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3.19. The relationship between nominal exchange rate and relative prices. From
the annual observations from 1980 to 1994, the following regression
results were obtained, where Y = exchange rate of the German mark to
the U.S. dollar (GM/S) and X = ratio of the U.S. consumer price index
to the German consumer price index; that is, X represents the relative
prices in the two countries:
= 6.682 — 4.318K,
se = (1.22)(1.333)
528
a. Interpret this regression. How would you interpret r??
'b. Does the negative value of X; make economic sense? What is the un-
derlying economic theory?
c. Suppose we were to redefine X as the ratio of German CPI to the U.S.
CPI. Would that change the sign of X? And whv?
3.19 (a) The slope value of 4.318 suggests that over the period 1980-
1994, for every unit increase im the relative price, on average, the
(GMS) exchange rate declined by about 4.32 units. That is, the
dollar depreciated because it was getting fewer German marks for
every dollar exchanged. Literally interpreted, the intercept value of
6.682 means that if the relative price ratio were zero, a dollar woul
exchange for 6.682 German marks. Of course, this interpretation
is not economically meaningful.
(b) The negative value of the slope coefficient makes perfect
economic sense because if U.S. prices go up faster than German,
prices, domestic consumers will switch to German goods, thus
increasing the demand for GM, which will lead to appreciation
of the German mark. This is the essence of the theory of purchasing
power parity (PPP), or the law of one price.
(c) In this case the slope coefficient is expected to be positive, for
the higher the German CPI relative to the U.S. CPI, the higher the
relative inflation rate in Germany which will lead to appreciation
of the U.S. dollar. Again, this is in the spirit of the PPP.5.8. Consider the following regression output":
0.2033 + 0.6560X,
(0.0976) (0.1961)
r2= 0397 RSS=0.0544 FSS =0.0358
‘
where Y= labor force participation rate (LFPR) of women in 1972 and
X= LFPR of women in 1968. The regression results were obtained from a
sample of 19 cities in the United States.
b.
How do you interpret this regression?
Test the hypothesis: Ho: fy = 1 against Hi: A: > 1. Which test do you
use? And why? What are the underlying assumptions of the test(s) you
‘Suppose that the LFPR in 1968 was 0.58 (or 58 percent). On the basis
of the regression results given above, what is the mean LFPR in 1972?
Establish a 95% confidence interval for the mean prediction.
How would you test the hypothesis that the error term in the popula-
tion regression is normally distribute? Show the necessary calculations.
(a) There is. positive association in the LFPR in 1972 and 1968,
which is not surprising in view of the fact since WW IT
there has been a steady increase in the LFPR of women.
(®) Use the one-tail ¢ rest.
tw OSS00>1 = 1.7542. For 17 df, the one-tailed ¢ value
at @ 5% is 1.740. Since the estimated t value is significant, at
this level of significance, we can reject the hypothesis that the
truc slope cocfficient is 1 or greater.
(©) The mean LEPR is : 0.2033 + 0.6560 (0.58) ~ 0.5838. To
‘establish a 95% confidence interval for this forecast value,
use the formula: 0.5838 + 2.11 (se of the mean forecast value),
where 2.11 is the 5% critical r value for 17 df. To get the
standard error of the forecast value, use Eq, (5.10.2). But note
that since the authors do not give the mean value of the LFPR
of women in 1968, we cannot compute this standard error
(q@) Without the actual data, we will not be able to answer this
question because we need the values of the residuals to
plot them and obtain the Normal Probability Plot or to
compute the value of the Jarque-Bera test.8.14,
B14
From a sample of 209 firms, Wooldridge obtained the following regres-
sion results":
log (Salary) = 4.32 + 0.280 log(sales) + 0.0174 roc + 0.00024 ros
se = (0.32) (0.035) (0.0041) (0.00054)
R?=0.283
where salary = salary of CEO
sales = annual firm sales
roe = return on equity in percent
ros = return on firm's stock
and where figures in the parentheses are the estimated standard errors.
‘a, Interpret the preceding regression taking into account any prior expec
tations that you may have about the signs of the various coefficients.
b. Which of the coefficients are individually statistically significant at the
5 percent level?
¢. What is the overall significance of the regression? Which test do you
use? And why?
. Can you interpret the coefficients of roe and ros as elasticity coeffi-
cients? Why or why not?
(@A priori, salary and cach of the explanatory variables are
‘expected to be positively related, which they are. The partial
coefficient of 0.280 means, cereris paribus, the elasticity of CEO.
salary is a 0.28 percent. The coefficient 0.0174 means, ceteris
paribus, if the rate of raturn on equity goes up by I percentage point
1 percent), then the CEO salary goes up by about 1.07
%. Similarly, ceteris paribus, if return on the firm's stock goes up
by I percentage point, the CEO salary goes up by about 0.024%.
(b) Under the individual, or separate, null hypothesis that each true
population coefficient is zero. you can obtain the ¢ values by simply
dividing cach estimated coefficient by its standard error. These f
values for the four coefficients shown in the model are, respectively,
13.5, 8, 4.25, and 0.44, Since the sample is large enough, using the
two-f rule of thumb, you can see that the first three coefficients areindividually highly statistically significant, whereas the last one is
‘insignificant.
(e) To test the overall significance, that is, all the slopes are equal to
zero, use the F test given in (8.5.11), which yields:
= RMD __ 0285/3 _ a7 99
C—R)Ka—B) (0.717) /205
Under the null hypothesis, this ¥ has the F distribution with
3 and 205 df in the numerator and denominator, respectively. The
p value of obtaining such an F value is extremely small, leading to
rejection of the null hypothesis,
(d) Since the dependent variable is in logarithmic form and the
roe and ros are in linear form, the coefficients of these variables
give semi elasticities, that is, the growth rate in the dependent
variable for an absolute (unit) change in the regressor.8.17. Consider, the following wage-determination equation for the British
economy’ for the period 1950-1969:
W,= 8582 + 0.304(PF), + 0.004(PF),_1— 2.560U;
(1.129) (0.080) (0.072) (0.658)
R'=0873 0 df=15
where W wages and salaries per employee
PF = prices of final output at factor cost
U unemployment in Great Britain as a percentage of the total
number of employees of Great Britain
t=time
(The figures in the parentheses are the estimated standard errors.)
a. Interpret the preceding equation.
b. Are the estimated coefficients individually significant?
¢. What is the rationale for the introduction of (PF).-1?
d. Should the variable (PF);_; be dropped from the model? Why?
‘e. How would you compute the elasticity of wages and salaries per em-
ployee with respect to the unemployment rate U?
8.18. A variation of the wage-determination equation given in exercise 8.17 is
as follows':
W,= 1.073 + 5.288V;— 0.116X, + 0.054M, + 0.046M,1
(0.797) (0.812) (0.111) (0.022) (0.019)
R=0.934 df=14
where W =Wwages and salaries per employee
unfilled job vacancies in Great Britain as a percentage of
the total number of employees in Great Britain
gross domestic product per person employed
port prices
port prices in the previous (or lagged) vear
(The estimated standard errors are given in the parentheses.)
a. Interpret the preceding equation.
b. Which of the estimated coefficients are individually statistically
significant?
¢. What is the rationale for the introduction of the X variable? A priori, is
the sign of X expected to be negative?
d. What is the purpose of introducing both M, and M,_1 in the model?
e. Which of the variables may be dropped from the model? Why?
£. Test the overall significance of the observed regression.

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