car and x (,
2
).
Goal is to estimate .
Statistical problem?
What will be the average mileage for all the 10000 cars leased?
Let x denote mileage for a leased car and x (,
2
).
Goal is to estimate .
Statistical problem?
What will be the average mileage for all the 10000 cars leased?
Let x denote mileage for a leased car and x (,
2
).
Goal is to estimate .
Estimating population mean using the sample
data
Point Estimation: Point estimator is a sample statistic that
best describes the population parameter.
Ex: = x
Leasing
One estimate of the average mileage for 10000 cars is 21,000
miles.
So one estimate of average prot=21000 0.3=$6300.
Based on the point estimate of the average prot, what do
you conclude about the average prot from all 10000 cars?
Interval Estimation
Instead of using one number (point estimate) to describe the
parameter, we want to use an interval to describe the
parameter.
Such intervals are popularly known as condence intervals.
Sampling distribution of sample mean
Let

X
150
denote average mileage for 150 cars. Then

X
150
N(,
2
/150).

X
150
follows a normal distribution from the Central Limit
Theorem because the sample size 150 is very large.
(1 )% Condence Interval for population mean

(1 )% condence interval for population mean is

x z

n
,
where z

2
is (1

2
)th percentile of standard normal
distribution.
For example: A 95% condence interval for is
x 1.96/

n where x is the sample mean and is the

population standard deviation.
Condence Coecient
Condence coecient (such as (1 )%) tells us how much
faith we should put in the condence interval.
Popular choices are 90%, 95%, and 99%.
Interpreting a 95% condence interval
Under repeated sampling, out of 100 condence intervals 95
will contain the true population parameter.
Leasing: x = 21, 000 miles
A 95% condence interval for average mileage is
21000 1.96 2352/

150 = [20623.6 miles, 21376.4 miles]

Leasing: Average Prot
[20623.6 0.3, 21376.4 0.3]=[$6187.08,$6412.92]
Understanding terms in the condence interval
formula
Larger condence level implies larger z

2
. Larger z

2
leads
to wider condence intervals. Narrower condence
intervals are more informative.
Larger sample size leads to narrower condence interval
but a larger sample size comes at a higher cost.
Conclusion
Can we conclude that average earning per car will be $6500?
Conclusion
Can we conclude that average earning per car will be $6500?
Caveat
While calculating the 95% condence interval for the average
mileage of the 10000 cars, we used s instead of . Is that
correct?
Ans. No
Caveat
While calculating the 95% condence interval for the average
mileage of the 10000 cars, we used s instead of . Is that
correct?
Ans. No
Caveat
When calculating condence interval using s instead of , we
have to use percentiles from t-distribution instead of
z-distribution.
t-distribution

X
n

s/

n
follows a t-distribution with n-1 degrees of freedom.
s/

n is also known as standard error.

t-distribution

X
n

s/

n
follows a t-distribution with n-1 degrees of freedom.
s/

n is also known as standard error.

t-distribution
Find 97.5th percentile for a t-distribution with degrees of
freedom
5
11
40
t-distribution
For a larger sample size (say n > 40), t distribution can be
approximated well by a normal distribution. Hence for a larger
sample size, a z-percentile will do a good job irrespective of
whether sample standard deviation is used for calculating
condence interval or population standard deviation is used for
calculating condence interval.
What about the Leasing Problem?
We are good because the sample size is very large.