1

CHAPTER 2
Exercise Solutions
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 2
EXERCISE 2.1
(a)
x y x-x ( ) x-x2 y-y ( ) x--xyy()
3 5 2 4 3 6
2 2 1 1 0 0
1 3 0 0 1 0
-1 2 -2 4 0 0
0 -2 -1 1 -4 4

∑ xi = ∑ yi = ∑(xi - x ) ∑( ) x x i - ∑( y - y) ∑( ) x - - = x y y
5 10
= 2= = ()
0 10 0 10
x y = = 1, 2
(b) ( )( )
2 ( )2 1
b xx = =
= 0
-
10
1.
xxyy
--
∑
∑ b2 is the estimated slope of the fitted line.
b y b x 1 2 = - = - × = 2 1 1 1. b1 is the estimated value of y when x = 0, it is the estimated
intercept of the fitted line.
(c) ( )
5
222222
1
3 2 1 1 0 15
i
i
x
=

∑ =+++-+=
()()
5
1
3 5 2 2 1 3 1 2 0 2 20
ii
i
xy
=

∑ =×+×+×+-×+×-=
()
55
2222
1 1
i i
= =

( )( )
55
20 5 1 2 10
iiii
x y Nxy x x y y
∑ ∑ -=-××==--
1 1
i i
= =

15 5 1 10
ii
x Nx x x
∑ ∑ -=-×==-
(d)
xi yi yˆi eˆi eˆi2 xi i eˆ
3 5 4 1 1 3
2 2 3 -1 1 -2
1 3 2 1 1 1
-1 2 0 2 4 -2
0 -2 1 -3 9 0
∑ xi = ∑ yi = ∑ yˆi = ∑eˆi = ∑eˆi2 = ∑ xi i eˆ =
5 10 10 0 16 0
(e) Refer to Figure xr2.1 below.
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 3
Exercise 2.1 (continued)
(f)
-3
-2
-1
6543210
-1.2 -0.8 -0.4 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2
x
y
Figure xr2.1 Fitted line, mean and observations
(g) y b b x y x b b = + = = = = 1 2 1 2 2, 1, 1, 1
Therefore: 2 1 1 1 = + ×
(h) yˆ ˆ = = + + + + = = ∑ y N y i (4 3 2 0 1 / 5 2 )
(i)
2
2 ˆ 16
ˆ 5.3333
23
ei
N
σ===
-
∑
(j) n( )
()
2
22
ˆ 5.3333
var .53333
10
i
b
xx
σ
===
∑-
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 4
EXERCISE 2.2
(a) Using equation (B.30),
P X ( ) 110 140 < < | $1000 | $1000 | $1000
110 140
yx yxyx
P <⎟
=<⎜
-
⎛ ⎞ -μ
μ
2 2 2 | $1000 | $1000 | $1000
yxyxyx
X
===
===
⎜⎟σσσ
⎝⎠
110 125 140 125 ( ) 2.1429 2.1429 0.9679
49 49
=<<=-<<=PZPZ⎛⎞⎜⎟--
⎝⎠
.00
.01
.02
.03
.04
.05
.06
100 110 120 130 140 150
Y
FY
Figure xr2.2 Sketch of PDF
(b) Using the same formula as above:
P X ( ) 110 140 < < 110 125 140 125 ( ) 1.6667 1.6667 0.9044
81 81
=<<=-<<=PZPZ⎛⎞⎜⎟--
⎝⎠
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 5
EXERCISE 2.3
The observations on y and x and the
estimated least-squares line are graphed in
(a) part (b).
The line drawn for part (a) will depend on
each student’s subjective choice about the
position of the line. For this
reason, it has been omitted.
(b) Preliminary calculations yield:
 21 44
7.3333 3.5
xi yi 22 ( )( ) 17.5 ( )2
y x x x y y ii xxi
= = --= -=
= = ∑ ∑
∑ ∑
The least squares estimates are
( )( )
2 ( )2

22
1.257
17.5
xxyy
b
xx
--
===
-
∑
∑
b y b x 1 2 = - = - × = 7.3333 1.2571 3.5 2.9333
9876543
10
11
12
01234567
x
y
Figure xr2.3 Observations and fitted line
(c) y y N = = = ∑ i 44 6 7.3333
21 6 3.5
xxN===∑i
The predicted value for y at x = x is
y b b x ˆ = + = + × = 1 2 2.9333 1.2571 3.5 7.3333
We observe that
yˆ = + = b b x y 1 2 . That is, the predicted value at the sample mean x is the
sample mean of the dependent variable y . This implies that the least-squares estimated
line passes through the point ( , ) x y .
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 6
Exercise 2.3 (continued)
The values of the least squares residuals, computed
(d)
from e y b b x ˆi i i = - - 1 2 , are:
eˆ1 = -0.19048
eˆ4 = -0.96190 eˆ2 = 0.55238 eˆ3 = 0.29524
Their sum is ˆ 0. eˆ5 = -0.21905 eˆ6 = 0.52381
∑ei =
(e) ∑ x e i i ˆ = × - + × + × + × - + × - + × = 1 0.190 2 0.552 3
0.295 4 0.962 5 0.291 6 0.524 0
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 7
EXERCISE 2.4
If β = 1 0, the simple linear regression model
(a)
becomes
yi i i = β + 2x e
Graphically, setting β = 1 0 implies the mean of the
simple linear regression model
(b) E( ) y x i i = β2 passes through the origin (0, 0).
To save on subscript notation we set β2 = β. The sum
of squares function becomes
(c)
2222222
()()(2)2
iiiiiiiiii
Syxyxyxyxyx
β=-β=-β+β=-β+β
∑∑∑∑∑
1 1
i i
= =
N N
22
352 2 176 91 352 352 91
=-×β+β=-β+β
10
15
20
25
30
35
40
1.6 1.8 2.0 2.2 2.4
BETA
SUM_SQ
Figure xr2.4(a) Sum of squares for β2
The minimum of this function is approximately 12 and occurs at approximately β = 2 1.95.
The significance of this value is that it is the least-squares estimate.
(d) To find the value of β that minimizes S( ) β we obtain
222
iii
dS
xyx
d
=-+β
β∑ ∑
Setting this derivative equal to zero, we have
2

b x x y ∑ ∑ i i i = or i i 2
i
xy
b
x
=
∑∑
Thus, the least-squares estimate is
2
176
1.9341
91
b==
which agrees with the approximate value of 1.95 that we obtained geometrically.
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 8
Exercise 2.4 (Continued)
(e)
86420
10
12
0123456
X1
Y1
* (3.5, 7.333)

Figure xr2.4(b) Fitted regression line and mean

The fitted regression line is plotted in Figure xr2.4 (b). Note that the point ( , ) x y does not
lie on the fitted line in this instance.
(f) The least squares residuals, obtained from e y b x ˆi i i = - 2 are:
eˆ1 = 2.0659 eˆ2 = 2.1319 eˆ3 =1.1978
eˆ4 = -0.7363 eˆ5 = -0.6703 eˆ6 = -0.6044
Their sum is ˆ 3.3846.
∑ei = Note this value is not equal to zero as it was for β ≠ 1 0.
(g) ∑ x e i i ˆ = × + × + × 2.0659 1 2.1319 2 1.1978 3
- × - × - × = 0.7363 4 0.6703 5 0.6044 6 0
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 9
EXERCISE 2.5
(a The consultant’s report implies that the least squares estimates satisfy the following two
) equations
b b 1 2 + = 450 7500
b b 1 2 + = 600 8500
Solving these two equations yields
2
1000 b1 =
6.6667 4500
b==
150
4000
5000
6000
7000
8000
9000
0 100 200 300 400 500 600
ADVERT
SALES
* weekly averages
Figure xr2.5 Graph of sales-advertising regression line
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 10
EXERCISE 2.6
(a) The intercept estimate b1 = -240 is an estimate of the number of sodas sold when the
temperature is 0 degrees Fahrenheit. A common problem when interpreting the estimated
intercept is that we often do not have any data points near X = 0. If we have no
observations in the region where temperature is 0, then the estimated relationship may not
be a good approximation to reality in that region. Clearly, it is impossible to sell -240
sodas and so this estimate should not be accepted as a sensible one.
The slope estimate b2 = 6 is an estimate of the increase in sodas sold when temperature
increases by 1 Fahrenheit degree. This estimate does make sense. One would expect the
number of sodas sold to increase as temperature increases.
 If temperature is 80 degrees, the predicted number of sodas
sold is
yˆ = - + × = 240 6 80 240
(b) If no sodas are sold, y = 0, and
0 240 6 = - + × x or x = 40
Thus, she predicts no sodas will be sold below 40°F.
A graph of the estimated regression line:
(c)
(d)
-300
-200
-100
0
100
200
300
0 20 40 60 80
TEMP
SODAS

Figure xr2.6 Graph of regression line for soda sales and temperature
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 11
EXERCISE 2.7
(a) Since
2
2 ˆ
ˆ 2.04672
2
ei
N
σ==
-
∑
it follows that
∑e N ˆi2 = - = × = 2.04672( 2) 2.04672 49 100.29
(b) The standard error for b2 is
n
se( ) var( ) 0.00098 0.031305 b b 2 2 = = =
Also,
n
2
22
ˆ
var( )
()i
b
xx
σ
=
∑-
Thus,
()
n( )
2
var b 0.00098
2.04672
ˆ
2088.5
2
2
x x iσ
∑ -===
The value b2 = 0.18 suggests that a 1% increase in the percentage of males 18 years or
older who are high school graduates will lead to an increase of $180 in the mean
income
of males who are 18 years or older.
(c) b y b x 1 2 = - = - × = 15.187 0.18 69.139 2.742
Since ∑ ∑ ( ) xi i - = - x x N x 2 2 2 , we have
∑ ∑ x x x N x i i 2 2 2 = - + = + × ( )2 2088.5 51 69.139 = 245,879
For Arkansas
e y y y b b x ˆ ˆ i i i i i = - = - - = - - × = - 1 2 12.274 2.742 0.18 58.3 0.962
(d)
(e)
(f)

Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 12

EXERCISE 2.8
(a) The EZ estimator can be written as
21
yy y yky
1 1 ⎛ ⎛ ⎞
- ⎞ ∑
b

21
-=⎟⎜⎟ = =⎜
2121
21
EZ
xxxx xx ii

--⎝⎠ -⎝⎠
where
1
21
1
k
xx
-
=
-
21
,2 1
k xx
=
-
, and k3 = k4 = ... = kN = 0
Thus, bEZ is a linear estimator.
Taking expectations yields
() () ()
21 2 1
(b) yy 1 1
EbE Ey Ey
⎡⎤-
 2121 21
xxxx xx EZ
⎣⎦-- -
=⎢ =⎥ -
()()
122121
2121
222121
2121

2 2 xxxx
=β⎜ -=β⎟ - =
--
2121
xxxx
--⎝⎠
Thus, bEZ is an unbiased estimator.
The variance is
(c)
given by
var var( ) var ( ) b k y k e k EZ i i i i i = = = σ ∑ ∑
∑ 222( )
2
2
2
⎛ 1 1 +
⎞σ
=σ⎜
=⎟
11
xx
xxxx
xxxx
=β+β-β+β
--
ββ⎛⎞
()()()
222
212121
xxxxxx
⎜⎟
⎝⎠---
(d) If e N i ~ 0, ( σ2) , then
() bN
xx EZ

2
~, ⎥
⎢β
⎡ σ⎤
⎥
⎢⎣ -
⎦
2
22
21

Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 13

Exercise 2.8 (continued)
(e) To convince E.Z. Stuff that var(b2) < var(bEZ), we need to show that
()()
22
22
21
2
xxxxi
σσ
>
--∑
or that ( )2 ( ) 2 1 2
i2

xx
xx
-
∑->
Consider
( ) 2 1 2 1 2 1 2 2 2 ( ) 2 1 ( ) 2 ( ) ( ) 2( )( )
2
Thus, we need to show 2 2
that
x-xxxxxxxxx⎡---⎤⎣⎦xxxx-+----
==
( )2 2 2 ( ) 2 1 2 1 ( ) ( )( )
1
22
N
i
i
xxxxxxxxxx
=

∑ ->-+----
or that
( ) 1 2 2 1 2 2 2 ( ) ( )( ) ( )
3
220
N
i
i
xxxxxxxxxx
=

-+-+--+->∑
or that
( ) 1 2 ( ) 2 ( )2
3
2 0.
N
i
i
xxxxxx
=

⎡-+-⎤+->⎣⎦∑
This last inequality clearly holds. Thus, bEZ is not as good as the least squares estimator.
Rather than prove the result directly, as we have done above, we could also refer Professor
E.Z. Stuff to the Gauss Markov theorem.
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 14
EXERCISE 2.9
(a Plots of UNITCOSTt against CUMPRODt and ln(UNITCOSTt ) against ln( )
) CUMPRODt
appear in Figure xr2.9(a) & (b). The two plots are quite similar in nature.
16
18
20
22
24
26
1000 2000 3000 4000
CUMPROD
UNITCOST
Figure xr2.9(a) The learning curve data
2.7
2.8
2.9
3.0
3.1
3.2
3.3
7.0 7.2 7.4 7.6 7.8 8.0 8.2
ln(CUMPROD)
ln(UNITCOST)
Figure xr2.9(b) Learning curve data with logs
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 15
Exercise 2.9 (continued)
(b) The least squares estimates are
b1 = 6.0191 b2 = -0.3857
Since ln(UNITCOST1) = β1, an estimate of u1 is
UNITCOST b n1 1 = = = exp exp 6.0191 411.208 ( ) ( )
This result suggests that 411.2 was the cost of producing the first unit. The estimate b2 =
-0.3857 suggests that a 1% increase in cumulative production will decrease costs by
0.386%. The numbers seem sensible.
2.7
2.8
2.9
3.0
3.1
3.2
3.3
3.4
7.0 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 8.0 8.1 8.2
ln(CUMPROD)
ln(UNITCOST)
Figure xr2.9(c) Observations and fitted line
The coefficient covariance matrix
(c)
has the elements
var 0.075553 n( ) b 1 = cov , 0.009888 b
var 0.001297 b 2 = n( ) (d)
The error variance estimate is b 1 2 = - n( )
σ = = ˆ 2 2 0.049930 0.002493.
When CUMPROD0 = 2000 , the (e)
predicted unit cost is
UNITCOST n0=exp 6.01909 0.385696ln 2000 21.921 ( - = ( ))
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 16
EXERCISE 2.10
The model is a simple regression model because it can be written as y = β + β + 1 2x e
(a
where
)
y = - r r j f , x = - r r m f , β1 = α j and β2 = β j .
(b)
 Microsoft General
Electric
Firm
General
Motors IBM Disney Exxon- Mobil
2
ˆ 1.430 0.983 1.074 1.268 0.959 0.403
b=βj
The stocks Microsoft, General Motors and IBM are aggressive with Microsoft being the
most aggressive with a beta value of β = ˆ 2 1.430 . General Electric, Disney and ExxonMobil are
defensive with Exxon-Mobil being the most defensive since it has a beta value
of
2
β = ˆ 0.403.
(c)
Microsoft General
Electric
Firm
General
Motors IBM Disney Exxon- Mobil
b1 = ˆ
0.010 0.006 -0.002 0.007 -0.001 0.007
αj
All the estimates of ˆ
α j are close to zero and are therefore consistent with finance theory.
In the case of Microsoft, Figure xr2.10 illustrates how close the fitted line is to passing
through the origin.
-.4
-.3
-.2
-.1
.0
.1
.2
.3
.4
.5
-.20 -.15
-
-.05 .
.
MKT- 0
1
RKFREE 0
0
.05 .10
MSFT-RKFREE
Figure xr2.10 Observations and fitted line for microsoft
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 17
Exercise 2.10 (continued)
(d) The estimates for β j given α = j 0 are as follows.
Microsoft General
Electric
Firm
General
Motors IBM Disney Exxon- Mobil
ˆ
1.464 1.003 1.067 1.291 0.956 0.427
βj
The restriction αj = 0 has led to only small changes in the βˆ j.
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 18
EXERCISE 2.11
(a)
0
400000
800000
1200000
1600000
0 2000 4000 6000 8000
SQFT
PRICE
Figure xr2.11(a) Price against square feet – all houses
0
200000
400000
600000
800000
1000000
1200000
0 2000 4000 6000 8000
SQFT
PRICE
Figure xr2.11(b) Price against square feet for houses of traditional style
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 19
Exercise 2.11 (continued)
The estimated equation for all houses is
(b
n
)
PRICE SQFT = - + 60,861 92.747
The coefficient 92.747 suggests house price increases by approximately $92.75 for each
additional square foot of house size. The intercept, if taken literally, suggests a house with
zero square feet would cost - $60,861, a meaningless value. The model should not be
accepted as a serious one in the region of zero square feet.
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1,600,000
0 2,000 4,000 6,000 8,000
SQFT
PRICE
Figure xr2.11(c) Fitted line for Exercise 2.11(b)
(c) The estimated equation for traditional style houses is
n
PRICE SQFT = - + 28,408 73.772
The slope of 73.772 suggests that house price increases by approximately $73.77 for each
additional square foot of house size. The intercept term is - 28,408 which would be
interpreted as the dollar price of a traditional house of zero square feet. Once again, this
estimate should not be accepted as a serious one. A negative value is meaningless and
there is no data in the region of zero square feet.
Comparing the estimates to those in part (b), we see that extra square feet are not worth as
much in traditional style houses as they are for houses in general ($77.77 < $92.75). A
comparison of intercepts is not meaningful, but we can compare equations to see which
type of house is more expensive. The prices are equal when
- + - + 28,408 73.772 60,861 92.747 SQFT = SQFT
Solving for SQFT yields
60861 28408
1710
92.747 73.772
SQFT = = -
-
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 20
Exercise 2.11(c) (continued)
Thus, we predict that the price of traditional style houses is greater than the price of
houses in general when SQFT <1710 . Traditional style houses are cheaper when
(c)
SQFT >1710 .
Residual plots:
(d)
-400000
-300000
-200000
-100000
0
100000
200000
300000
400000
500000
0 2000 4000 6000 8000
SQFT
RESID
Figure xr2.11(d) Residuals against square feet – all houses
-300000
-200000
-100000
0
100000
200000
300000
400000
500000
600000
0 2000 4000 6000 8000
SQFT
RESID
Figure xr2.11(e) Residuals against square feet for houses of traditional style
The magnitude of the residuals tends to increase as housing size increases suggesting that
SR3 var | ( ) e xi = σ2 [homoskedasticity] could be violated. The larger residuals for larger
houses imply the spread or variance of the errors is larger as SQFT increases. Or, in other
words, there is not a constant variance of the error term for all house sizes.
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 21
EXERCISE 2.12
(a) We can see a positive relationship between price and house size.
0
100000
200000
300000
400000
500000
600000
0 1000 2000 3000 4000 5000
SQFT
PRICE
Figure xr2.12(a) Price against square feet
(b) The estimated equation for all houses in the sample is
n
PRICE SQFT = - + 18,386 81.389
The coefficient 81.389 suggests house price increases by approximately $81 for each
additional square foot in size. The intercept, if taken literally, suggests a house with zero
square feet would cost - $18,386, a meaningless value. The model should not be accepted
as a serious one in the region of zero square feet.
0
100,000
200,000
300,000
400,000
500,000
600,000
0 1,000 2,000 3,000 4,000 5,000
SQFT
PRICE
Figure xr2.12(b) Fitted regression line
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 22
Exercise 2.12 (continued)
The estimated equation when a house is vacant at the time of
(c sale is
) n
PRICE SQFT = - + 4792.70 69.908
For houses that are occupied it is
n
PRICE SQFT = - + 27,169 89.259
These results suggest that price increases by $69.91 for each additional square foot in size
for vacant houses and by $89.26 for each additional square foot of house size for houses
that are occupied. Also, the two estimated lines will cross such that vacant houses will
have a lower price than occupied houses when the house size is large, and occupied houses
will be cheaper for small houses. To obtain the break-even size where prices are equal we
write
- + = - + 4792.70 69.908 27,169 89.259 SQFT SQFT
Solving for SQFT yields
27169 4792.7
1156
89.259 69.908
SQFT = = -
-
Thus, we estimate that occupied houses have a lower price per square foot when
SQFT <1156 and a higher price per square foot when SQFT >1156 .
(d) Residual plots
-120,000
-80,000
-40,000
0
40,000
80,000
120,000
160,000
200,000
0 1,000 2,000 3,000 4,000 5,000
SQFT
RESID
Figure xr2.12(c) Residuals against square feet for occupied houses
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 23
Exercise 2.12(d) (continued)
(d)
-100,000
-50,000
0
50,000
100,000
150,000
200,000
250,000
0 1,000 2,000 3,000 4,000 5,000
SQFT
RESID
Figure xr2.12(d) Residuals against square feet for vacant houses
The magnitude of the residuals tends to be larger for larger-sized houses suggesting that
SR3 var | ( ) e xi = σ2 [the homoskedasticity assumption of the model] could be violated.
As the size of the house increases, the spread of distribution of residuals increases,
indicating that there is not a constant variance of the error term with respect to house size.
(e) Using the model estimated in part (b), the predicted price when SQFT = 2000 is
PRICE n= - + × = 18,386 81.389 2000 $144,392
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 24
EXERCISE 2.13
(a)
98765
10
11
1990 1995 2000 2005
FIXED_RATE
Figure xr2.13(a) Fixed rate against time
20
40
60
80
100
120
140
90 92 94 96 98 00 02 04
SOLD
Figure xr2.13(b) Houses sold (1000’s ) against time
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 25
Exercise 2.13(a) (continued)
(a)
400
800
1200
1600
2000
2400
90 92 94 96 98 00 02 04
STARTS
Figure xr2.13(c) New privately owned houses started against time
(b) Refer to Figure xr2.13(d).
(c) The estimated model is
n
STARTS FIXED_RATE = - 2992.739 194.233
The coefficient -194.233 suggests that the number of new privately owned housing starts
decreases by 194,233 for a 1% increase in the 30 year fixed interest rate for home loans.
The intercept suggests that when the 30 year fixed interest rate is 0%, 2,992,739 will be
started. Caution should be exercise with this interpretation, however, because it is beyond
the range of the data.
Figure xr2.13(d) shows us where the fitted line lies among the data points. The fitted line
appears to go evenly through the centre of data and the residuals appear be of relatively
equal magnitude as we move along the fitted line.
400
800
1200
1600
2000
2400
5 6 7 8 9 10 11
FIXED_RATE
STARTS
Figure xr2.13 (d) Fitted line and observations for housing starts against the fixed rate
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 26
Exercise 2.13 (continued)
(d Refer to Figure xr2.13(e).
) The estimated model is
 (e n
) SOLD FIXED_RATE = - 167.548 13.034
The coefficient -13.034 suggests that a 1% increase in the 30 year fixed interest rate for
home loans is associated with a decrease of around 13,034 houses sold. The intercept
suggests that when the 30 year fixed interest rate is 0%, 167,548 houses will be sold over a
period of 1 month. Caution should be exercise with this interpretation, however, because it
is beyond the range of the data.
20
40
60
80
100
120
140
5 6 7 8 9 10 11
SOLD
FIXED_RATE
Figure xr2.13(e) Fitted line and observations for houses sold against fixed rate
Figure xr2.13(e) shows us where the fitted line lies amongst the data points. From this
figure we can see that the data appear slightly convex relative to the fitted line suggesting
that a different functional form might be suitable. A plot of the residuals against the fixed
rate might shed more light oin this question. We can see also that the residuals appear to
have a constant distribution over the majority of fixed rates.
(f) Using the model estimated in part (c), the predicted number of monthly housing starts for
FIXED RATE _ = 6 is

(STARTS n)× = - × × = × = 1000 2992.739 194.233 6 1000 1827.34 1000 1,827,340 ( )

There will be 1,827,340 new privately owned houses started at a 30 year fixed interest rate
of 6%. This is a seasonally adjusted annual rate. On a monthly basis we estimate 155,278
starts.
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 27
EXERCISE 2.14
(a)
35
40
45
50
55
60
65
-16 -12 -8 -4 0 4 8 12
GROWTH
VOTE
Figure xr2.14(a) Incumbent share against growth rate of real GDP per capita
There appears to be a positive association between VOTE and GROWTH.
(b) The estimated equation is
n
VOTE GROWTH = + 51.939 0.660
The coefficient 0.660 suggests that for an increase in 1% of the annual growth rate of GDP
per capita, there is an associated increase in the share of votes of the incumbent party of
0.660.
The coefficient 51.939 indicates that the incumbent party receives 51.9% of the votes on
average, when the growth rate in real GDP is zero. This suggests that when there is no
real GDP growth, the incumbent party will still maintain the majority vote.
A graph of the fitted line and data is shown in Figure xr2.14(b).
35
40
45
50
55
60
65
-16 -12 -8 -4 0 4 8 12
VOTE
GROWTH
Figure xr2.14(b) Graph of vote-growth regression
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 28
Exercise 2.14 (continued)
(c) Figure xr2.14(c) shows a plot of VOTE against INFLATION. It shows a negative
correlation between the two variables.
The estimated equation is:
n
VOTE = INFLATION 53.496 0.445 -
The coefficient -0.445 indicates that a 1% increase in inflation, the GDP deflator, during
the incumbent party’s first 15 quarters, is associated with a 0.445 drop in the share of
votes.
The coefficient 53.496 suggest that on average, when inflation is at 0% for that party’s
first 15 quarters, the associated share of votes won by the incumbent party is 53.496%; the
incumbent party maintains the majority vote when inflation, during their first 15 quarters,
is at 0%.
35
40
45
50
55
60
65
012345678
INFLATION
VOTE
Figure xr2.14(c) Graph of vote-inflation regression line and observations
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 29
EXERCISE 2.15
(a)
0
50
100
150
200
250
300
350
400
2 4 6 8 10 12 14 16 18
Series: EDUC
Sample 1 1000
Observations 1000
13.285
00
Mean 13.000
Median 00
Maximu 18.000
m 00
Minimu 1.0000
m 00
Std. 2.4681
Dev. 71
Skewne -
ss 0.2116
Kurtosis 46
Jarque- 4.5250
Bera 53
Probabili 104.37
ty 34
0.0000
00
Figure xr2.15(a) Histogram and statistics for EDUC
From Figure xr2.15 we can see that the observations of EDUC are skewed to the left
indicating that there are few observations with less than 12 years of education. Half of the
sample has more than 13 years of education, with the average being 13.29 years of
education. The maximum year of education received is 18 years, and the lowest level of
education achieved is 1 year.
0
40
80
120
160
200
240
0 10 20 30 40 50 60
Series: WAGE_HISTOGRAM_STATS
Sample 1 1000
Observations 1000
10.213
02
8.7900
00
Mean 60.190
Median 00
Maximum 2.0300
Minimum 00
Std. Dev. 6.2466
Skewness 41
Kurtosis 1.9532
Jarque- 58
Bera 10.010
Probability 28
2683.5
39
0.0000
00
Figure xr2.15(b) Histogram and statistics for WAGE
Figure xr2.15(b) shows us that the observations for WAGE are skewed to the right
indicating that most of the observations lie between the hourly wages of 5 to 20, and that
there are few observations with an hourly wage greater than 20. Half of the sample earns
an hourly wage of more than 8.79 dollars an hour, with the average being 10.21 dollars an
hour. The maximum earned in this sample is 60.19 dollars an hour and the least earned in
this sample is 2.03 dollars an hour.
Chapter 2, Exercise Solutions, Principles of Econometrics, 3e 30
Exercise 2.15 (continued)
The estimated equation is
(b
n
)
WAGE EDUC = - + 4.912 1.139
The coefficient 1.139 represents the associated increase in the hourly wage rate for an
extra year of education. The coefficient -4.912 represents the estimated wage rate of a
worker with no years of education. It should not be considered meaningful as it is not
possible to have a negative hourly wage rate. Also, as shown in the histogram, there are no
data points at or close to the region EDUC = 0.
(c) The residuals are plotted against education in Figure xr2.15(c). There is a pattern evident;
as EDUC increases, the magnitude of the residuals also increases. If the assumptions
SR1-SR5 hold, there should not be any patterns evident in the least squares residuals.
-20
-10
0
10
20
30
40
50
0 4 8 12 16 20
EDUC
RESID
Figure xr2.15(c) Residuals against education
(d) The estimated regressions are
If female: WAGE EDUC n = - + 5.963
If male: 1.121
 If black: WAGE EDUC n = - + 3.562
If white: 1.131
WAGE EDUC n = + 0.653
0.590
WAGE EDUC n = - + 5.151
1.167
From these regression results we can see that the hourly wage of a white worker increases
significantly more, per additional year of education, compared to that of a black worker.
Similarly, the hourly wage of a male worker increases more per additional year of
education than that of a female worker; although this difference is relatively small.