THEORETICAL PROBLEMS

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THEORETICAL PROBLEMS
Question a)

The estimate of B1 will not be a consistent estimate of the effect of living in a poor neighborhood on this
standardized test. Given the regression equation is;

Score = B0 + B1poornhd + u, where;

 Score is outcome score

 β0 is coefficient for the intercept,
 β1 is coefficient for the slope which is also the slope difference for the two categories,
 poorhd is:
 1 if the ith unit is in the treatment group(poornhd);
 0 if the ith unit is in the control group;
 ei is residual.

The coefficient β1 of slope will therefore not be constant and will change with variation between the 2
groups

Question b)

Perennial income will be used as the instrument variable which is assumed to be correlated with the
outcome. The instrument is then assumed not to have any causal effects on the outcome and the
existing correlation is due to an unknown confounding factor. The instrument is then assumed to have
an effect on the treatment variable and is randomly assigned to units. The correlation between the
instrument variable and the outcome is as a result of the correlation between the instrument variable
and the treatment variable.

The instrumental variable does not have a direct effect on the outcome and it is subject to the effect it
has on the treatment variable. Therefore the estimate made as an effect of B1 cannot be consistently
accurate

Question c)

Red pen and blue pen in this case are dummy variables. Dummy variables are useful because they
enable the researcher to use a single regression equation to represent multiple groups. The key term in
the model is β1, the estimate of the difference between the groups. The coefficient of slope will be
different for each category and therefore finding the difference between groups by finding the
difference between their equations will result to a consistent estimate for B1

Question d)

From the law of iterated expectations;

E[E(Y/X)]= E(Y)

E[E(Y/X)]= E(Y)
E(Y)=[(0.8(110) + 0.2(130)] + 0

E(Y)= 114

Expected outcome= 114

References
Luz, Adria. 3. On the role of dummy variables and interactions in linear regression. November 2020.
Accessed November 27, 2021. https://towardsdatascience.com/on-the-role-of-dummy-
variables-and-interactions-in-linear-regression-558d9644fc67.

Maheshrawi, Saiurabh. 2020. Solving Conditional Probability Problems with the Laws of Total
Expectation, Variance, and Covariance. February 28. Accessed November 28, 2021.
https://towardsdatascience.com/solving-conditional-probability-problems-with-the-laws-of-
total-expectation-variance-and-c38c07cfebfa.