Getting Familiar with the Central Limit Theorem and the Standard Error

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If you want to expand your knowledge in statistics, understanding how the Central Limit Theorem works, will be right up your street. However, first, let’s introduce a concept – a sampling distribution.

Sampling Distribution

Say you have the population of used cars in a car shop.

Population of used cars, central limit theorem

We want to analyze the car prices and be able to make some predictions on them. Population parameters which may be of interest are:

Normally, in statistics, we would not have data on the whole population, but rather just a sample.

Drawing a Sample

The mean is $2,617.23.

Now, a problem arises from the following fact. If we take another sample, we may get a completely different mean – $3,201.34.

Then a third with a mean of $2,844.33.

The mean of 3 samples, central limit theorem

As you can see, the sample mean depends on the incumbents of the sample itself. So, taking a single value is definitely suboptimal.

 

Drawing Many Samples

What we can do is draw many, many samples and create a new dataset, comprised of sample means.

Draw many samples, central limit theorem

These values are distributed in some way, so we have a distribution. When we are referring to a distribution formed by samples, we use the term – a sampling distribution. For our case, we can be even more precise – we are dealing with a sampling distribution of the mean.

Sampling distribution of the mean, central limit theorem

The Population Mean

Now, if we inspect these values closely, we will realize that they are different. However, they are concentrated around a certain value.  For our case – somewhere around $2,800.

Somewhere around $2,800, central limit theorem

Each of these sample means is nothing but an approximation of the population mean. The value they revolve around is actually the population mean itself. Most probably, none of them are the population mean, but taken together, they give a really good idea.

Taken together, they give a really good idea, sampling distribution of the mean, central limit theoremIn fact, if we take the average of those sample means, we expect to get a very precise approximation of the population mean.

The average of those sample means, central limit theorem

Visualizing the Distribution of the Sampling Means

Here’s a plot of the distribution of the car prices.

Distribution of car prices, central limit theorem

We know that this is not a normal distribution. It has a right skew and that’s about all we can see.

Here’s the big revelation.

It turns out that if we visualize the distribution of the sampling means, we get something else. Something useful.

A normal distribution.

A normal distribution, central limit theorem

And that’s what the Central Limit Theorem states.

The Central Limit Theorem

The sampling distribution of the mean will approximate a normal distribution. No matter the distribution of the population – Binomial, Uniform, Exponential or another one.

Binomial, Uniform, Exponential, central limit theorem

Not only that, but its mean is the same as the population mean.

Its mean is the same as the population mean

That’s something we already noticed.

The Variance

What about the variance?

Well, it depends on the size of the samples we draw but it is quite elegant. It is the population variance divided by the sample size.

Population variance divided by the sample size

Since the sample size is in the denominator, the bigger the sample size, the lower the variance. Or in other words – the closer the approximation we get. So, if you are able to draw bigger samples, your statistical results will be more accurate. Usually for the Central Limit Theorem to apply, we need a sample size of at least 30 observations.

For the Central Limit Theorem to apply, we need a sample size of at least 30 observations

Why the Central Limit Theorem is Important

As you probably know, the normal distribution has elegant statistics and an unmatched applicability in calculating confidence intervals and performing tests.

The Central Limit Theorem allows us to perform tests, solve problems and make inferences using the normal distribution even when the population is not normally distributed.

Reasons to use the normal distribution, central limit theorem

The discovery and proof of the theorem revolutionized statistics as a field and we will be relying on it a lot in the subsequent tutorials.

Standard error

Now, there is another important notion which spurs from the sampling distribution and is closely related to CLT. The standard error. It is the standard deviation of the distribution formed by the sample means.

Standard error

In other words – the standard deviation of the sampling distribution.

So how do we find it? We know its variance: sigma squared, divided by n. Therefore, the standard deviation is sigma, divided by the square root of n.

How do we find the standard error

Like a standard deviation, the standard error shows variability. In this case, it is the variability of the means of the different samples we extracted.

Variability of sample means

You can guess that since the term has its own name, it is widely used and very important.

Why We Need it

Standard error is used for almost all statistical tests. This is because it is a probabilistic measure that shows how well you approximated the true mean.

Why we need it

Important: It decreases as the sample size increases! This makes sense, as bigger samples give a better approximation of the population.

Standard error decreases when sample size increases

What’s Next

To sum up, the Central Limit Theorem states:

No matter the underlying distribution of the data set, the distribution of the sample means would be normal. Moreover, its mean would be equal to the original mean. Its variance, however, would be equal to the original variance divided by the sample size.

Now, if you want to get deeper into the subject of statistics, we have covered just the right concept. Find out how estimators work and what you can use them for, in the linked tutorial.

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Interested in learning more? You can take your skills from good to great with our statistics course!

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Next Tutorial: How to Use Point Estimates and Confidence Intervals

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