# Econometrics - Questions and selected answers

Juergen Bracht (Ph.D. Economics, Pittsburgh, U.S.A.) 24 February 2009
Abstract

Tutorial 1 Problems Problem 1) Suppose that you are asked to conduct a study to determine whether smaller class sizes improve performance on standardized tests of fourth graders in Scotland. (a) If you could conduct any experiment you want, what would do? Be speciﬁc. (b) More realistically, suppose you can collect observational data on several thousand fourth graders. You can obtain the size of their fourth-grade class and a standardized test score taken at the end of fourth grade. Why might you expect a negative correlation between class size and test score? (c) Would a negative correlation necessarily show that smaller class sizes cause better performance? Explain. Problem 2) Suppose a secondary-school student is preparing to take an university-entrance exam. Explain why her eventual score is properly viewed as a random variable. Problem 3) Let X be a random variable distributed as Normal(5,4). Find the probabilities of the following events: a) P (X <= 6). b) P (X > 4). c) P (|X − 5| > 1).

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.. Y2 . Hint: What does the inequality become when the ai satisfy the restriction from part (a)? 2 . an . Show that W is also an unbiased estimator of μ.. Let Y = 1 (Y1 + Y2 + Y3 + Y4 ) denote the average of these four random 4 variables. c) For any numbers a1 . .Tutorial 2 Problems Problem 1) Let Y1 . Y or W ? Problem 2) This is a more general version of Problem 1)... Y4 independent.. the following inequalities holds: (a1 + a2 + .. Let Y1 . Let Y denote the sample average... Use this along with parts (a) and (b) to show that V ar(Wa ) >= V ar(Y ) whenever Wa is 2 n unbiased so that Y is the best linear unbiased estimator. identically distributed random variables from a population with mean μ and variance σ 2 . consider a diﬀerent estimator of μ: W = 1 Y1 + 1 Y2 + 1 Y3 + 1 Y4 ... + a2 . Yn be n pairwise uncorrelated random variables with common mean μ and common variance σ 2 . Find the variance of W . a) Deﬁne the class of linear estimators of μ by Wa = a1 Y1 + a2 Y2 + . a2 . Y2 . + an )2 /n <= a2 + 1 a2 + . + an Yn where the ai are constants. This is an example of a 8 8 4 2 weighted average of the Yi .. What restriction on the ai is needed for Wa to be an unbiased estimator of μ? b) Find V ar(Wa ). c) Based on the answer to parts (a) and (b) which estimator do you prefer. Y3 . a) What are the expected value and variance of Y in terms of μ and variance σ 2 ? b) Now. .

Are there other cases when β 1 is unbiased? e b c) Show that the V ar(β 1 ) <= V AR(β 1 ). Verify that β 1 is unbiased for β 1 when the population e intercept (β 0 ) is zero. Hint: For any sample of data. b b e The usual OLS estimators β 0 and β 1 are unbiased for their respective population parameters. Let β 1 be the estimator of β 1 obtained by assuming the intercept is zero. e b) Find the variance of β 1 (Hint: The variance does not depend on β 0 ).Tutorial 3 Problem (Diﬃcult) Consider the standard simple regression model y = β 0 + β 1 x + u under Gauss-Markov assumptions. with e b d) Comment on the trade-oﬀ between bias and variance when choosing between β 1 and β 1 . 3 . P x2 >= i P (xi − x)2 . e e a) Find E(β 1 ) in terms of xi . strict inequality when unless x. β 0 and β 1 .

148totwork − 11.25 − 0. What does the intercept in this equation mean? (1b) If totwork increases by 2 hours. (3c) Does including educ and age in the model greatly aﬀect the estimated trade-oﬀ between sleeping and working? (3d) Suppose that the sleep equation contains heteroskedasticity. We could use either variable as the dependent variable. (3a) Is either educ or age individually signiﬁcant at the 5% level against a two-sided (5. 922-943 1) We study whether there is a trade-oﬀ between time spent sleeping per week and the time spent in paid work. what is the sign of β 1 ? (2b) What signs do you think β 2 and β 3 will have? (2c) Using the data. Are educ and age jointly signiﬁcant in the original equation at the 5% level? Justify your answer. Journal of Political Economy 98.017) 11.28) (0. What does this mean about the tests computed in parts (3a) and (3b)? 4 .20age. If someone works ﬁve more hours per week. by how many minutes is sleep predicted to fall? Is this a large trade-oﬀ? (2d) Discuss the sign and magnitude of the estimated coeﬃcient on educ.148totwork − (112.113. Sleep and the Allocation of Time. the [ estimated equation is sleep = 3638.45) alternative? (3b) Drop educ and age from the equation. R2 = 0. For concreteness. by how much is sleep estimated to fall? Do you ﬁnd this to be a large eﬀect? 2) The following model is a simpliﬁed version of the multiple regression model used in Biddle and Hamermesh (1990) to study the trade-oﬀ between time spent sleeping and working and to look at other factors aﬀecting sleep: sleep = β 0 +β 1 totwork+β 2 educ+β 3 age+u where sleep and totwork are measured in minutes per week and educ and age are measured in years.25 − 0.Tutorial 4 (Computer Problem) Use the data in SLEEP75. (2e) Would you say totwork.13educ + 2.13educ + 2.wf1 from Biddle and Hamermesh (1990).88) (1. (2a) If adults trade oﬀ sleep for work. (1a) Report your results in equation form along the number of observations and R2 . estimate the model sleep = β 0 + β 1 totwork + u where sleep is minutes spent sleeping at night per week and totwork is total minutes worked during the week. educ and age explain much of the variation in sleep? What other factors might aﬀect the time spent sleeping? Are these likely to be correlated with totwork? [ 3) We now report the standard errors along with the estimates: sleep = 3638.20age where n = 706.

we do not know — nor can we predict with certainty — what the score will be. how the student feels on exam day. and which particular questions were asked. are just a few. Another possibility is that.5) ≈ 0.5) ≈ 0.6915) + (1 − 0. as observers. (The student’s innate ability. and aﬄuent children generally score better on standardized tests. a head teacher might assign the better students to smaller classes. Some way of controlling for the confounding factors is needed. many of which we. we could randomly assign students to classes of diﬀerent sizes. The actual score depends on numerous factors. Solution 3) a) P (X < 6) = P [ X−5 < 2 variable.5) = P (Z < 0. 5 . 1) random (4−5) ] 2 = P (Z > −0. We used answers from parts (a) and (b).6915.6915) = 0.6915. with observational data. b) A negative correlation means that larger class size is associated with lower performance. where Z denotes a Normal(0. let alone know ahead of time. and this is the subject of multiple regression analysis.) The eventual exam score clearly satisﬁes the requirements of a random variable. cannot even list. c) P (|X − 5| > 1) = P (X − 5 > 1) + P (X − 5 < −1) = P (X > 6) + P (X < 4) ≈ (1 − 0. c) Given the potential for confounding factors — some of which are listed in (b) — ﬁnding a negative correlation would not be strong evidence that smaller class sizes actually lead to better performance.617. children from more aﬄuent families might be more likely to attend schools with smaller class sizes. For example. each student is assigned a diﬀerent class size without regard to any student characteristics such as ability and family background. That is. there are other reasons we might ﬁnd a negative relationship. within a school. We might ﬁnd a negative correlation because larger class size actually hurts performance. However.Tutorial 1 Solutions Solution 1) a) Ideally. b) P (X > 4) = P [ X−5 > 2 6−5 ] 2 = P (Z < 0. Solution 2) Before the student takes the exam. We also would like substantial variation in class sizes.

. But then V ar(Y ) = σ 2 /n <= σ 2 (a2 + a2 + . Solution 2) a) E(Wa ) = a1 E(Y1 ) + a2 E(Y2 ) + . b) E(W ) = E(Y1 )/8 + E(Y2 )/8 + E(Y3 )/4 + E(Y4 )/2 = μ[(1/8) + (1/8) + (1/4) + (1/2)] = μ(1 + 1 + 2 + 4)/8 = μ. + an V ar(Yn ) = (a2 + a2 + . + an E(Yn ) = (a1 + a2 + . + a2 . + an )μ. + an = 1 for unbiasedness.. Therefore. Because the Yi are independent. so Y is preferred to W because each is unbiased. when a1 + a2 + +an = 1 — the condition needed for unbiasedness of Wa — we have 1/n <= a2 + a2 + .. + an )σ 2 . with n = 4: E(Y ) = μ and V ar(Y ) = σ 2 /4. b) V ar(Wa ) = a2 V ar(Y1 ) + a2 V ar(Y2 ) + .. we must have a1 + a2 + .. + an ) = V ar(Wa )..... 1 2 n 1 2 n c) From the hint.Tutorial 2 Solutions Solution 1) a) This is a special case of what is covered in the text... V ar(W ) > V ar(Y ) for any σ 2 > 0... which shows that W is unbiased. 1 2 n 1 2 n 6 .. V ar(W ) = V ar(Y1 )/64 + V ar(Y2 )/64 + V ar(Y3 )/16 + V ar(Y4 )/4 = σ 2 [(1/64) + (1/64) + (4/64) + (16/64)] = σ2 (22/64) = σ 2 (11/32). c) Because 11/32 > 8/32 = 1/4.

³X ´−2 ³X ´−2 ³X ´ P e x2 V ar(ui ) x2 V ar ( xi ui ) = x2 V ar(β 1 ) = i i i ³X ´−2 ³ X ´ σ2 σ2 x2 = X . Bias is zero when β 0 = 0.66: β 1 = xi yi . conditional on the xi . e b) From the last expression for β 1 we have. = x2 i i 2 b c) From (2. x2 i The numerator can be written as β 0 Plug in: e β1 = β0 xi x2 i e Plugging in yi = β 0 + β 1 xi + ui gives β 1 = P xi + β 1 P x2 + i P xi ui . x2 i e Conditional on the xi . It is P also zero when xi = 0 (hence x = 0). x2 i xi x2 i e Therefore. 7 . (xi −x)2 X x2 >= i 2 e d) For ﬁxed n. regression through the origin is identical to regression with an intercept. x2 i xi (β 0 +β 1 xi +ui ) . In the latter case. X x and n (in addition to the size of x2 ).57). + β1 + xi ui . we have E(β 1 ) = β 0 + β 1 because E(ui ) = 0 for all i. Then bias in β 1 is also small when β 0 is b e small. But as x e e b increases. the variance of β 1 increases relative to V ar β 1 . Therefore. From the hint. the bias of β 1 increases as x increases ´ ³ (holding the sum of the xi ﬁxed). the bias in β 1 is given by the ﬁrst term in the equation.Tutorial 3 Solutions e a) Textbook Equation 2. V ar(β 1 ) = X σ . i X e b (xi −x)2 so V ar(β 1 ) <= V ar(β 1 ). whether we prefer β 1 and β 1 on a mean squared error basis depends on the sizes of β 0 .

151 to −0. The standard critical value (df = ∞ ) is 1. (3c) Not really. We fail to reject the null hypothesis at the 5% level. Age is also statistically insigniﬁcant at the 5% level.148 ∗ 300 = 44. If there is heteroskedasticity in the equation. (2c) 4totwork = 0.88 tage = 2. would be correlated with totwork.45 (3b) We could to compute the R2 -form of the F statistic for joint signiﬁcance. The eﬀect is quite small.113−0.702 distribution can be obtained with a denominator df = ∞: 3. so β 1 < 0. this is not a overwhelming change. F = 0.019. 1. for example. Therefore.96 for a two-tailed test at 5% level. One important factor in the error term is general health. (2d) If we assume the diﬀerence between college and high school is four years. For a week.113 2 3. (2e) Not surprisingly.148. and so educ and age are jointly signiﬁcant at the 2% level). (3d) The t and F statistics that we used assume homoskedasticity.12 (minutes).5 hours per night.Tutorial 4 Solutions [ (1a) The estimated equation is sleep = 3586.13 ∗ 4 = 44. [ (1b) If someone works two more hours per week then 4totwork = 120 and so 4sleep = −0. (3a) df = 706 − 4 = 702.5172.3% of the variation in sleep. and whether the person has children.103. Also.4 minutes or about 59. the college graduate sleeps about 11.00.13 = −1. The intercept implies that the estimated amount of sleep per week for someone who does not work is 3586. 8 .20 = 1. These variables are jointly signiﬁcant.4 (minutes). the p value is about 0. Health.151∗120 = −18.8929. The 5% critical value is the F2. more work implies less sleep (other things equal). the tests are no longer valid. educ and age are jointly signiﬁcant at the 5% level. but including them only changes the coeﬃcient on totwork from −0. R2 = 0.151totwork with n = 706. the three explanatory variables explain only about 11.4 − 0. This is only a few minutes a night. (2b) The signs of β 2 and β 3 are not obvious. Now teduc = −11. 52 (minutes) less per week. 5. (In fact. (2a) If adults trade oﬀ sleep for work.9572.103 702 = 1−0.44 hours per week or about 8. Another is marital status.

Sample Standard Deviation.S. rather than having data on individual workers. Standard Normal Distribution. Let Y denote the sample average. the variable sales is ﬁrm sales.. you have information on hours of job training per worker (training) and number of nondefective items produced per worker hour (output). 1 . Sampling Distribution. 1a) Carefully state the ceteris paribus thought experiment underlying this policy question (5 marks). Binary Random Variable. p value. 1b) Does it seem likely that a ﬁrm’s decision to train its workers will be independent of worker characteristics? What are some of those measurable and unmeasurable worker characteristics? (5 marks) 1c) Name a factor other than worker characteristics that can aﬀect worker productivity. the variable ceoten is prior number of years as company CEO. corporations from 1990. Asymptotic Normality.Exam #1 Econometrics 1) A justiﬁcation for job training programs is that they improve worker productivity. Sample Average. Cumulative Distribution Function. in millions. (20 marks) 3a) Let Y1 . The variable salary is annual compensation. Her data set contains information on 177 chief executives for U. Sample Variance. Central Limit Theorem. Suppose that you are asked to evaluate whether more job training makes workers more productive. in millions. Show that Y is an unbiased estimator of the population mean μ. (7 marks) 2) Brieﬂy explain these terms: Experiment. (3 marks) 1d) If you ﬁnd a positive correlation between output and training. for each ﬁrm. However. you have access to manufacturing ﬁrms in Scotland. in thousands of dollars. Rejection Region. the variable val is market value. Random Sample. Y2 . Verify that V ar(Y ) = σ 2 /n. would you have convincingly established that job training makes workers more productive? Explain. Sampling Variance. the variable marg is proﬁts as % of sales. In particular. .. (10 marks) 3b) Why has "unbiasedness" appeal as a property for an estimator? (5 marks) 3c) What are weaknesses of "unbiasedness" as a property for an estimator? (5 marks) 4) A researcher investigates what factors aﬀect chief executives oﬃcer salaries. Sample Correlation Coeﬃcient. Yn be n pairwise linear uncorrelated random variables with common mean μ and common variance σ 2 . Normal Distribution.. the variable comten is years with company.

767983 0.2983 R-squared 0.049214 2.0000 LOG(SALES) 0.050393 2.0024 COMTEN -0. Are these explanatory variables statistically signiﬁcant? What do the estimates imply? (4 marks) 4d) What do you make of the fact that longer tenure with the company.980590 0.040003 4. is associated with lower salary.352537 4a) Comment on the eﬀect of marg on CEO salary.0440 MARG -0.0001 LOG(VAL) 0. (4 marks) 4c) Interpret the coeﬃcients on ceoten and comten.005540 3.961077 0.280858 Model 2 log(salary) = β 0 + β 1 log(sales) + β 2 log(val) + β 3 marg Variable Coeﬃcient Std.0000 LOG(SALES) 0.03781 0.0063 R-squared 0.158483 0.81039 0.2951 CEOTEN 0.003337 -2.027129 8.002211 0.267132 0.187787 0. C 4.039814 3. Error t-Statistic Prob.303494 Model 3 log(salary) = β 0 + β 1 log(sales) + β 2 log(val) + β 3 marg + β 4 ceoten + β 5 comten Variable Coeﬃcient Std. C 4. (4 marks) 4e) What is the parameter β 1 ? What do the estimates mean? (4 marks) 2 .16709 0.0272 MARG -0.099872 0.199960 24.043124 0. C 4.0000 R-squared 0. holding the other factors ﬁxed.Dependent Variable: log(salary) Method: Least Squares Included observations: 177 Model 1 log(salary) = β 0 + β 1 log(sales) Variable Coeﬃcient Std. Would you include marg in a ﬁnal model explaining CEO compensation in terms of ﬁrm performance? Explain.0000 LOG(VAL) 0.253466 18.112261 0.017104 0. (4 marks) 4b) Does market value have a signiﬁcant eﬀect? Explain.620690 0.029345 0. Error t-Statistic Prob.224279 0.002165 -1.571977 0. Error t-Statistic Prob.227701 0.050132 0.254344 18.087309 0.0000 LOG(SALES) 0.009238 0.694340 0.002259 0.002105 -1.

92%. 4a) In model 2 and 3. unless the amount of training is randomly assigned. 4e) β 1 is an elasticity. This ﬁnding at ﬁrst seems surprising but could be related to the superstar eﬀect: ﬁrms hire CEOs from outside the company often go after a small pool of highly regarded candidates and salaries of these people are bid up. although its t statistics is only about −1. two ﬁrms with exactly the same kinds of employees would generally have diﬀerent outputs if they use diﬀerent amounts of capital or technology. where “ability” might be diﬃcult to quantify but where a manager has some idea about the relative abilities of diﬀerent employees.19% in salary. gender or race.Exam #1 Econometrics 1a) One way to pose the question: If two ﬁrms. Moreover. proﬁt margin has no eﬀect on CEO salary. It appears that. So. but not as a CEO. Another year with the company.96. 1c) The amount of capital and technology available to workers would also aﬀect output. say A and B. 4c-d) These variables are individually signiﬁcant at a low signiﬁcance level.05. Some observed characteristics are years of schooling. Because the coeﬃcient β 2 is an elasticity. 3 . and this might not be evident to employers. The standard critical value is 1. lowers salary be 0. Related case: Regression of log(wage) on experience and tenure. So log(val) is just signiﬁcant at the 5% level against a two-sided alternative. years in the workforce and experience in a particular job. by how much would ﬁrm A’s output diﬀer from ﬁrm B’s? 1b) Firms are likely to choose job training depending on the characteristics of workers. 0. Firms might even discriminate based on age. 4b) Model 3 controls for the most factors aﬀecting salary. 1% increase in sales. The many factors listed in parts (b) and (c) can contribute to ﬁnding a positive correlation between output and training even if job training does not improve worker productivity. Perhaps ﬁrms choose to oﬀer training to more or less able workers. are identical in all respects except that ﬁrm A supplies job training one hour per worker more than ﬁrm B.Selected answers . More non-CEOs years with the company makes it less likely the person was hired as an outside manager. ¡1 P ¢ 1 P P P 1 1 1 3a) E(Y ) = E n Yi = n E ( Yi ) = n E(Yi ) = n μ = n nμ = μ. The t statistics on log(val) is about 2. once ﬁrm sales and market value have been controlled for. 1d) No. a ceteris paribus increase in market value is predicted to increase salary by 1%. The quality of managers would also have an eﬀect. diﬀerent kinds of workers might be attracted to ﬁrms that oﬀer more job training on average. the coeﬃcient on marg is negative.