When the relationship is of a quantitative nature, the appropriate statistical tool for discovering and measuring the relationship and expressing it in a brief formula is known as correlation. Following observations highlight the importance or significance of correlation as a statistical method:
1) Formation of laws and concepts: The study of correlation shows the direction and degree of relationship between the variables. This has helped the formation of various laws and concepts in economic theory, such as law of demand and concept of elasticity of demand.
2) Cause and Effect relationship: Correlation coefficient sometimes suggests cause and effect relationship between different variables. This helps in understanding why certain variables behave the way they behave.
3) Business decisions: Correlation analysis facilitates business decisions because the trend path of one variable may suggest the expected changes in the other. Accordingly, the businessman may plan his business decisions for the future.
4) Policy Formulation: Correlation analysis also helps policy formulation. If the government finds a negative correlation between tax and tax collection, it should pursue the policy of low tax rate. Because, low tax rate would lead to high tax collection.
