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a. The theoretical model that will be used is known as the Cobb–Douglas Production
Function model. In general, a production function is a specification of how the quantity
of output behaves as a function of the inputs used in production where production is
measured in monetary form. This concept can be applied at the level of individual firms,
industries, or entire economies. The mathematical model is denoted by:
Y = AKα N 1−α where 0<α<1

Y represents aggregate output or income, K the capital input, and N the labor input
(capital and labor being the two “factors of production” in this function). The A term
represents Total Factor Productivity (TFP for short); we can think of this as a “quality”
factor as opposed to K and N which are just quantitative. The value of A reflects the state
of technology as well as the skill and education level of the workforce. All being well, we
would expect A to be gradually increasing over time. Therefore in apriori, we expect all
the variables to be positive in the study given on standard of living as they aid an
increment in the production and income level.

b.
Y =β0 + β1 X1+β2 X2 +β3 X3 +β4 X4 + β5 X5 +µ

Where X1 = Cattle; X2 = Scotchcart; X3 = dNon_farm; X4 = dRemitences and X5 =

Dist_town

Assumptions for Linear Regression

The following are the assumptions that are present for linear regression.
1. Linear relationship. One of the most important assumptions is that a linear relationship is
said to exist between the dependent and the independent variables.
2. No auto-correlation or independence. The residuals (error terms) are independent of each
other. In other words, there is no correlation between the consecutive error terms of the
time series data.
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3. No Multicollinearity. The independent variables shouldn’t be correlated. If

multicollinearity exists between the independent variables, it is challenging to predict the
outcome of the model.

4. Homoscedasticity. Homoscedasticity means the residuals have constant variance at every

level of x. The absence of this phenomenon is known as heteroscedasticity.

5. Normal distribution of error terms. The last assumption that needs to be checked for
linear regression is the error terms’ normal distribution.

c.

d. The Breusch-Pagan test

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The Wooldridge test

The definitions of the variables created with the above code is as follows; f = fitted values, r =
residuals, f2 = fitted values squared, r2 = residuals squared, lm = Lagrange multiplier test
statistic
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e.

f.

g.
Overall, the model was statistically significant at 1% level given the F statistic probability
value of 0.000. The R squared shows that about 10.8% of the variation in the level of
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income is explained by the given explanatory variables which are (Cattle, Scotchcart,
dNon_farm, Dist_town and dRemitences).

Cattle and dNon_farm are statistically insignificant and may have no meaningful value in
explaining the level of income. In line with the theoretical underpinnings, the dNon_farm
and dRemitences have negative effect on income level hence inconsistence with the
expectation as they should add value positively on the level of income. However since
the model is suffering from heteroscedasticity problem, the coefficients becomes spurious
to interpret.

Comment on the results in f

The results in f shows the model free from heteroscedasticity corrected through feasible
least squares estimator (weighted least squares estimator). After correcting the problem of
heteroscedasticity, majority of the variables became statistically significant at 1% level,
and the coefficients scale changed as well. Only dRemitences remained with a negative
effect which is against the expectation.

The variable Cattle shows that, a 1 percent increase in cattle herd composition, the level
of income may increase by 0.179 percent all things equal. Scotchcart, has a positive
coefficient and statistically significant at 1% level. This shows that if an individual have a
scotchcart, there is a probability that the level of income increase by 4 times all things
equal. dNon_farm is statistically insignificant hence has no meaningful value to explain
the income level. Distance to town is positively related to level of income and is
statistically significant at 1% level hence the variable is useful in explaining income
level.

Remittances have a negative impact on income level and is statistically significant at 1%

level. This means that for a 1 percent increase in remittances, the level of income may go
down by approximately 6.26 percent all things equal.
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After correcting the problem of heteroscedasticity, the model is still statistically

significant at 1 % level given the probability value of Chi-square of 0.000.