PRINCIPLES OF ECONOMETRICS

5TH EDITION

ANSWERS TO ODD-NUMBERED
EXERCISES IN CHAPTER 2

1
 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 2

EXERCISE 2.1
(a)
 xi =5  yi = 10  ( xi − x ) = 0  ( xi − x )  ( y − y ) = 0  ( x − x )( y − y ) = 8
2
= 10

̅ = 1, =2

(b) b2 =
 ( x − x )( y − y ) = 8 = 0.8
( x − x )
2
10

b1 = y − b2 x = 2 − 0.8 × 1 = 1.2

5
(c)  xi2 = 15
i =1
5
 xi yi = 18
i =1
5
 xi2 − Nx 2 = 10
i =1
5
 xi yi − Nxy = 8
i =1

(d)
 xi =5  yi =10  yˆi =10  eˆi =0  eˆi2 =3.6  xi eˆi =0

s y2 = 2.5
s x2 = 2.5
sxy = 2
rxy = 0.8
CVx = 158.11388
median( x) = 1

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 3

(e)
Figure xr2.1 Observations and fitted line

4
3
2
1
0

-1 0 1 2 3
x

y Fitted values

(f) See figure above. The fitted line passes through the point of the means, ̅ = 1, = 2.

(g) =2, + ̅= 2

(h) yˆ = 2

(i) σˆ 2 = 1.2

(j) ( |x) = 0.12 and ( ) = 0.34641

EXERCISE 2.3
(a) We show the least squares fitted line.
20
15
10
5

1 2 3 4 5 6
x

y Fitted values

(b) b2 = 2.285714 , b1 = 2

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 4

Figure xr2.3 Observations and linear fitted line

20
15
y
10
5 1 2 3 4 5 6
x

y yhat

(c) y = 10 and x = 3.5 and yˆ = b1 + b2 x = 10

(d)
eˆi
1.71429
−2.57143
2.14286
−2.14286
−0.42857
1.28571

(e)  eˆi = 0 , and  eˆi2 = 20.57143

(f) ∑ ̂ =0

EXERCISE 2.5
(a) SALES = 4000 + 4 × ADVERT

Figure xr2.5
Regression line
15000
10000
sales
5000

0 1000 2000 3000

advert

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 5

EXERCISE 2.7
(a)  eˆi2 = 697.82566

(b) ∑( − ̅ ) = 1553.8833

(c) b2 = 1.02896 suggests that a 1% increase in the percentage of the population with a
bachelor’s degree or more will lead to an increase of $1028.96 in the mean income per
capita.

(d) b1 = 11.519745

(e)  xi2 = 39722.17

(f) eˆi = −4.9231453

EXERCISE 2.9

( )
(a) E βˆ 2, mean | x = E ( y2 − y1 ) ( x2 − x1 ) | x  = 1 ( x2 − x1 )  E ( y2 − y1 ) | x 

E ( y2 − y1 ) | x  = E [ y2 | x ] − E [ y1 | x]

1 6  1 6 1 6
E [ y2 | x ] = E   i = 4 yi | x  =  i = 4 E ( yi | x ) =  i = 4 ( β1 + β2 xi )
3  3 3
1
3
6


1
3
6
( )
= 3β1 + β2  i = 4 xi  = β1 + β2  i = 4 xi = β1 + β2 x2

Similarly E [ y1 | x ] = β1 + β 2 x1 . Then

E ( y2 − y1 ) | x  = E [ y2 | x] − E [ y1 | x] = ( β1 + β2 x2 ) − ( β1 + β2 x1 ) = β2 ( x2 − x1 )

Finally,

( )
E βˆ 2, mean | x = E ( y2 − y1 ) ( x2 − x1 ) | x  = 1 ( x2 − x1 )  E ( y2 − y1 ) | x 
= 1 ( x2 − x1 )  β 2 ( x2 − x1 ) = β 2

( )  (  )
(b) E βˆ 2, mean = Ex  E βˆ 2, mean | x  = Ex ( β 2 ) = β 2

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 6

( )
(c) var βˆ 2, mean | x = 1 ( x2 − x1 )  var ( y2 − y1 ) | x  = 1 ( x2 − x1 )  {var [ y2 | x ] + var [ y1 | x ]}
2 2

1 6  1 1
3  9  ( 9
)
var [ y2 | x ] = var   i = 4 y i | x  =   i = 4 var y i | x  = ( 3σ 2 ) = σ 2 3
6

Similarly var [ y1 | x ] = σ 2 3 . So that

2 σ σ2 
2
2σ 2
( )
var βˆ 2, mean | x = 1 ( x2 − x1 )  {var [ y2 | x ] + var [ y1 | x ]} = 1 ( x2 − x1 )   +  =
2

 3 3  3 ( x2 − x1 )2

( )
We know that var βˆ 2, mean | x is larger than the variance of the least squares estimator because

βˆ 2, mean is a linear estimator. To show this note that

 6 y     6 yi
  i = 4 i
1    3 yi 
3
y 
βˆ 2,mean = ( y2 − y1 ) ( x2 − x1 ) =  −  i =1  =  i = 4
− i =1 i

( x2 − x1 )  3   3
 
   3 ( x2 − x1 ) 3 ( x2 − x1 ) 
  
=  i =1 ai yi
6

−1 1
Where a1 = a2 = a3 = and a4 = a5 = a6 =
3 ( x2 − x1 ) 3 ( x2 − x1 )

Furthermore βˆ 2, mean is an unbiased estimator. From the Gauss-Markov theorem we know that the

least squares estimator is the “best” linear unbiased estimator, the one with the smallest variance.

( )
Therefore, we know that var βˆ 2, mean | x is larger than the variance of the least squares estimator.

EXERCISE 2.11
(a) We estimate that each additional $100 per month income is associated with an additional 52
cents per person expenditure, on average, on food away from home. If monthly income is
zero, we estimate that household will spend an average of $13.77 per person on food away
from home.
(b) yˆ = 24.17 .
(c) εˆ = 0.43 .
(d) In this log-linear relationship, the elasticity is εˆ = 0.007 ( 20 ) = 0.14 .
(e) For x = 20, dyˆ / dx = 0.1860 . For x = 30, dyˆ / dx = 0.1995 . It is increasing at an increasing
rate. Also, the second derivative, the rate of change of the first derivative is
d 2 yˆ / dx 2 = exp ( 3.14 + 0.007 x )( 0.007 ) > 0 . A positive second derivative means that the
2

function is increasing at an increasing rate for all values of x.

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 7

(f) The number of zeros is 2334 – 2005 = 329. The reason for the reduction in the number of
observations is that the logarithm of zero is undefined and creates a missing data value. The
software throws out the row of data when it encounters a missing value when doing its
calculations.

EXERCISE 2.13
(a) We estimate that each additional 1000 FTE students increase real total academic cost per
student by $266, holding all else constant. The intercept suggests if there were no students
the real total academic cost per student would be $14,656.
(b) _ = 22.0907.
(c) eˆ = −0.6877 .
(d) ACA = 20.732975 .

EXERCISE 2.15
y2 − y1  1   1 
(a) bEZ = =  y2 −   y1 =  ki yi
x2 − x1  x2 − x1   x2 − x1 
−1 1
where k1 = , k2 = , and k3 = k4 = ... = kN = 0
x2 − x1 x2 − x1

Thus, bEZ is a linear estimator.

 y − y1  1 1
(b) E ( bEZ | x ) = E  2 | x = (β1 + β2 x2 ) − ( β1 + β2 x1 ) = β2 = E ( bEZ )
x − x
 2 1  x2 − x1 x2 − x1

2σ 2
(c) var ( bEZ | x ) = var( ki yi | x) =  ki2 var ( ei | x ) = σ 2  ki2 =
( x2 − x1 )
2

 2σ 2 
(d) ( )
If ei ~ N 0, σ2 , then bEZ | x ~ N β2 , 
 ( x2 − x1 ) 
2

(e) To convince E.Z. Stuff that var(b2|x) < var(bEZ|x), we need to show that

( x2 − x1 )
2
2σ 2 σ2
 ( xi − x )
2
> or that >
( x2 − x1 )  ( xi − x )
2 2
2

Consider
2
( x2 − x1 ) ( x2 − x ) − ( x1 − x )  ( x − x ) + ( x1 − x ) − 2 ( x2 − x )( x1 − x )
2 2 2

= = 2
2 2 2
Thus, we need to show that
N
2 ( xi − x ) > ( x2 − x ) + ( x1 − x ) − 2 ( x2 − x )( x1 − x )
2 2 2

i =1

or that

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 8

N
( x1 − x ) + ( x2 − x ) + 2 ( x2 − x )( x1 − x ) + 2 ( xi − x ) > 0
2 2 2

i =3

or that
2 N
( x1 − x ) + ( x2 − x )  + 2 ( xi − x ) > 0.
2

i =3

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.

EXERCISE 2.17
(a)
Figure xr2.17a Collegetown: Price and Square Foot
1500 1000
Price, $1000
500 0

0 20 40 60 80 100
Sqft, 100s

Figure xr2.11(a) Price (in $1,000s) against square feet for houses (in 100s)

(b) The fitted linear relationship is

= −115.4236 + 13.40294
( ) (13.0882) (0.4492)
We estimate that an additional 100 square feet of living area will increase the expected home
price by $13,402.94 holding all else constant. The estimated intercept −115.4236 would
imply that a house with zero square feet has an expected price of $−115,423.60.

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 9

Figure xr2.17b Observations and fitted line

1500 1000
Price, $1000
500 0

0 20 40 60 80 100
Sqft, 100s

selling price of property ($1000) Fitted values

Figure xr2.17(b) Observations and fitted line

(c) The fitted quadratic model is

= 93.5659 + 0.1845
( ) (6.0722) (0.00525)
We estimate that an additional 100 square feet of living area for a 2000 square foot home
will increase the expected home price by $7,380.80 holding all else constant.

(d)
Figure xr2.17d Observations and quadratic fitted line
2000 1500
Price, $1000
1000500
0

0 20 40 60 80 100
Sqft, 100s

selling price of property ($1000) Fitted values

tangent

Figure xr2.17(d) Observations and quadratic fitted line

(e) ̂ = 0.882

(f) The residual plots are

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 10

Figure xr2.17 Residuals from linear relation Figure xr2.17 Residuals from quadratic relation

400 400

Residuals, quadratic fit

200 200
Residuals, linear fit

0 0

-200 -200

-400 -400
0 20 40 60 80 100 0 20 40 60 80 100
Sqft, 100s Sqft, 100s

Figures xr2.17(f) Residuals from linear and quadratic relations

In both models, the residual patterns do not appear random. The variation in the residuals
increases as SQFT increases, suggesting that the homoskedasticity assumption may be
violated.
(g) The sum of square residuals linear relationship is 5,262,846.9. The sum of square residuals
for the quadratic relationship is 4,222,356.3. In this case the quadratic model has the lower
SSE. The lower SSE means that the data values are closer to the fitted line for the quadratic
model than for the linear model.

EXERCISE 2.19

(a)
Figure xr2.19a Selling price vs. square feet
600 400
Price, $1000
200
0

10 20 30 40 50
Sqft, 100s

Figure xr2.19(a) Scatter plot of selling price and living area

(b) The estimated linear relationship is

= −35.9664 + 9.8934
( ) (3.3085) (0.1912)
We estimate that an additional 100 square feet of living area will increase the expected home
price by $9,893.40 holding all else constant. The estimated intercept −35.9664 would imply
that a house with zero square feet has an expected price of $−35,966.40. This estimate is not

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 11

meaningful in this example. The reason is that there are no data values with a house size
near zero.

Figure xr2.19b Fitted linear relation

600 400
Price, $1000
200 0

10 20 30 40 50
Sqft, 100s

selling price of home, $1000 dollars Fitted values

Figure xr2.19(b) Fitted linear relation

(c) The estimated quadratic equation is

= 56.4572 + 0.2278
( ) (1.6955) (0.0043)
We estimate that an additional 100 square feet of living area for a 1500 square foot home
will increase the expected home price by $6,834 holding all else constant.

(d)
Figure xr2.19d Fitted linear and quadratic
600
Price, $1000
200 0 400

10 20 30 40 50
Sqft, 100s

selling price of home, $1000 dollars Fitted values

Fitted values

Figure xr2.19(d) Fitted linear and quadratic relations

The sum of squared residuals for the linear relation is SSE = 1,879,826.9948. For the
quadratic model the sum of squared residuals is SSE = 1,795,092.2112. In this instance, the
sum of squared residuals is smaller for the quadratic model, one indicator of a better fit.

(e) If the quadratic model is in fact “true,” then the results and interpretations we obtain for the
linear relationship are incorrect, and may be misleading.

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 12

EXERCISE 2.21
(a)
= 152.6144 − 0.9812
( ) (3.3473) (0.0949)
We estimate that a house that is new, AGE = 0, will have expected price $152,614.40.
We estimate that each additional year of age will reduce expected price by $981.20,
other things held constant. The expected selling price for a 30-year-old house is
= $123,177.70 .
(b)
Figure xr2.21b Observations and linear fitted line
600 400
Selling Price
200 0

0 20 40 60 80 100
Age

selling price of home, $1000 dollars Fitted values

Figure xr2.21(b) Observations and linear fitted line

The data show an inverse relationship between house prices and age. The data on newer
houses is not as close to the fitted regression line as the data for older homes.
(c) ln( ) = 4.9283 − 0.0075
( ) (0.0205) (0.0006)
We estimate that each additional year of age reduces expected price by about 0.75%,
holding all else constant.

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 13

(d)
Figure xr2.21d Observations and log-linear fitted line

400 600
Selling Price
200 0

0 20 40 60 80 100
Age

selling price of home, $1000 dollars spricehat2

Figure xr2.21(c) Observations and log-linear fitted line

The fitted log-linear model is not too much different than the fitted linear relationship.
(e) The expected selling price of a house that is 30 years old is = $110,370.32.

(f) For the estimated linear relationship ∑ − = 5,580,871. For the

log-linear model ∑ − = 5,727.332. The sum of squared
differences between the data and fitted values is smaller for the estimated linear relationship,
by a small margin. In this case, based on fit alone, we might choose the linear relationship
rather than the log-linear relationship.

EXERCISE 2.23
(a)
Figure xr2.23a Vote vs Growth
60
democratic share of presidential vote
40 45 50
35 55

-10 -5 0 5 10 15
Growth

Figure xr2.23(a) Vote against Growth

There appears to be a positive association between VOTE and GROWTH.

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 14

(b) The estimated equation for 1916 to 2012 is

= 48.6160 + 0.9639
( ) (0.9043) (0.1658)
The coefficient 0.9639 suggests that for a 1 percentage point increase in a favorable growth
rate of GDP in the 3 quarters before the election there is an estimated increase in the share
of votes of the democratic party of 0.9639 percentage points.
We estimate, based on the fitted regression intercept, that that the Democratic party’s
expected vote is 48.62% when the growth rate in GDP is zero. This suggests that when
there is no real GDP growth, the Democratic party is expected to lose the popular vote. A
graph of the fitted line and data is shown in the following figure.

Figure xr2.23b Vote vs Growth fitted

60
50
40
30

-10 -5 0 5 10 15
Growth

democratic share of presidential vote Fitted values

Figure xr2.23(a) Vote vs Growth fitted

(c) In 2016 the actual growth rate in GDP was 0.97% and the predicted expected vote in favor
of the Democratic party was = 49.55, or 49.55%. The actual popular vote in favor
of the Democratic party was 50.82%.

(d) The figure below shows a plot of VOTE against INFLATION. It is difficult to see if there
is positive or inverse relationship.

Figure xr2.23d Vote vs Inflat

60
dem ocratic share of presidential vote
40 45 3550 55

-10 -5 0 5 10
Inflation

Figure xr2.23(d) Vote against Inflat

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 15

(e) The estimated equation (plotted in the figure below) is

= 49.6229 + 0.2616
( ) (1.4188) (0.3907)
We estimate that a 1 percentage point increase in inflation during the party’s first 15
quarters increases the share of Democratic party’s vote by 0.2616 percentage points.
The estimated intercept suggests that when inflation is at 0% for that party’s first 15
quarters, the expected share of votes won by the Democratic party is 49.6%.

Figure xr2.23e Vote vs Inflat fitted

60
55
50
45
40
35

-10 -5 0 5 10
Inflation

democratic share of presidential vote Fitted values

Figure xr2.23(e) Vote vs Inflat fitted

(f) The actual inflation value in the 2016 election was 1.42%. The predicted vote in favor of
the Democratic candidate (Clinton) was = 49.99, or 49.99%.

EXERCISE 2.25
(a)
Figure xr2-25a Histogram of FOODAWAY
60
40
Percent
20
0

0 500 1000 1500

food away from home expenditure per month per person past quarter, $

Figure xr2.25(a) Histogram of foodaway

The mean of the 1200 observations is 49.27, the 25th, 50th and 75th percentiles are 12.04,
32.56 and 67.60.

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 16

(b)
N Mean Median
ADVANCED = 1 257 73.15 48.15

COLLEGE = 1 369 48.60 36.11

NONE 574 39.01 26.02

(c)
Figure xr2-25c Histogram of ln(FOODAWAY)
15
10
Percent
5
0

0 2 4 6 8
lfoodaway

Figure xr2.25(c) Histogram of ln(foodaway)

There are 178 fewer values of ln(FOODAWAY) because 178 households reported spending
$0 on food away from home per person, and ln(0) is undefined. It creates a “missing value”
which software cannot use in the regression.

(d) The estimated model is

ln( ) = 3.1293 + 0.0069
( ) (0.0566) (0.0007)
We estimate that each additional $100 household income increases food away expenditures
per person of about 0.69%, other factors held constant.

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 17

(e)
Figure xr2.25e Observations and log-linear fitted line

8
6
ln(foodaway)
4 2
0

0 50 100 150 200

Income

lfoodaway Fitted values

Figure xr2.25(e) Observations and log-linear fitted line

The plot shows a positive association between ln(FOODAWAY) and INCOMEs.

(f)
Figure xr2.25f Residuals vs. Income
4
2
OLS residuals
0-2
-4

0 50 100 150 200

Income

Figure xr2.25(f) Residuals vs. income

The OLS residuals do appear randomly distributed with no obvious patterns. There are fewer
observations at higher incomes, so there is more “white space.”

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 18

EXERCISE 2.27
(a)
Figure xr2.27a motel_pct vs. relprice

100
Motel Occupancy Rate
60 40 80

65 70 75 80 85
100*Relative price

Figure xr2.27(a) Motel_pct vs. 100relprice

There seems to be an inverse association between relative price and occupancy rate.

(b)
_ = 166.6560 − 1.2212
( ) (43.5709) (0.5835)
Based economic reasoning we anticipate a negative coefficient for RELPRICE. The slope
estimate is interpreted as saying, the expected model occupancy rate falls by 1.22% given a
1% increase in relative price, other factors held constant.
(c)
Figure xr2.27c OLS residuals
20 0
OLS residuals
-20 -40

0 5 10 15 20 25
Time

Figure xr2.27(c) OLS residuals

The residuals are scattered about zero for the first 16 observations but for observations 17-
23 all but one of the residuals is negative. This suggests that the occupancy rate was lower
than predicted by the regression model for these dates.
(d) _ = 79.3500 − 13.2357
( ) (3.1541) (5.9606)

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 19

We estimate that during the non-repair period the expected occupancy rate is 79.35%.
During the repair period, the expected occupancy rate is estimated to fall by 13.24%, other
things held constant, to 66.11%.

EXERCISE 2.29
(a)
Figure xr2.29a Histogram of ln(wage)
.8
.6
Density
.4 .2
0

1 2 3 4 5
ln(wage)

variable N mean median min max skewness kurtosis

ln(WAGE) 1200 2.9994 2.9601 1.3712 5.3986 0.2306 2.6846
Figure xr2.29(a) Histogram and statistics for ln(WAGE)

The histogram shows the distribution of ln(WAGE) to be almost symmetrical. Note that the
mean and median are similar, which is not the case for skewed distributions. The skewness
coefficient is not quite zero. Similarly, the kurtosis is not quite three, as it should be for a
normal distribution.
(b) The OLS estimates are
ln( ) = 1.5968 + 0.0987
( ) (0.0702) (0.0048)
We estimate that each additional year of education predicts a 9.87% higher wage, all else
held constant.
(c) For someone with 12 years of education the predicted value is = 16.1493 and for
someone with 16 years of education it is = 23.9721.
(d) For individuals with 12 and 16 years of education, respectively, these values are $1.1850
and $1.5801.
(e)

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 Chapter 2, Exercise Answers, Principles of Econometrics, 5e 20

Figure xr2.29e Observations with linear and loglinear fitted line

200
150
100
50
0 0 5 10 15 20
years of education

earnings per hour, $ Fitted values

wagehat

Figure xr2.29(e) Observations with linear and loglinear fitted lines

The log-linear model fits the data better at low levels of education.
(f) For the log-linear model this value is 228,573.5 and for the linear model 220,062.3. Based
on this measure the linear model fits the data better than the linear model.

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