Economics 561

Econometrics 1
Problem Set 3: Simple Linear Regression

1. The following table contains information about a sample of workers. WAGE is the weekly wage of the workers in
dollars. AGE is the person’s age in years.

(i) Estimate the linear relationship between WAGE and AGE using OLS; that is, obtain the intercept and slope
WAGE     age  
1 2 i . Provide an interpretation of your estimates. How much is
estimates in the equation:
WAGE predicted to increase if age is increased by 5 years?

OBSERVATION WAGE AGE

NUMBER
1 450 43
2 360 36
3 160 38
4 500 48

(ii) Compute the R-squared and adjusted R-squared from this regression and provide an interpretation of each.

(y- yhat-
obs y x   y-ybar ybar)^2 yhat ybar (yhat-ybar)^2
1 450 43   82.5 6806.25 399.78 31.78 1009.9684
2 360 36   -7.5 56.25 258.38 -109.62 12016.5444
3 160 38   -207.5 43056.25 298.78 -69.22 4791.4084
4 500 48   132.5 17556.25 500.78 132.78 17630.5284
41.2
means 368 5 sums 0 67475     35448.4496

(iii) Compute σ^ 2 for this regression and provide an interpretation.

to compute the standard error of the estimate of  2 and provide an interpretation of

2
(iv) Use your value of σ^
this estimate. (Hint: using matrix notation will simplify things).

(v) Test the hypothesis that the true effect of age (that is, the population effect) is zero against the alternative that it
is not zero, at the 5% level.

(vi) Again estimate the relationship between WAGE and AGE using OLS; but use a log-linear functional form. That
ln(WAGE)     age  
1 2 i . Provide an
is, obtain the intercept and slope estimates in the equation:
interpretation of your estimates. How much is WAGE predicted to increase if age is increased by 5 years?

(vii) Again estimate the relationship between WAGE and AGE using OLS; but use a log-log functional form. That
ln(WAGE)     ln(age)  
1 2 i . Provide an
is, obtain the intercept and slope estimates in the equation:
interpretation of your estimates. How much is WAGE predicted to increase if age is increased by 5 percent?

EC561 – Problem Set 3 Answers – Page 1 of 3

2. Consider the following simple models relating the percentage discount off of the regular air fare to the distance
between the destination and Washington, D.C. The variable pdisc i is the percentage discount for destination i and
disti is the distance in hundreds of miles from Washington D.C. Standard errors are in parentheses. In both models,
the number of observations is 23.

pdisc  54.93  0.28dist

 2.22 (014
. )
(2.1) R2 = .083

pdisc  45.73  5.30 ln(dist )

 4.65 (2.88)
(2.2) R2 = .085

(i) Interpret the coefficient on dist in the two equations; remember that dist is measured in hundreds of
miles.

(ii) Is there a statistically significant relationship between expected discount and distance? Explain.

(iii) Using equation 2.1, construct a 95% confidence interval around dist and provide an interpretation
of this interval.

3. Let ̂ 1 and ̂ 2 be the intercept and slope from the estimation of the model y i  1  2 x i  i . Let c1 and c2,
~ ~ ~
with c2  0, be constants and let  1 and  2 
be the intercept and slope from the estimation of the model c1yi = 1 +
~ ~ ~
 2 c2xi. Show that  2 = (c1/c2) ̂ 2 and  1 = c1 ̂ 1 and provide an interpretation of this result

4. The Stata output below shows least squares estimate of the following equation:

childnum   1   2 age   i
(3.1)

Where childnum denotes the number of children an individual has and age denotes age in years. For reference, the
mean of childnum is 1.63 and the mean of age is 35.62.

. reg childnum age

Source | SS df MS Number of obs = 180

---------+------------------------------ F( 1, 178) = 5.11
Model | 3.34592177 1 3.34592177 Prob > F = 0.0249
Residual | 116.454078 178 .654236395 R-squared = 0.0279
---------+------------------------------ Adj R-squared = 0.0225
Total | 119.80 179 .669273743 Root MSE = .80885

------------------------------------------------------------------------------
childnum | Coef. Std. Err. t P>|t| [95% Conf. Interval]
---------+--------------------------------------------------------------------
age | .0274932 .0121572 2.261 0.025 .0035023 .051484
_cons | .6541174 .4371769 1.496 0.136 -.2085992 1.516834
------------------------------------------------------------------------------

EC561 – Problem Set 3 Answers – Page 2 of 3

The X’X-1 matrix for this regression is:

. matrix list xxi

symmetric xxi[2,2]
age _cons
age .00022591
_cons -.00804615 .29213245

(i) Provide a brief interpretation of the slope coefficient in the regression.

(ii) Test the hypothesis, at the 5% significance level, that age has no effect on the number of children a person has
against the alternative age has a positive effect on the number of children a person has.

(iii) Test the hypothesis, at the 5% significance level, that each additional year of age increases the number of
children a person has by .5 against the alternative that each additional year of age does not increase the number of
children a person has by .5.

(iv) Predict the number of children for someone who is 35 years old. For someone who is 40 years old.

(v) Compute σ^ 2 for this regression.

(vi) Verify that your estimate of σ 2 for this regression yields the standard errors given in the Stata output (i.e.,
use your estimate of σ2 to compute the standard errors and show that they match those provided in the Stata
output).

EC561 – Problem Set 3 Answers – Page 3 of 3