Solutions Chapter 4 PDF

CHAPTER 4
Exercise Solutions
60
Chapter 4, Exercise Solutions, Principles of Econometrics, 3e 61
EXERCISE 4.1
(a) R2 = 1
ei2 =1
182.85
= 0.71051
( yi y )
2
631.63
( yi y )
2
(b) To calculate R 2 we need ,
( yi y ) = yi2 N y 2 = 5930.94 20 16.0352 = 788.5155

2
Therefore,
SSR 666.72
R2 = = = 0.8455
SST 788.5155
(c) From
R2 = 1
ei2 =1
( N K ) 2
SST SST
we have,
SST (1 R 2 ) 552.36 (1 0.7911)
2 = = = 6.4104
N K (20 2)
EXERCISE 4.2
y = 5.83 + 8.69 x x
(a) where x =
(1.23) (1.17) 10
y = 0.583 + 0.0869 x y
(b) where y =
(0.123) (0.0117) 10
y = 0.583 + 0.869 x y x
(c) where y = and x =
(0.123) (0.117) 10 10
The values of R 2 remain the same in all cases.

EXERCISE 4.3
(a) y 0 = b1 + b2 x0 = 1 + 1 5 = 6
n 1 ( x0 x ) 2 1 (5 1) 2
(b) var( f ) = 2 1 + + = 5.3333 1 + + = 14.9332
N ( xi x ) 2 5 10
se( f ) = 14.9332 = 3.864
(c) Using se( f ) from part (b) and tc = t(0.975,3) = 3.182 ,
y 0 tc se( f ) = 6 3.182 3.864 = ( 6.295,18.295)
(d) Using se( f ) from part (b) and tc = t(0.995,3) = 5.841 ,
y 0 tc se( f ) = 6 5.841 3.864 = ( 16.570, 28.570)
(e) Using x = x0 = 1 , the prediction is y 0 = 1 + 1 1 = 2 , and
n 1 ( x0 x ) 2 1 (1 1) 2
var( f ) = 2 1 + + = 5.3333 1 + + = 6.340
N ( xi x ) 2 5 10
se( f ) = 6.340 = 2.530
y 0 tc se( f ) = 2 3.182 2.530 = (6.050,10.050)
Width in part (c) = 18.295 ( 6.295 ) = 24.59
Width in part (e) = 10.050 ( 6.050 ) = 16.1
The width in part (e) is smaller than the width in part (c), as expected. Predictions are
more precise when made for x values close to the mean.
EXERCISE 4.4
(a) When estimating E ( y0 ), we are estimating the average value of y for all observational
units with an x-value of x0 . When predicting y0 , we are predicting the value of y for one
observational unit with an x-value of x0 . The first exercise does not involve the random
error e0 ; the second does.
(b) E (b1 + b2 x0 ) = E (b1 ) + E (b2 ) x0 = 1 + 2 x0
var(b1 + b2 x0 ) = var(b1 ) + x02 var(b2 ) + 2 x0 cov(b1 , b2 )

2 xi2 2 x02 2 2 x0 x
= +
N ( xi x ) 2 ( xi x ) 2 ( xi x ) 2
2 ( ( xi x ) 2 + Nx 2 ) 2 ( x02 2 x0 x )
= +
N ( xi x ) 2 ( xi x )2
1 x 2 2 x0 x + x 2 1 ( x0 x ) 2
= 2 + 0 = 2
+ 2
N ( xi x )2 N ( xi x )
(c) It is not appropriate to say that E ( y 0 ) = y0 because y0 is a random variable.
[ E ( y0 ) = 1 + 2 x0 ] [1 + 2 x0 + e0 = y0 ]
We need to include y0 in the expectation so that
E ( y 0 y0 ) = E ( y 0 ) E ( y0 ) = 1 + 2 x0 ( 1 + 2 x0 + E (e0 ) ) = 0.
EXERCISE 4.5
(a) If we multiply the x values in the simple linear regression model y = 1 + 2 x + e by 10,
the new model becomes

y = 1 + 2 ( x 10 ) + e
10
= 1 + *2 x + e where *2 = 2 10 and x = x 10
The estimated equation becomes
b
y = b1 + 2 ( x 10 )
10
Thus, 1 and b1 do not change and 2 and b2 becomes 10 times smaller than their
original values. Since e does not change, the variance of the error term var(e) = 2 is
unaffected.
(b) Multiplying all the y values by 10 in the simple linear regression model y = 1 + 2 x + e
gives the new model
y 10 = ( 1 10 ) + ( 2 10 ) x + ( e 10 )
or
y = 1* + *2 x + e
where
y = y 10, 1* = 1 10, *2 = 2 10, e = e 10
The estimated equation becomes
y = y 10 = ( b1 10 ) + ( b2 10 ) x
Thus, both 1 and 2 are affected. They are 10 times larger than their original values.
Similarly, b1 and b2 are 10 times larger than their original values. The variance of the new
error term is
var(e ) = var ( e 10 ) = 100 var(e) = 100 2
Thus, the variance of the error term is 100 times larger than its original value.
EXERCISE 4.6
(a) The least squares estimator for 1 is b1 = y b2 x . Thus, y = b1 + b2 x , and hence ( y , x )

lies on the fitted line.
(b) Consider the fitted line yi = b1 + xi b2 . Averaging over N, we obtain
yi 1
( b1 + xi b2 ) = ( b1 N + b2 xi ) = b1 + b2 i = b1 + b2 x
1 x
y =
N
=
N
N N
From part (a), we also have y = b1 + b2 x . Thus, y = y .

EXERCISE 4.7
(a) y 0 = b2 x0
(b) Using the solution from Exercise 2.4 part (f)
SSE = ei2 = (2.0659 2 + 2.13192 + 1.19782 + ( 0.7363)

2
+ ( 0.6703) + ( 0.6044 ) = 11.6044

2 2
yi2 = 42 + 62 + 72 + 7 2 + 92 + 112 = 352

11.6044
Ru2 = 1 = 0.967
352
( )
2
2yy yi y ( yi y )
(42.549) 2
(c) ryy2 = 2 2 = = = 0.943
y y ( y y )2 y y( ) 65.461 29.333
2
i i
The two alternative goodness of fit measures Ru2 and ryy2 are not equal.
(d) SST = 29.333, SSR = 67.370
{SSR + SSE = 67.370 + 11.6044 = 78.974} {SST = 29.333}

The decomposition does not hold.
EXERCISE 4.8
(a) Simple linear regression results:

yt = 0.6776 + 0.0161t R 2 = 0.4595
(se) ( 0.0725 ) ( 0.0026 )
*** ***
Linear-log regression results:

yt = 0.5287 + 0.1855 ln ( t ) R 2 = 0.2441
(se) ( 0.1472 ) ( 0.0481)
*** ***
Quadratic regression results:

yt = 0.7914 + 0.000355 t 2 R 2 = 0.5685
(se) ( 0.0482 ) ( 0.000046 )
*** ***
(b) (i) (ii)

2.4
2.0
1.6
1.2
.8
0.8
.4
0.4
.0
-.4
-.8
50 55 60 65 70 75 80 85 90 95
Residual Actual Fitted
Figure xr4.8(a) Fitted line and residuals for the simple linear regression
2.4
2.0
1.6
1.2
1.2
0.8
0.8
0.4
0.4
0.0
-0.4
-0.8
50 55 60 65 70 75 80 85 90 95
Figure xr4.8(b) Fitted line and residuals for the linear-log regression
Exercise 4.8(b) continued
(b)
2.4
2.0
1.6
1.2
.6
0.8
.4
.2 0.4
.0
-.2
-.4
-.6
50 55 60 65 70 75 80 85 90 95
Figure xr4.8(c) Fitted line and residuals for the quadratic regression
(iii) Error normality tests Jarque-Bera:

Simple linear: JB = 0.279 p-value = 0.870
Linear log: JB = 1.925 p-value = 0.382
Quadratic: JB = 0.188 p-value = 0.910
(iv) Values of R 2 are given in part (a)
To choose the preferred equation we consider the following.

1. The signs of the response parameters 2 , 2 and 2 : We expect them to be positive
because we expect yield to increase over time as technology improves. The signs of the
estimates of 2 , 2 and 2 are as expected.
2. R 2 : The value of R 2 for the third equation is the highest, namely 0.5685.
3. The plots of the fitted equations and their residuals: The upper parts of the figures
display the fitted equation while the lower parts display the residuals. Considering the
plots for the fitted equations, the one obtained from the third equation seems to fit the
observations best. In terms of the residuals, the first two equations have concentrations
of positive residuals at each end of the sample. The third equation provides a more
balanced distribution of positive and negative residuals throughout the sample.
The third equation is preferable.
EXERCISE 4.9
(a) Equation 1: y 0 = 0.6776 + 0.0161 49 = 1.467
Equation 2: y 0 = 0.5287 + 0.1855ln(49) = 1.251
Equation 3: y 0 = 0.7914 + 0.0003547 (49)2 = 1.643
m
dyt
(b) Equation 1: = 1 = 0.0161
dt
m
dyt 1 0.1855
Equation 2: = = = 0.0038
dt t 49
m
dyt
Equation 3: = 2 1 t = 2 0.0003547 49 = 0.0348
dt
(c) Evaluating the elasticities at t = 49 and the relevant value for y 0 gives the following
results.
n
dyt t t 49
Equation 1: = 1 = 0.0161 = 0.538
dt yt y 0 1.467
n
dyt t 1 0.1855
Equation 2: = = = 0.148
dt yt y t 1.251
n
dyt t 2 1 t 2 2 0.0003547 492
Equation 3: = = = 1.037
dt yt y 0 1.643
dyt dyt t
(d) The slopes and the elasticities give the marginal change in yield and the
dt dt yt
percentage change in yield, respectively, that can be expected from technological change
in the next year. The results show that the predicted effect of technological change is very
sensitive to the choice of functional form.
EXERCISE 4.10
(a) For households with 1 child

n = 1.0099 0.1495ln(TOTEXP )
WFOOD
(se) (0.0401) (0.0090) R 2 = 0.3203
(t ) (25.19) (16.70)
For households with 2 children:

n = 0.9535 0.1294ln(TOTEXP)
WFOOD
(se) (0.0365) (0.0080) R 2 = 0.2206
(t ) (26.10) ( 16.16)
For 2 we would expect a negative value because as the total expenditure increases the
food share should decrease with higher proportions of expenditure devoted to less
essential items. Both estimations give the expected sign. The standard errors for b1 and b2
from both estimations are relatively small resulting in high values of t ratios and
significant estimates.
(b) For households with 1 child, the average total expenditure is 94.848 and
= ( )
b1 + b2 ln TOTEXP + 1 1.0099 0.1495 [ln(94.848) + 1]
= = 0.5461
(
b1 + b2 ln TOTEXP ) 1.0099 0.1495 ln(94.848)
For households with 2 children, the average total expenditure is 101.168 and
= ( )
b1 + b2 ln TOTEXP + 1 0.9535 0.12944 [ ln(101.168) + 1]
= = 0.6363
(
b1 + b2 ln TOTEXP ) 0.9535 0.12944 ln(101.168)
Both of the elasticities are less than one; therefore, food is a necessity.
Exercise 4.10 (continued)
0.8 0.4
0.6 0.2
WFOOD1
RESID
0.4 0.0
0.2 -0.2
0.0 -0.4
3 4 5 6 3 4 5 6
X1 X1
Figure xr4.10(a) Figure xr4.10(b)
(c) Figures xr4.10 (a) and (b) display the fitted curve and the residual plot for households with
1 child. The function linear in WFOOD and ln(TOTEXP) seems to be an appropriate one.
However, the observations vary considerably around the fitted line, consistent with the
low R 2 value. Also, the absolute magnitude of the residuals appears to decline as
ln(TOTEXP) increases. In Chapter 8 we discover that such behavior suggests the existence
of heteroskedasticity.
Figures xr4.10 (c) and (d) are plots of the fitted equation and the residuals for households
with 2 children. They lead to similar conclusions to those made for the one-child case.
The values of JB for testing H 0 : the errors are normally distributed are 10.7941 and
6.3794 for households with 1 child and 2 children, respectively. Since both values are
greater than the critical value (0.95,
2
2) = 5.991 , we reject H 0 . The p-values obtained are
0.0045 and 0.0412, respectively, confirming that H 0 is rejected. We conclude that for
both cases the errors are not normally distributed.
0.8 0.4
0.6 0.2
WFOOD2
RESID
0.4 0.0
0.2 -0.2
0.0 -0.4
3.5 4.0 4.5 5.0 5.5 6.0 3.5 4.0 4.5 5.0 5.5 6.0
X2 X2
Figure xr4.10(c) Figure xr4.10(d)

EXERCISE 4.11
(a) Regression results:

n = 51.9387 + 0.6599GROWTH
VOTE R 2 = 0.3608
(se) ( 0.9054 ) ( 0.1631)
(t ) ( 57.3626 )( 4.4060 )
Predicted value of VOTE in 2000:

n = 51.9387 + 0.6599 1.603 = 52.9965
VOTE0
Least squares residual:

n = 50.2650 52.9965 = 2.7315
VOTE0 VOTE0
(b) Estimated regression:

n = 52.0281 + 0.6631GROWTH
VOTE
(se) (0.931) (0.1652)
Predicted value of VOTE in 2000:

n = 52.0281 + 0.6631 1.603 = 53.0910
VOTE0
Prediction error in forecast:

n 0 = 50.2650 53.0910 = 2.8260
f = VOTE0 VOTE
This prediction error is larger in magnitude than the least squares residual. This result is
expected because the estimated regression in part (b) does not contain information about
VOTE in the year 2000.
(c) 95% prediction interval:

n t
VOTE0 (0.975, 28) se( f ) = 53.091 2.048 5.1648 = (42.513, 63.669)
(d) The non-incumbent party will receive 50.1% of the vote if the incumbent party receives
49.9% of the vote. Thus, we want the value of GROWTH for which
49.9 = 52.0281 + 0.6631 GROWTH
Solving for GROWTH yields
GROWTH = 3.209
Real per capita GDP would have had to decrease by 3.209% in the first three quarters of
the election year for the non-incumbent party to win 50.1% of the vote.
EXERCISE 4.12
(a) Estimated regression:

n = 2992.739 194.2334 FIXED_RATE
STARTS 0 0
In May 2005: n = 2992.739 194.2334 6.00 = 1827

STARTS
In June 2005: n = 2992.739 194.2334 5.82 = 1862

STARTS
(b) Prediction error for May 2005:

n = 2041 1827 = 214
f = STARTS0 STARTS 0
Prediction error for June 2005:

n = 2065 1862 = 203
f = STARTS0 STARTS 0
(c) Prediction interval for May 2005:

n t
STARTS 0 (0.975,182) se( f ) = 1827 1.973 159.58 = (1512, 2142)
Prediction interval for June 2005:

n t
STARTS 0 (0.975,182) se( f ) = 1862 1.973 159.785 = (1547, 2177)
Both prediction intervals contained the true values.

EXERCISE 4.13

ln( PRICE ) = 10.5938 + 0.000596 SQFT
( se ) ( 0.0219 )( 0.000013)
(t ) ( 484.84 ) ( 46.30 )
The intercept 10.5938 is the value of ln(PRICE) when the area of the house is zero. This
is an unrealistic and unreliable value since there are no prices for houses of zero area. The
coefficient 0.000596 suggests an increase of one square foot is associated with a 0.06%
increase in the price of the house.
To find the slope d ( PRICE ) d ( SQFT ) we note that
d ln( PRICE ) d ln( PRICE ) dPRICE 1 dPRICE

= = = 2
dSQFT dPRICE dSQFT PRICE dSQFT
Therefore
dPRICE
= 2 PRICE
dSQFT
At the mean
dPRICE
= 2 PRICE = 0.00059596 112810.81 = 67.23
dSQFT
The value 67.23 is interpreted as the increase in price associated with a 1 square foot
increase in living area at the mean.
The elasticity is calculated as:

1 dPRICE dPRICE PRICE %PRICE
2 SQFT = SQFT = =
PRICE dSQFT dSQFT SQFT %SQFT
At the mean,
elasticity = 2 SQFT = 0.00059596 1611.9682 = 0.9607
This result tells us that, at the mean, a 1% increase in area is associated with an
approximate 1% increase in the price of the house.
(b) Regression results:

ln( PRICE ) = 4.1707 + 1.0066ln( SQFT )
( se ) ( 0.1655) ( 0.0225)
(t ) ( 25.20 ) ( 44.65 )
The intercept 4.1707 is the value of ln(PRICE) when the area of the house is 1 square foot.
This is an unrealistic and unreliable value since there are no prices for houses of 1 square
foot in area. The coefficient 1.0066 says that an increase in living area of 1% is associated
with a 1% increase in house price.
The coefficient 1.0066 is the elasticity since it is a constant elasticity functional form.
To find the slope d ( PRICE ) d ( SQFT ) note that
d ln( PRICE ) SQFT dPRICE

= = 2
d ln( SQFT ) PRICE dSQFT
Therefore,
dPRICE PRICE
= 2
dSQFT SQFT
At the means,
dPRICE PRICE 112810.81
= 2 = 1.0066 = 70.444
dSQFT SQFT 1611.9682
The value 70.444 is interpreted as the increase in price associated by a 1 square foot
increase in living area at the mean.
(c) From the linear function, R 2 = 0.672 .

From the log-linear function in part(a),
[cov( y, y )]
2
2
1.99573 109
R = [corr( y, y )] =
2 2
= = 0.715
var( y ) var( y ) 2.78614 109 1.99996 109
g
From the log-log function in part(b),
[cov( y, y )]
2
2
1.57631 109
R = [corr( y, y )] =
2 2
= = 0.673
var( y ) var( y ) 2.78614 109 1.32604 109
g
The highest R 2 value is that of the log-linear functional form. The linear association
between the data and the fitted line is highest for the log-linear functional form. In this
sense the log-linear model fits the data best.
(d)
120
100
80
60
40
20
0
-0.75 -0.50 -0.25 0.00 0.25 0.50 0.75
Figure xr4.13(a) Histogram of residuals for log-linear model
120
100
80
60
40
20
0
-0.75 -0.50 -0.25 0.00 0.25 0.50 0.75
Figure xr4.13(b) Histogram of residuals for log-log model
200
160
120
80
40
0
-100000 0 100000 200000
Figure xr4.13(c) Histogram of residuals for simple linear model
Log-linear: Jarque-Bera = 78.85, p -value = 0.0000

Log-Log: Jarque-Bera = 52.74, p -value = 0.0000
Simple linear: Jarque-Bera = 2456, p -value = 0.0000
All Jarque-Bera values are significantly different from 0 at the 1% level of significance.
We can conclude that the residuals are not normally distributed.
(e)
1.2
0.8
0.4
residual
0.0
-0.4
-0.8
0 1000 2000 3000 4000 5000
SQFT
Figure xr4.13(d) Residuals of log-linear model
1.2
0.8
0.4
residual
0.0
-0.4
-0.8
0 1000 2000 3000 4000 5000
SQFT
Figure xr4.13(e) Residuals of log-log model
250000
200000
150000
100000
residaul
50000
-50000
-100000
-150000
0 1000 2000 3000 4000 5000
SQFT
Figure xr4.13(f) Residuals of simple linear model
The residuals appear to increase in magnitude as SQFT increases. This is most evident in
the residuals of the simple linear functional form. Furthermore, the residuals in the area
around 1000 square feet of the simple linear model are all positive indicating that perhaps
the functional form does not fit well in this region.
(f) Prediction for log-linear model:

n = exp ( b + b SQFT + 2 2 )
PRICE 1 2
= exp (10.59379+0.000595963 2700+ 0.203032 2 )

= 203,516
Prediction for log-log model:
n = exp ( 4.170677 + 1.006582 log(2700)+ 0.2082512 2 )
PRICE
= 188, 221
Prediction for simple linear model:
n = 18385.65 + 81.3890 2700 = 201,365
PRICE
(g) The standard error of forecast for the log-linear model is
( x0 x )
2
1
se( f ) = 1 + +
2

N ( xi x )
2
( 2700 1611.968) = 0.20363

2
1
= 0.203034 1 + +
880 248768933.1
The 95% confidence interval for the prediction from the log-linear model is:
n
(
exp ln( y ) t(0.975,878) se ( f ) )
= exp (10.59379+0.000595963 2700 1.96267 0.20363)
= [133,683; 297,316]
The standard error of forecast for the log-log model is
( 7.90101 7.3355) = 0.20876

2
1
se( f ) = 0.208251 1 + +
880 85.34453
The 95% confidence interval for the prediction from the log-log model is
n
(
exp ln( y ) t(0.975,878) se ( f ) )
= exp ( 4.170677 + 1.006582 log(2700) 1.96267 0.20876 )
= [122, 267; 277, 454]
Exercise 4.13(g) (continued)
(g) The standard error of forecast for the simple linear model is
( 2700 1611.968 ) = 30348.26

2
1
se( f ) = 30259.2 1 + +
880 248768933.1
The 95% confidence interval for the prediction from the simple linear model is
y 0 t(0.975,878) se ( f ) = 201,364.62 1.96267 30,348.26
= (141,801; 260,928 )
(h) The simple linear model is not a good choice because the residuals are heavily skewed to
the right and hence far from being normally distributed. It is difficult to choose between
the other two models the log-linear and log-log models. Their residuals have similar
patterns and they both lead to a plausible elasticity of price with respect to changes in
square feet, namely, a 1% change in square feet leads to a 1% change in price. The log-
linear model is favored on the basis of its higher Rg2 value, and its smaller standard
deviation of the error, characteristics that suggest it is the model that best fits the data.
EXERCISE 4.14
(a)
240
200
160
120
80
40
0
0 10 20 30 40 50 60
Figure xr4.14(a) Histogram of WAGE
80
70
60
50
40
30
20
10
0
1.0 1.5 2.0 2.5 3.0 3.5 4.0
Figure xr4.14(b) Histogram of ln(WAGE)
Neither WAGE nor ln(WAGE) appear normally distributed. The distribution for WAGE is
positively skewed and that for ln(WAGE) is too flat at the top. However, ln(WAGE) more
closely resembles a normal distribution. This conclusion is confirmed by the Jarque-Bera
test results which are JB = 2684 (p-value = 0.0000) for WAGE and JB = 17.6 (p-value =
0.0002) for ln(WAGE).
(b) The regression results for the linear model are

n = 4.9122 + 1.1385 EDUC
WAGE R 2 = 0.2024
( se ) ( 0.9668) ( 0.0716 )
b2 1.1385
The estimated return to education at the mean = 100 = 100 = 11.15%
WAGE 10.2130
The results for the log-linear model are
( )
n = 0.7884 + 0.1038 EDUC
ln WAGE R 2 = 0.2146
( se ) ( 0.0849 ) ( 0.0063)
The estimated return to education = b2 100 = 10.38%.
(c)
240
200
160
120
80
40
0
-10 0 10 20 30 40
Figure xr4.14(c) Histogram of residuals from simple linear regression
90
80
70
60
50
40
30
20
10
0
-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5
Figure xr4.14(d) Histogram of residuals from log-linear regression
The Jarque-Bera test results are JB = 3023 (p-value = 0.0000) for the residuals from the
linear model and JB = 3.48 (p-value = 0.1754) for the residuals from the log-linear model.
Both the histograms and the Jarque-Bera test results suggest the residuals from the log-
linear model are more compatible with normality. In the log-linear model a null hypothesis
of normality is not rejected at a 10% level of significance. In the linear regression model it
is rejected at a 1% level of significance.
(d) Linear model: R 2 = 0.2024

Log-linear model:
[cov( y, y )]
2
6.871962
R = [corr( y, y )] =
2 2
= = 0.2246
38.9815 5.39435
g
var( y ) var( y )
Since, Rg2 > R 2 we conclude that the log-linear model fits the data better.
(e)
50
40
30
20
residual
10
-10
-20
0 2 4 6 8 10 12 14 16 18 20
EDUC
Figure xr4.14(e) Residuals of the simple linear model
2.0
1.6
1.2
0.8
residual
0.4
0.0
-0.4
-0.8
-1.2
-1.6
0 2 4 6 8 10 12 14 16 18 20
EDUC
Figure xr4.14(f) Residuals of the log-linear model
The absolute value of the residuals increases in magnitude as EDUC increases, suggesting
heteroskedasticity which is covered in Chapter 8. It is also apparent, for both models, that
there are only positive residuals in the early range of EDUC. This suggests that there
might be a threshold effect education has an impact only after a minimum number of
years of education. We also observe the non-normality of the residuals in the linear model;
the positive residuals tend to be greater in absolute magnitude than the negative residuals.
(f) Prediction for simple linear model:

n = 4.9122 + 1.1385 16 = 13.30
WAGE0
Prediction for log-linear model:

n = exp ( 0.7884 + 0.1038 16 + (0.49022 ) / 2 ) = 13.05
WAGEc
Actual average wage of all workers with 16 years of education = 13.30
(g) The log-linear function is preferred because it has a higher goodness-of-fit value and its
residuals are consistent with normality. However, when predicting the average age of
workers with 16 years of education, the linear model had a smaller prediction error
EXERCISE 4.15
Results using cps_small.dat
(a), (b)
Summary statistics for WAGE
Sub-sample Mean Std Dev Min Max CV
(i) all males 11.525 6.659 2.07 60.19 57.8
(ii) all females 8.869 5.484 2.03 41.32 61.8
(iii) all whites 10.402 6.343 2.03 60.19 61.0
(iv) all blacks 8.259 4.740 3.50 25.26 57.4
(v) white males 11.737 6.716 2.07 60.19 57.2
(vi) white females 9.007 5.606 2.03 41.32 62.2
(vii) black males 9.066 5.439 3.68 25.26 60.0
(viii) black females 7.586 4.003 3.50 18.44 52.8
These results show that, on average, white males have the highest wages and black
females the lowest. The wage of white females is approximately the same as that of black
males. White females have the highest coefficient of variation and black females have the
lowest.
(c)
Regression results
Sub-sample Constant EDUC % return R2
(i) all males 1.0075 0.0967 9.67 0.2074
(se) (0.1144) (0.0084)
(ii) all females 0.5822 0.1097 10.97 0.2404
(se) (0.1181) (0.0088)
(iii) all whites 0.7822 0.1048 10.48 0.2225
(se) (0.0881) (0.0065)
(iv) all blacks 1.0185 0.0744 7.44 0.1022
(se) (0.3108) (0.0238)
(v) white males 0.9953 0.0987 9.87 0.2173
(se) (0.1186) (0.0087)
(vi) white females 0.6099 0.1085 10.85 0.2429
(se) (0.1223) (0.0091)
(vii) black males 1.3809 0.0535 5.35 0.0679
(se) (0.4148) (0.0321)
(viii) black females 0.2428 0.1275 12.75 0.2143
(se) (0.4749) (0.0360)
The return to education is highest for black females (12.75%) and lowest for black males
(5.35%). It is approximately 10% for all other sub-samples with the exception of all blacks
where it is around 7.5%.
Results using cps_small.dat
(d) The model does not fit the data equally well for each sub-sample. The best fits are for all
females and white females. Those for all blacks and black males are particularly poor.
(e) The t-value for testing H 0 : 2 = 0.10 against H1 : 2 0.10 is given by

b2 0.1
t=
se(b2 )
We reject H 0 if t > tc or t < tc where tc = t(0.975,df ) . The results are given in the following
table.
Test results for H 0 : 2 = 0.10 versus H1 : 2 0.10
Sub-sample t-value df tc p-value Decision
(i) all males 0.394 504 1.965 0.6937 Fail to reject H 0

(ii) all females 1.103 492 1.965 0.2707 Fail to reject H 0
(iii) all whites 0.745 910 1.963 0.4563 Fail to reject H 0
(iv) all blacks 1.074 86 1.988 0.2856 Fail to reject H 0
(v) white males 0.149 464 1.965 0.8817 Fail to reject H 0
(vi) white females 0.931 444 1.965 0.3525 Fail to reject H 0
(vii) black males 1.447 38 2.024 0.1560 Fail to reject H 0
(viii) black females 0.764 46 2.013 0.4485 Fail to reject H 0
There are no sub-samples where the data contradict the assertion that the wage return to an
extra year of education is 10%. Thus, although the estimated return to education is much
lower for all blacks and black males, it is not sufficiently less to conclude conclusively it
is not equal to 10%.
EXERCISE 4.15
Results using cps.dat
(a), (b)
Summary statistics for WAGE
Sub-sample Mean Std Dev Min Max CV
(i) all males 11.315 6.521 1.05 74.32 57.6
(ii) all females 8.990 5.630 1.28 78.71 62.6
(iii) all whites 10.358 6.275 1.05 78.71 60.6
(iv) all blacks 8.626 5.387 1.57 39.35 62.5
(v) white males 11.491 6.591 1.05 74.32 57.4
(vi) white females 9.105 5.648 1.28 78.71 62.0
(vii) black males 9.307 5.274 2.76 34.07 56.7
(viii) black females 8.129 5.424 1.57 39.35 66.7
These results show that, on average, white males have the highest wages and black
females the lowest. Males have higher average wages than females and whites have higher
average wages than blacks. The highest wage earner is, however, a white female. Black
females have the highest coefficient of variation and black males have the lowest.
(c)
Regression results
Sub-sample Constant EDUC % return R2
(i) all males 0.9798 0.0982 9.82 0.1954
(se) (0.0543) (0.0040)
(ii) all females 0.4776 0.1173 11.73 0.2479
(se) (0.0579) (0.0043)
(iii) all whites 0.7965 0.1040 10.40 0.2030
(se) (0.0428) (0.0032)
(iv) all blacks 0.6230 0.1066 10.66 0.1800
(se) (0.1390) (0.0106)
(v) white males 0.9859 0.0988 9.88 0.2009
(se) (0.0561) (0.0042)
(vi) white females 0.5142 0.1152 11.52 0.2453
(se) (0.0611) (0.0045)
(vii) black males 1.0641 0.0798 7.98 0.1167
(se) (0.2063) (0.0157)
(viii) black females 0.2147 0.1327 13.27 0.2569
(se) (0.1820) (0.0138)
The return to education is highest for black females (13.27%) and lowest for black males
(7.98%). It is approximately 10% for all other sub-samples with the exception of all
females and white females where it is around 11.5%.
Results using cps.dat
(d) The model does not fit the data equally well for each sub-sample. The best fits are for all
females, white females and black females. That for black males is particularly poor.
(e) The t-value for testing H 0 : 2 = 0.10 against H1 : 2 0.10 is given by

b2 0.1
t=
se(b2 )
We reject H 0 if t > tc or t < tc where tc = t(0.975,df ) . The results are given in the following
table.
Test results for H 0 : 2 = 0.10 versus H1 : 2 0.10
Sub-sample t-value df tc p-value Decision
(i) all males 0.444 2435 1.961 0.6568 Fail to reject H 0

(ii) all females 4.023 2294 1.961 0.0001 Reject H 0
(iii) all whites 1.276 4264 1.961 0.2019 Fail to reject H 0
(iv) all blacks 0.629 465 1.965 0.5294 Fail to reject H 0
(v) white males 0.296 2238 1.961 0.7669 Fail to reject H 0
(vi) white females 3.385 2024 1.961 0.0007 Reject H 0
(vii) black males 1.284 195 1.972 0.2005 Fail to reject H 0
(viii) black females 2.370 268 1.969 0.0185 Reject H 0
The null hypothesis is rejected for females, white females and black females. In these
cases the wage return to an extra year of education is estimated as greater than 10%. In all
other sub-samples, the data do not contradict the assertion that the wage return is 10%.
EXERCISE 4.16

n = 65.503 + 0.003482 BUSH
BUCHANAN R 2 = 0.7535
( se ) (17.293) ( 0.000249 )
(t ) ( 3.788 ) (13.986 )
The R 2 tells us that 75.35% of the variation in votes for Pat Buchanan are explained by
variation in the votes for George Bush (excluding Palm Beach).
(b) The vote in Palm Beach for George Bush is 152,846. Therefore, the predicted vote for Pat
Buchanan is:
n
BUCHANAN 0 = 65.503 + 0.003482 152,846 = 598
1 (152,846 41761.9697 )
2
se( f ) = 112.2647 1 + + = 116.443

66 2.0337296 1011
The 99.9% confidence interval is
y 0 t(0.9995, 66) se ( f ) = 597.7 3.449 116.443 = (196, 999 )
The actual vote for Pat Buchanan in Palm Beach was 3407 which is not in the prediction
interval. The model is clearly not a good one for explaining the Palm Beach vote. This
conclusion is confirmed by the scatter diagram in part (c).
(c)
3500
3000
2500
BUCHANAN
2000
1500
1000
500
0
0 200 400 600 800 1000 1200
BUCHANANHAT
Figure xr4.16(a) Predictions versus actual observations on Buchanan vote

(d) Regression results:

n = 109.23 + 0.002544 GORE
BUCHANAN R 2 = 0.6305
( se ) (19.52 ) ( 0.000243)
(t ) ( 5.596 ) (10.450 )
The R 2 tells us that 63.05% of the variation in votes for Pat Buchanan are explained by
variation in the votes for Al Gore (excluding Palm Beach).
The vote in Palm Beach for Al Gore is 268,945. Therefore, the predicted vote for Pat
Buchanan is:
n
BUCHANAN 0 = 109.23 + 0.002544 268945 = 793
1 ( 268,945 39975.55 )
2
se( f ) = 137.4493 1 + + = 149.281

66 3.188628 1011
The 99.9% confidence interval is
y 0 t(0.9995, 66) se ( f ) = 793.3 3.449 149.281 = ( 278, 1308 )
The actual vote for Pat Buchanan in Palm Beach was 3407 which is not in the prediction
interval. The model is clearly not a good one for explaining the Palm Beach vote. This
conclusion is confirmed by the scatter diagram below.
3,500
3,000
2,500
BUCHANAN
2,000
1,500
1,000
500
0
0 200 400 600 800 1,000 1,200
BUCHANANHAT2
Figure xr4.16(b) Predictions versus actual observations on Buchanan vote

(e) Regression results:

n = 0.0017 + 0.01142 BUSHSHARE
BUCHSHARE R 2 = 0.1004
( se ) ( 0.0024 ) ( 0.00427 )
(t ) ( 0.710 ) ( 2.673)
The share of votes for George Bush in Palm Beach was 0.354827. Therefore, the predicted
share of votes in Palm Beach for Pat Buchanan is:
n 0 = 0.001706 + 0.011424 0.354827 = 0.002348
BUCHSHARE
The standard error of the forecast error is
1 ( 0.354827 0.554756 )
2
se( f ) = 0.003078 1 + + = 0.0032168

66 0.518621
A 99.9% confidence interval is given by
y 0 t(0.9995, 66) se ( f ) = 0.002349 3.449 0.0032168 = ( 0.0087457, 0.0134437 )
There were 430,762 total votes cast in Palm Beach. Multiplying the confidence interval
endpoints by this figure yields ( 3767, 5791) . The actual vote for Pat Buchanan in Palm
Beach was 3407 which falls inside this interval.

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What are the main exercises covered in the chapter?

What are the main exercises covered in the chapter?

How are predictions and estimations differentiated?

How are predictions and estimations differentiated?

CHAPTER 4

( yi y ) = yi2 N y 2 = 5930.94 20 16.0352 = 788.5155

The values of R 2 remain the same in all cases.

se( f ) = 14.9332 = 3.864

(c) Using se( f ) from part (b) and tc = t(0.975,3) = 3.182 ,

y 0 tc se( f ) = 6 3.182 3.864 = ( 6.295,18.295)

(d) Using se( f ) from part (b) and tc = t(0.995,3) = 5.841 ,

y 0 tc se( f ) = 6 5.841 3.864 = ( 16.570, 28.570)

(e) Using x = x0 = 1 , the prediction is y 0 = 1 + 1 1 = 2 , and

se( f ) = 6.340 = 2.530

y 0 tc se( f ) = 2 3.182 2.530 = (6.050,10.050)

Width in part (c) = 18.295 ( 6.295 ) = 24.59

Width in part (e) = 10.050 ( 6.050 ) = 16.1

(b) E (b1 + b2 x0 ) = E (b1 ) + E (b2 ) x0 = 1 + 2 x0

var(b1 + b2 x0 ) = var(b1 ) + x02 var(b2 ) + 2 x0 cov(b1 , b2 )

(c) It is not appropriate to say that E ( y 0 ) = y0 because y0 is a random variable.

(a) The least squares estimator for 1 is b1 = y b2 x . Thus, y = b1 + b2 x , and hence ( y , x )

(b) Consider the fitted line yi = b1 + xi b2 . Averaging over N, we obtain

From part (a), we also have y = b1 + b2 x . Thus, y = y .

(b) Using the solution from Exercise 2.4 part (f)

SSE = ei2 = (2.0659 2 + 2.13192 + 1.19782 + ( 0.7363)

+ ( 0.6703) + ( 0.6044 ) = 11.6044

yi2 = 42 + 62 + 72 + 7 2 + 92 + 112 = 352

(d) SST = 29.333, SSR = 67.370

{SSR + SSE = 67.370 + 11.6044 = 78.974} {SST = 29.333}

(a) Simple linear regression results:

Linear-log regression results:

Quadratic regression results:

(b) (i) (ii)

Residual Actual Fitted

Residual Actual Fitted

Exercise 4.8(b) continued

Residual Actual Fitted

(iii) Error normality tests Jarque-Bera:

(iv) Values of R 2 are given in part (a)

To choose the preferred equation we consider the following.

(a) Equation 1: y 0 = 0.6776 + 0.0161 49 = 1.467

Equation 2: y 0 = 0.5287 + 0.1855ln(49) = 1.251

Equation 3: y 0 = 0.7914 + 0.0003547 (49)2 = 1.643

(a) For households with 1 child

For households with 2 children:

Exercise 4.10 (continued)

Figure xr4.10(a) Figure xr4.10(b)

Figure xr4.10(c) Figure xr4.10(d)

(a) Regression results:

Predicted value of VOTE in 2000:

Least squares residual:

(b) Estimated regression:

Predicted value of VOTE in 2000:

Prediction error in forecast:

(c) 95% prediction interval:

(a) Estimated regression:

In May 2005: n = 2992.739 194.2334 6.00 = 1827

In June 2005: n = 2992.739 194.2334 5.82 = 1862

(b) Prediction error for May 2005: