FINAL EXAMINATION

ECONOMETRICS

6th May 2019, 180 minutes.

Answer all questions. The marks allocated to each questions are in square brack-
ets. This exam has 8 questions printed on 7 pages. Please read through the entire
exam before you begin. There is a total of 160 points in this exam. You should
think of points as equivalent to minutes you should spend on a question.

1. Consider the following equations.

(a) yi = β0 + β1 xi + ui
(b) yi = βb0 + βb1 xi + u
bi
(c) yi = βb0 + βb1 xi
(d) yi = βb0 + βb1 xi + ui
(e) yi = β0 + β1 xi
(f) yi = β0 + β1 xi + u
bi
Pn
(g) i=1 ui = 0
Pn
(h) i=1 ui xi = 0

Which equations are correct or incorrect? In the case when an equation is

incorrect, propose a correction. (8 points)

2. Each short question is worth (5 points)

(a) Are the conditional and unconditional means of a random variable the
same things? Explain.
(b) What is the p-value of a test statistic and why is it useful?
(c) Explain the difference between the slope and the elasticity in a simple
linear regression, if the model is

y = α + βx + u.

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 (d) If the error term of the linear model is not normally distributed, al-
though the OLS estimator is no longer BLUE, it is still unbiased. True
False or uncertain? Explain.
(e) As the sample size grows, R2 should fall. True False or uncertain?
Explain.

3. An upcoming senior, Alexia is interested in evaluating the effectiveness of a

job training program on the subsequent wages of workers. She propose the
following model in her capstone proposal,

ln(wage) = β0 + β1 train + β2 educ + β3 exper + u,

where train is a binary variable equal to unity if a worker participated in

the program. Alexia hopes to estimate this model using cross sectional data.
What can you say about the likely bias in the OLS estimator of β1 ? Propose
an empirical strategy that can deal with this bias? Please provide as much
detail as possible. (12 points)

4. Consider the multiple regression model:

yi = β0 + β1 x1i + β2 x2i + β3 x3i + ui , i = 1, . . . , 1000

Show how you would test the following hypotheses. Take the significance level
to be 5% and give the exact rejection region involving the test statistics and
the critical values from the appropriate distribution. You can assume that
the usual regression assumptions including normality and homoskedasticity
hold.

(a) H0 : β1 /β2 = 1, β3 = −2 vs. H1 : β1 /β2 6= 1, β3 6= −2. (8 points)

(b) H0 : β1 + β2 + β3 = 0 vs. H1 : β1 + β2 + β3 < 0. (8 points)
(c) H0 : β0 = β1 = β2 = β3 vs. H1 : At least one equality fails. (8 points)

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5. Using a dataset on test scores, we get the following estimated regression,

The variable sat is the combined SAT score, hsize is size of the student’s high
school graduating class, in hundreds, f emale is a gender dummy variable,
and black is a race dummy variable equal to one for blacks and zero otherwise.

(a) Is there strong evidence that hsize2 should be included in the model?
From this equation, what is the optimal high school size? (4 points)
(b) Holding hsize fixed, what is the estimated difference in SAT score be-
tween nonblack females and nonblack males? How statistically signifi-
cant is this estimated difference? (4 points)
(c) What is the estimated difference in SAT score between nonblack males
and black males? Test the null hypothesis that there is no difference
between their scores, against the alternative that there is a difference.
(4 points)
(d) What is the estimated difference in SAT score between black females
and nonblack females? What would you need to do to test whether the
difference is statistically significant? (4 points)

6. This question uses data from FebMar and NovDec 1992 on employment at
fast food restaurants in the US States of New Jersey and Pennsylvania taken
from Card and Krueger in The American Economic Review, Vol. 84(4),
Sept(94), “Minimum Wages and Employment: A Case Study of the Fast
Food Industry in New Jersey and Pennsylvania.” So each observation is a
fast food restaurant in a particular state at a point in time. We are interested
in how the minimum wage affects employment decisions in these restaurants.
In April 1992, New Jersey increased the minimum wage from $4.25 to $5.05.
In Pennsylvania, the minimum wage was unchanged, and we assume it to be
$3.80 for this exercise.
Refer to the stata output below.

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The command codebook, c provides a concise description of the variables
in the dataset. The next command
table state post, c( mean empft sd empft n empft)
tabulates the mean, standard deviation and number of observations of empft
by the two dummy variables, state and post.

(a) Using the STATA output provided, compute the treatment/policy effect
of this change in minimum wage on the full time employment at fast
food restaurants in New Jersey. (7 points)
(b) Instead of using a table of means, we could also estimate the policy
effect using the following model,

empf tit = β0 + β1 statei + β2 postt + β3 postt × statei + uit

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 where it indexes a specific restaurant i in period t. The variables statei
takes a value of 1 if i is located in New Jersey and 0 if it is in Pennsyl-
vania, and postt takes a value of 1 for the period after the law change
and 0 for before.
Using the means from the provided stata output, compute the estimates
that you expect for β̂1 , β̂2 , and β̂3 . (10 points)
(c) What is the underlying assumption that allows us to identify the policy
effect? How would you test this underlying assumption. (6 points)

7. This question refers to Angrist(89) ‘Lifetime Earnings and the Vietnam Era
Draft Lottery: Evidence from Social Security Administrative Records’, that
we covered in class.

(a) The author proposed the following labour earning equation,

ycti = δc + δt + αsi + ucti

Denote the earnings of man i in cohort c at time t by ycti and let si be

an indicator of veteran status. The term δc is a cohort effect, δt is a
period effect common to all cohorts, and uit , is the error term.
Why did the author allow for a cohort effect and time effect separately.
Explain precisely what are these two effects are meant to capture. (8
points)

Parts (b) and (c) refers to the following quote taken from the paper.
“If si is correlated with the unobserved components of the earnings equa-
tion, then α will not be consistently estimated by Ordinary Least Squares
(OLS).”

(b) Elaborate on what the author meant by this correlation between si and
uit . Provides examples of factors that can induce this correlation. (4
points)
(c) What does this correlation do to our OLS estimates? (4 points)
(d) Explain how the author used the natural experiment of a draft lottery
to overcome the inconsistency of OLS. (4 points)
(e) Refer to Table 1 on the next page taken from Angrist(89) ‘Lifetime
Earnings and the Vietnam Era Draft Lottery: Evidence from Social

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Security Administrative Records’. Explain the point and significance of
this table. What is the author trying to convey? (6 points)

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8. Consider the following panel data model

qit = β0 + β1 pit + β2 zi + αi + uit

where qit is the supplied quantity of wine of producer i at time t, pit is the
price, zi denotes regionals factors e.g. local average temperature which affects
wine production, αi is managerial ability, and uit is the error term. The
latent variables of the composite error term are independently distributed.
The variables αi ∼ N (0, σα2 ) and uit ∼ N (0, σu2 ).

(a) Considering two periods (t = 1, 2) derive the FD estimator. What are

its advantages and disadvantages? (6 points)
(b) Managerial abilities are probably related with the price that a firm is
willing to charge. Propose an estimator of the parameter β, state and
explain the transformation needed to obtain the estimator. (6 points)
(c) Suppose now that the price and managerial abilities are uncorrelated.
Suggest an estimator and explain its statistical properties. (6 points)
(d) Suppose now you have data on wine production, and you need to es-
timate a model to present the main conclusions. Suggest a test for
the correlation of price and managerial abilities, state the null and the
alternative, and explain how it works. (8 points)