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Metrics 2
Metrics 2
Metrics 2
If we now have a data sample over time (this is called a time series) of data on C and Y
We would now write this as
C t = a + bYt + u t
t=1,2,. ,n
(1)
If the data sample is taken from the UK annual data 1948-1995, the estimated regression
is
Ct =
443.79 + 0.815 Yt +
(470.29)
(0.002)
et
t=1,2, .,n
(2)
Equation (2) says that the point estimate of a (often called a) is 443.79,
the point estimate of b is 0.815. The interesting thing about the point
estimate of b is that it is positive and lies between zero and one. This is
clearly promising in terms of whether the mpc lies between zero and one.
(ii)
Note that whereas in (1) the random variable is called u t in (2) it is called
e t . In (1) the random term is an unobserved disturbance. We never (or
very rarely) have data on u t . e t is a random residual. We can calculate
the n values of e t easily once we have estimates of a and b (given we also
have data on C t and Yt ) It will often be useful to investigate the values
of e t . But it is important to bear in mind that they are NOT the same as
ut .
(iii)
The results say that standard errors are in brackets. Nearly always when
regression results are given, there will be figures in brackets under the
estimates. Unfortunately there is no agreement as to what these figures
should be (although they are always intended to provide some measure of
the precision of the estimates). This is why it says standard errors in
brackets. This means that the estimated standard deviation of the point
estimate (443.79) is 470.29 and the estimated standard deviation of the
point estimate of the slope (0.815) is 0.002.
The estimate of the slope is more interesting. Precisely what it means depends on the
model. The slope parameter in this model is the marginal propensity to consume (mpc).
An mpc = 0.815 implies that for every extra pound of disposable income, consumption
will go up by 0.815. This appears to be sensible.
Suppose we wanted to know what these estimates indicate would happen if disposable
income ( Yt ) increased by 10 per cent i.e. we wanted the elasticity of consumption with
respect to disposable income. The formula for this elasticity (at a point) is given by
C t Yt
Yt C t
This depends on C t
Yt
varies over the sample. Thus the elasticity will also vary over the
Ct
sample. We can estimate the elasticity at the point of sample means or at a particular
date. The sample mean of C t is 105,780 million and of Yt is 129,320 million. Thus
the estimate of the elasticity at the point of the sample means is 0.996. Alternatively the
values of C t and Yt is 1995 were 406,375 million and 502,433 million respectively.
These figures given an estimate of the elasticity in 1995 of 1.008. In terms of the
consumption function, it is of interest that both these values are close to one.
This is a very useful fact because we can now construct a confidence interval for both
estimates. Using the tables of the t distribution and taking a 95% confidence interval, we
find that the confidence intervals are
443.79 470.292.014 for a, or -503.37 a 1,390.95
0.815 0.0022.014 for b, or 0.811 b 0.819
(2.014 is in fact the 0.975 point of the t distribution with 45 degrees of freedom)
Thus we can see that the intercept has a comparatively large 95 % confidence interval
reflecting the fact that its standard error is large. Whereas the estimate of the mpc has a
much smaller 95 % confidence interval reflecting the greater precision with which this
parameter has been estimated.
We are now in a position to answer the question with which we started this example
does the mpc lie between zero and one? These estimates suggest that, for this data
sample at least, we can say with a high degree of confidence that it does.
The model ASSUMES that the relationship between consumption and disposable
income is linear. Is this true? A scatter diagram of C t against Yt provides one
way of answering this question (see lecture).
(ii)
We will discuss the problem of non-independent residuals later in the unit. For the
moment we simply note that the observed pattern of residuals suggest that they are
probably not independent and that this raises questions about whether these regression
results are really quite as good as they might seem.
et
t = 1,2,..,n
(3)
Turning to the standard errors, they are both fairly large in relation to the estimated
parameters. In multiple regression the estimated parameters have a t distribution with
(n-k) degrees of freedom, where n is the number of observations and k is the number of
parameters in the model (or alternatively the number of explanatory variables plus one
for the intercept). Thus in this case both point estimates have a t distribution with 21
degrees of freedom. Using these facts we can construct 95% confidence intervals for
both parameters. They are
0.284 0.4992.08 or 0.754 1 1.322
0.007 0.2512.08 or 0.515 2 0.522
Both these confidence intervals include zero and some negative numbers. The estimates
are sufficiently imprecise to include values which we know cannot be correct.
The confidence interval for 1 also includes one, so the question of whether 1 + 2 = 1
is, at the moment, unresolved. Testing this hypothesis requires techniques which will be
introduced later in the course, so we will leave this question to one side for the moment.
The point of this discussion is that the comparatively wide confidence intervals suggest
that these regression results may also be flawed in some way. For instance on the basis
of these estimates we cannot reject the hypotheses that either 1 = 0 or 2 = 0 .
This is not necessarily a problem, but it does raise a question about whether these
regression results are very useful.
Again the best method of investigating what is going on is to look at graphs of the
variables and the residuals. In models where there is more than one explanatory variable,
scatter diagrams are not always informative. However we can examine how these three
variables and the residuals behave over the sample period. (For a discussion of these
graphs and their implications see the lectures.)
In the consumption function case we might wish to test the hypothesis that b = 1. Thus
H0 : b = 1
H1 : b < 1
This is a one-sided test. The test statistic is
1 0.815
= 92.5
0.002
This is distributed as t with 46 degrees of freedom. The 95% critical value for a one
sided test is 1.68, and thus the null hypothesis ( H 0 ) is rejected.
In the production function example if we wished to test the hypothesis that 1 = 1,we
could do so by testing the null against a two-sided alternative;
H 0 : 1 = 1
H 1 : 1 1
The test statistic is
1 0.284
= 1.435
0.499
This has a t distribution with 21 degrees of freedom. The 95% critical value is 2.08. We
cannot reject H 0 . From this it can be seen that confidence intervals and two-sided
hypothesis tests are very similar. An per cent confidence interval gives the range of
two-sided null hypotheses that will not be rejected at the per cent level.