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Introduction To Econometrics, 5 Edition: Review: Random Variables, Sampling, Estimation, and Inference
Introduction To Econometrics, 5 Edition: Review: Random Variables, Sampling, Estimation, and Inference
Introduction to Econometrics,
5th edition
Chapter heading
Review: Random Variables,
Sampling, Estimation, and
Inference
2.5% 2.5%
1
ONE-SIDED t TESTS
2.5% 2.5%
We will start by considering the case where m can take only two possible values: m0, as
under the null hypothesis, and m1, the only possible alternative.
2
ONE-SIDED t TESTS
2.5% 2.5%
An example of this situation is where you are selling computer accessories and among
your products there are two types of removable lap-top batteries: regular (average charge
duration m0) and long life (average charge duration m1).
3
ONE-SIDED t TESTS
2.5% 2.5%
You have been sent an unmarked shipment and you take a sample and see how long they
last. Your null hypothesis is that they are regular batteries.
4
ONE-SIDED t TESTS
2.5% 2.5%
Suppose that the sample outcome is as shown. You would not reject the null hypothesis
because the sample estimate lies within the acceptance region for H0.
5
ONE-SIDED t TESTS
2.5% 2.5%
Here you would reject the null hypothesis and conclude that the shipment was of long life
batteries.
6
ONE-SIDED t TESTS
2.5% 2.5%
7
ONE-SIDED t TESTS
2.5% 2.5%
A sample outcome such as this one gives rise to a serious problem. It lies in the rejection
region for H0, so our first impulse would be to reject H0.
8
ONE-SIDED t TESTS
2.5% 2.5%
But to reject H0 and go with H1 is nonsensical. Granted, the sample outcome seems to
contradict H0, but it contradicts H1 even more strongly.
9
ONE-SIDED t TESTS
2.5% 2.5%
The probability of getting a sample outcome like this one is much smaller under H1 than it is
under H0.
10
ONE-SIDED t TESTS
2.5%
For this reason the left tail should be eliminated as a rejection region for H0. We should use
only the right tail as a rejection region.
11
ONE-SIDED t TESTS
2.5%
The probability of making a Type I error, if H0 happens to be true, is now 2.5%, so the
significance level of the test is now 2.5%.
12
ONE-SIDED t TESTS
5%
We can convert it back to a 5% significance test by building up the right tail until it contains
5% of the probability under the curve. It starts 1.645 standard deviations from the mean.
13
ONE-SIDED t TESTS
5%
Why would we want to do this? For the answer, we go back to the trade-off between Type I
and Type II errors.
14
ONE-SIDED t TESTS
5%
With a 5% test, there is a greater chance of making a Type I error if H0 happens to be true,
but there is less risk of making a Type II error if it happens to be false.
15
ONE-SIDED t TESTS
5%
Note that the logic for dropping the left tail depended only on m1 being greater than m0. It did
not depend on m1 being any specific value.
16
ONE-SIDED t TESTS
5%
Hence we can generalize the one-sided test to cover the case where the alternative
hypothesis is simply that m is greater than m0.
17
ONE-SIDED t TESTS
5%
To justify the use of a one-sided test, all we have to do is to rule out, on the basis of
economic theory or previous empirical experience, the possibility that m is less than m0.
18
ONE-SIDED t TESTS
5%
Sometimes, given a null hypothesis H0: m = m0, on the basis of economic theory or previous
experience, you can rule out the possibility of m being greater than m0.
19
ONE-SIDED t TESTS
5%
In this situation you would also perform a one-sided test, now with the left tail being used
as the rejection region. With this change, the logic is the same as before.
20
ONE-SIDED t TESTS
2.5% 2.5%
We will next investigate how the use of a one-sided test improves the trade-off between the
risks of making Type I and Type II errors.
21
ONE-SIDED t TESTS
2.5% 2.5%
We will start by returning to the case where m can take only two possible values, m0 and m1.
22
ONE-SIDED t TESTS
2.5% 2.5%
23
ONE-SIDED t TESTS
2.5% 2.5%
However, H0 may be false. In that case the probability of not rejecting it and making a Type
II error is given by the blue shaded area.
24
ONE-SIDED t TESTS
2.5% 2.5%
This area gives the probability of the estimate lying within the acceptance region for H0, if
H1 is in fact true.
25
ONE-SIDED t TESTS
5%
Now suppose that you use a one-sided test, taking advantage of the fact that it is irrational
to reject H0 if the estimate is in the left tail.
26
ONE-SIDED t TESTS
5%
Having expanded the right tail to 5%, we are still performing a 5% significance test, and the
risk of making a Type I error is still 5%, if H0 is true.
27
ONE-SIDED t TESTS
5%
But if H0 is false, the risk of making a Type II error is smaller than before. The probability of
an estimate lying in the acceptance region for H0 is now given by the red area.
28
ONE-SIDED t TESTS
This is smaller than the blue area for the two-sided test.
29
ONE-SIDED t TESTS
Thus, with no increase in the probability of making a Type I error (if H0 is true), we have
reduced the probability of making a Type II error (if H0 is false).
30
ONE-SIDED t TESTS
When the alternative hypothesis is H1: m > m0 or H1: m < m0, the more general (and more
typical) case, we cannot draw this diagram.
31
ONE-SIDED t TESTS
Nevertheless we can be sure that, by using a one-sided test, we are reducing the probability
of making a Type II error, if H0 happens to be false.
32
ONE-SIDED t TESTS
2.5% 2.5%
–1.96 0 1.96 sd X
sd
One-sided tests are often particularly useful where the analysis relates to the evaluation of
treatment and effect. Suppose that a number of units of observation receive some type of
treatment and Xi is a measure of the effect of the treatment for observation i.
33
ONE-SIDED t TESTS
2.5% 2.5%
–1.96 0 1.96 sd X
sd
To demonstrate that the treatment did have an effect, we set up the null hypothesis H0: m = 0
and see if we can reject it, given the sample average X.
34
ONE-SIDED t TESTS
2.5% 2.5%
–1.96 0 1.96 sd X
sd
If you use a two-sided 5% significance test, X must be 1.96 standard deviations above or
below 0 if you are to reject H0.
35
ONE-SIDED t TESTS
2.5%
–1.96 0 1.65 sd X
sd
However, if you can justify the use of a one-sided test, for example with H1: m > 0, your
estimate has to be only 1.65 standard deviations above 0.
36
ONE-SIDED t TESTS
2.5%
–1.96 0 1.65 sd X
sd
This makes it easier to reject H0 and thereby demonstrate that the treatment has had a
significant effect.
37
ONE-SIDED t TESTS
2.5%
–1.96 0 1.65 sd X
sd
Throughout this sequence, it has been assumed that the standard deviation of the
distribution of b2 is known, and the normal distribution has been used in the diagrams.
38
ONE-SIDED t TESTS
2.5%
–1.96 0 1.65 sd X
sd
In practice, of course, the standard deviation has to be estimated as the standard error, and
the t distribution is the relevant distribution. However, the logic is exactly the same.
39
ONE-SIDED t TESTS
2.5%
–1.96 0 1.65 sd X
sd
At any given significance level, the critical value of t for a one-sided test is lower than that
for a two-sided test.
40
ONE-SIDED t TESTS
2.5%
–1.96 0 1.65 sd X
sd
Hence, if H0 is false, the risk of not rejecting it, thereby making a Type II error, is smaller.
41
Copyright Christopher Dougherty 2016.
Individuals studying econometrics on their own who feel that they might benefit
from participation in a formal course should consider the London School of
Economics summer school course
EC212 Introduction to Econometrics
http://www2.lse.ac.uk/study/summerSchools/summerSchool/Home.aspx
or the University of London International Programmes distance learning course
EC2020 Elements of Econometrics
www.londoninternational.ac.uk/lse.
2015.12.17