Type author name/s here

Dougherty

Introduction to Econometrics,
5th edition
Chapter heading
Chapter 4: Nonlinear Models and
Transformations of Variables

© Christopher Dougherty, 2016. All rights reserved.

 SEMILOGARITHMIC MODELS

Y   1e  2 X

This sequence introduces the semilogarithmic model and shows how it may be applied to
an earnings function. The dependent variable is linear but the explanatory variables,
multiplied by their coefficients, are exponents of e.
1
 SEMILOGARITHMIC MODELS

Y   1e  2 X

dY
  1  2 e  2 X   2Y
dX

The differential of Y with respect to X simplifies to b2Y.

2
 SEMILOGARITHMIC MODELS

Y   1e  2 X

dY
  1  2 e  2 X   2Y
dX

dY Y
 2
dX

Hence the proportional change in Y per unit change in X is equal to b2. It is therefore
independent of the value of X.

3
 SEMILOGARITHMIC MODELS

Y   1e  2 X

Y  Y   1 e  2  X  X 
  1 e  2 X e  2 X
 Ye  2 X
   2 X 
2

 Y  1   2 X   ... 
 2 

Strictly speaking, this interpretation is valid only for small values of b2. When b2 is not
small, the interpretation may be a little more complex.

4
 SEMILOGARITHMIC MODELS

Y   1e  2 X

Y  Y   1 e  2  X  X 
  1 e  2 X e  2 X
 Ye  2 X
   2 X 
2

 Y  1   2 X   ... 
 2 

Suppose that X increases by an amount DX and that as a consequence Y increases by an

amount DY.

5
 SEMILOGARITHMIC MODELS

Y   1e  2 X

Y  Y   1 e  2  X  X 
  1 e  2 X e  2 X
 Ye  2 X
   2 X 
2

 Y  1   2 X   ... 
 2 

We can rewrite the right side of the equation as shown.

6
 SEMILOGARITHMIC MODELS

Y   1e  2 X

Y  Y   1 e  2  X  X 
  1 e  2 X e  2 X
 Ye  2 X
   2 X 
2

 Y  1   2 X   ... 
 2 

We can simplify the right side of the equation as shown.

7
 SEMILOGARITHMIC MODELS

Y   1e  2 X

Y  Y   1 e  2  X  X 
  1 e  2 X e  2 X
 Ye  2 X
   2 X 
2

 Y  1   2 X   ... 
 2 
Z2 Z3
e  1 Z 
Z
  ...
2! 3!

Now expand the exponential term using the standard expression for e to some power.

8
 SEMILOGARITHMIC MODELS

Y   1e  2 X

Y  Y   1 e  2  X  X 
  1 e  2 X e  2 X
 Ye  2 X
   2 X 
2

 Y  1   2 X   ... 
 2 

   2 X 
2

Y  Y   2 X   ... 
 2 

Subtract Y from both sides.

9
 SEMILOGARITHMIC MODELS

   2 X 
2

Y  Y   2 X   ... 
 2 

  2 X  2 negligible

We now consider two cases: where b2 and DX are so small that (b2 DX)2 is negligible, and the
alternative.

10
 SEMILOGARITHMIC MODELS

   2 X 
2

Y  Y   2 X   ... 
 2 

  2 X  2 negligible

Y  Y 2 X

Y / Y
 2
X

If (b2 DX)2 is negligible, we obtain the same interpretation of b2 as we did using the calculus,
as one would expect.

11
 SEMILOGARITHMIC MODELS

   2 X 
2

Y  Y   2 X   ... 
 2 

  2 X  2 not negligible

Y / Y  22 X
 2   ...
X 2
 22
 2   ...
2

If (b2 DX)2 is not negligible, the proportional change in Y given a DX change in X has an extra
term. (We are assuming that b2 and DX are small enough that terms with higher powers of
DX can be neglected.)
12
 SEMILOGARITHMIC MODELS

   2 X 
2

Y  Y   2 X   ... 
 2 

  2 X  2 not negligible

Y / Y  22 X
 2   ...
X 2
 22
 2   ... if DX is one unit
2

Usually we talk about the effect of a one-unit change in X. If DX = 1, the proportional

change in Y is as shown. The issue now becomes whether b2 is so small that the second
and subsequent terms can be neglected.
13
 SEMILOGARITHMIC MODELS

Y   1e  2 X

X  0  Y   1e 0   1

b1 is the value of Y when X is equal to zero (note that e0 is equal to 1).

14
 SEMILOGARITHMIC MODELS

Y   1e  2 X

log Y  log  1e  2 X
 log  1  log e  2 X
  1'   2 X log e
  1'   2 X

To fit a function of this type, you take logarithms of both sides. The right side of the
equation becomes a linear function of X (note that the logarithm of e, to base e, is 1).
Hence we can fit the model with a linear regression, regressing log Y on X.
15
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source | SS df MS Number of obs = 500
-----------+------------------------------ F( 1, 498) = 60.71
Model | 16.5822819 1 16.5822819 Prob > F = 0.0000
Residual | 136.016938 498 .273126381 R-squared = 0.1087
-----------+------------------------------ Adj R-squared = 0.1069
Total | 152.59922 499 .30581006 Root MSE = .52261
----------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
_cons | 1.83624 .1289384 14.24 0.000 1.58291 2.089571
----------------------------------------------------------------------------

Here is the regression output from a wage equation regression using Data Set 21. The
estimate of b2 is 0.066. As an approximation, this implies that an extra year of schooling
increases hourly earnings by a proportion 0.066.
16
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source | SS df MS Number of obs = 500
-----------+------------------------------ F( 1, 498) = 60.71
Model | 16.5822819 1 16.5822819 Prob > F = 0.0000
Residual | 136.016938 498 .273126381 R-squared = 0.1087
-----------+------------------------------ Adj R-squared = 0.1069
Total | 152.59922 499 .30581006 Root MSE = .52261
----------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
_cons | 1.83624 .1289384 14.24 0.000 1.58291 2.089571
----------------------------------------------------------------------------

In everyday language it is usually more natural to talk about percentages rather than
proportions, so we multiply the coefficient by 100. It implies that an extra year of schooling
increases hourly earnings by 6.6%.
17
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source | SS df MS Number of obs = 500
-----------+------------------------------ F( 1, 498) = 60.71
Model | 16.5822819 1 16.5822819 Prob > F = 0.0000
Residual | 136.016938 498 .273126381 R-squared = 0.1087
-----------+------------------------------ Adj R-squared = 0.1069
Total | 152.59922 499 .30581006 Root MSE = .52261
----------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
_cons | 1.83624 .1289384 14.24 0.000 1.58291 2.089571
----------------------------------------------------------------------------

  2 X  2 not negligible
Y / Y  2
 0.066  2

If DX is one unit,  2   ...  0.066 

2
 0.068
X 2 2

If we take account of the fact that a year of schooling is not a marginal change, and work
out the effect exactly, the proportional increase is 0.068 and the percentage increase 6.8%.

18
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source | SS df MS Number of obs = 500
-----------+------------------------------ F( 1, 498) = 60.71
Model | 16.5822819 1 16.5822819 Prob > F = 0.0000
Residual | 136.016938 498 .273126381 R-squared = 0.1087
-----------+------------------------------ Adj R-squared = 0.1069
Total | 152.59922 499 .30581006 Root MSE = .52261
----------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
_cons | 1.83624 .1289384 14.24 0.000 1.58291 2.089571
----------------------------------------------------------------------------

  2 X  2 not negligible
Y / Y  2
 0.066  2

If DX is one unit,  2   ...  0.066 

2
 0.068
X 2 2

In general, if a unit change in X is genuinely marginal, the estimate of b2 will be small and
one can interpret it directly as an estimate of the proportional change in Y per unit change
in X.
19
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source | SS df MS Number of obs = 500
-----------+------------------------------ F( 1, 498) = 60.71
Model | 16.5822819 1 16.5822819 Prob > F = 0.0000
Residual | 136.016938 498 .273126381 R-squared = 0.1087
-----------+------------------------------ Adj R-squared = 0.1069
Total | 152.59922 499 .30581006 Root MSE = .52261
----------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
_cons | 1.83624 .1289384 14.24 0.000 1.58291 2.089571
----------------------------------------------------------------------------

  2 X  2 not negligible
Y / Y  2
 0.066  2

If DX is one unit,  2   ...  0.066 

2
 0.068
X 2 2

However if a unit change in X is not small, the coefficient may be large and the second term
might not be negligible. In the present case, a year of schooling is not marginal, but evem
so the refinement makes only a small difference.
20
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source | SS df MS Number of obs = 500
-----------+------------------------------ F( 1, 498) = 60.71
Model | 16.5822819 1 16.5822819 Prob > F = 0.0000
Residual | 136.016938 498 .273126381 R-squared = 0.1087
-----------+------------------------------ Adj R-squared = 0.1069
Total | 152.59922 499 .30581006 Root MSE = .52261
----------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
_cons | 1.83624 .1289384 14.24 0.000 1.58291 2.089571
----------------------------------------------------------------------------

  2 X  2 not negligible
Y / Y  2
 0.066  2

If DX is one unit,  2   ...  0.066 

2
 0.068
X 2 2

In general, when b2 is less than 0.1, there is little to be gained by working out the effect
exactly.

21
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source
Source | | SSSS dfdf MSMS Number
Number ofof obs
obs = = 540
500
-------------+------------------------------
-----------+------------------------------ F(F(1,1, 498)538)
= = 60.71
140.05
Model
Model | |16.5822819
38.5643833 1 116.5822819
38.5643833 Prob
Prob > F
> F = =0.0000
0.0000
Residual
Residual | |136.016938
148.14326 498538.273126381
.275359219 R-squared
R-squared = =0.1087
0.2065
-------------+------------------------------
-----------+------------------------------ Adj
Adj R-squared
R-squared = =0.1069
0.2051
Total
Total | | 152.59922
186.707643 499539 .30581006
.34639637 Root
Root MSE
MSE = =.52261
.52475
----------------------------------------------------------------------------
------------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
-------------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
S
_cons | | .1096934
1.83624 .0092691
.1289384 11.83
14.24 0.000
0.000 .0914853
1.58291 .1279014
2.089571
_cons | 1.292241 .1287252 10.04 0.000 1.039376 1.545107
----------------------------------------------------------------------------
------------------------------------------------------------------------------

log ˆ1  1.836

ˆ1  e1.836  6.27

The intercept in the regression is an estimate of log b1. From it, we obtain an estimate of b1
equal to e1.836, which is 6.27.

22
 SEMILOGARITHMIC MODELS

. reg LGEARN S
----------------------------------------------------------------------------
Source
Source | | SSSS dfdf MSMS Number
Number ofof obs
obs = = 540
500
-------------+------------------------------
-----------+------------------------------ F(F(1,1, 498)538)
= = 60.71
140.05
Model
Model | |16.5822819
38.5643833 1 116.5822819
38.5643833 Prob
Prob > F
> F = =0.0000
0.0000
Residual
Residual | |136.016938
148.14326 498538.273126381
.275359219 R-squared
R-squared = =0.1087
0.2065
-------------+------------------------------
-----------+------------------------------ Adj
Adj R-squared
R-squared = =0.1069
0.2051
Total
Total | | 152.59922
186.707643 499539 .30581006
.34639637 Root
Root MSE
MSE = =.52261
.52475
----------------------------------------------------------------------------
------------------------------------------------------------------------------
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
LGEARN | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-----------+----------------------------------------------------------------
-------------+----------------------------------------------------------------
S | .0664621 .0085297 7.79 0.000 .0497034 .0832207
S
_cons | | .1096934
1.83624 .0092691
.1289384 11.83
14.24 0.000
0.000 .0914853
1.58291 .1279014
2.089571
_cons | 1.292241 .1287252 10.04 0.000 1.039376 1.545107
----------------------------------------------------------------------------
------------------------------------------------------------------------------

log ˆ1  1.836

ˆ1  e1.836  6.27

Literally this implies that a person with no schooling would earn $6.27 per hour. However it
is dangerous to extrapolate so far from the range for which we have data.

23
 SEMILOGARITHMIC MODELS

4
Logarithm of hourly earnings

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years of schooling (highest grade completed)

Here is the scatter diagram with the semilogarithmic regression.

24
 SEMILOGARITHMIC MODELS

120

100
Hourly earnings ($)

80

60

40

20

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years of schooling (highest grade completed)

Here is the semilogarithmic regression line plotted in a scatter diagram with the
untransformed data, with the linear regression shown for comparison.

25
 SEMILOGARITHMIC MODELS

120

100
Hourly earnings ($)

80

60

40

20

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years of schooling (highest grade completed)

There is not much difference in the fit of the regression lines, but the semilogarithmic
regression is more satisfactory in two respects.

26
 SEMILOGARITHMIC MODELS

120

100
Hourly earnings ($)

80

60

40

20

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years of schooling (highest grade completed)

The linear specification predicts that hourly earnings will increase by a fixed amount, $1.27,
with each additional year of schooling. This is implausible for high levels of education. The
semi-logarithmic specification allows the increment to increase with level of education.
27
 SEMILOGARITHMIC MODELS

120

100
Hourly earnings ($)

80

60

40

20

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years of schooling (highest grade completed)

Second, the linear specification predicts very low earnings for an individual with no
schooling. The semilogarithmic specification predicts hourly earnings of $6.27, which at
least is not obvious nonsense.
28
Copyright Christopher Dougherty 2016.

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Introduction to Econometrics, fifth edition 2016, Oxford University Press.
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2016.05.02