ECO 324

PRACTICE QUESTIONS SET 1

Course instructor: Innocent Makuta
PART 1: THEORY
Question 1
Attempt the following questions from Gujarati.
chapter 3: 3.1; 3.6; 3.7; 3.9; 3.10; 3.11; 3.14; 3.15; 3.21.
chapter 5: 5.3; 5.5; 5.7; 5.8;

Question 2
Comment on the significance of the following Classical Linear Regression Model
(CLRM) assumptions:
i. Zero mean of the errors.
ii. Homoscedasticity.
iii. Zero correlation between the error term and the regressors.

Question 3
You are given the following regression with all the assumptions of the Classical
Normal Linear Regression Model (CNLRM) holding.
Yi  0  1 X i   i
(a) Show that the maximum likelihood estimators of 0 and 1 are identical to the OLS
estimators
(b) Show that the maximum likelihood estimator of  is biased

Question 4

In the simple linear regression model Yi   0  1 X i  ui , suppose that. E(u)  0 Letting

  E u  , show that the model can always be rewritten with the same slope, but a new
intercept and error, where the new error has a zero expected value.

Question 5
You are given the following regression with all the assumptions of the Classical
Normal Linear Regression Model (CNLRM) holding. The model is estimated using
OLS
Yi   0  1 X i   i

(a) Show that if E i   0 ; then ̂ 1 is biased.

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(b) Suppose that  1  0 ; find the OLS estimator of  0 :
ˆ 2
(c) Show that the mean square error of the OLS estimator in (b) is MSEˆ 0  
n

Question 6
You are given the following linear regression
e
Yi   0  1 X i  u i , u  2
X
where e is a random variable with E e   0 and var( e)   e2 . Assume that e is independent
of income.
(a) Show that E u X   0 , so that the key zero conditional mean assumption is
satisfied. [Hint: If e is independent of X, then E e X   E e  ]
(b) Show that so that the homoskedasticity Assumption is violated. [Hint:
var e X   var e  , if e and X are independent.]

(c) Assuming X  0 ; show that MSE ˆ0    n

ˆ u2

1 cov X , Y   covu , Y 
(d) Show the following 1 
var Y 

Question 7
Suppose you are given the following regression which satisfies all the Gaussian assumptions.
Yi   0  1 X i   i
You estimate the parameters  0 and  1 using two linear estimators. Using least squares, you
~ ~
obtain ˆ 0 and ˆ while the other technique you obtain  0 and  .
1 1

(a) Assuming that the least squares weight is w and that of the other estimator is v , show
~ ~
that v must satisfy for  0 and  1 to be unbiased.
 
1  
~
 
(b) Show that var ˆ  var  and var ˆ  var 
1 0
~
  0

Question 8
Suppose you are given the following regression which satisfies all the Gaussian assumptions.
Yi   0  ui

(a) Show that ˆ 0  Y

 2
(b) Show that ˆ0 
n

 yi2  Yi  Y 
n n
2
(c) Show that the residual sum of squares is
i 1 i 1

Question 9
Suppose you are given the following regression which satisfies all the Gaussian assumptions.
Yi    X i   i

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  
(a) Show that ˆ      ˆ X   ; and deduce that E ˆ   
1 X2   2X 2
(b) Show that var ˆ      2
 
 n n xi2  nn xi2
 i 1  i 1

(c) Show that ̂ is a consistent estimator of 

PART 2: APPLICATIONS

Question 10
A researcher is interested in examining the relationship between corruption and income
inequality as measured by the gini coefficient. He collects data from 6 countries.
His empirical model is given as follows: Yi   0  1 X i  i
where Y =is an index of corruption, higher values imply higher levels of corruption,
X = is a gini coefficient, and  i is an error term. The sample data is summarised
as follows:

6 6 6

 Yi  11.5
i 1
 X i  3.13
i 1
Y X
i 1
i i  7.38
6 6

 Yi 2  25.75
i 1
X
i 1
i
2
 2.27

(a) What is the a priori expected relationship between Y and X?

(b) Estimate the corruption model and interpret your results.
(c) Compute the average elasticity of corruption with respect to inequality, and
interpret your result.
(d) What part of variation in corruption is not explained by inequality?
(e) Find the standard error of the regression.
(f) Find the standard errors of the coefficients.
(g) What is the policy implication of the results from the corruption model?
(h) Does this simple regression necessarily capture a causal relationship between
corruption and inequality? Explain.
(i) What are the predicted levels of corruption for the most equal and most unequal
countries?
(j) What is the predicted level of inequality for the average country in terms of
corruption?

Question 11
The following results have been obtained from a sample of 20 observations on the value of
output (Y ) produced by a firm and the corresponding labour input (X).
  
20 20 20
i 1
X i  2786 Y  546
i 1 i
Y X i  68719
i 1 i
i=1
 Y S   3218473
20
i 1 i
2
x  X S   132585.7
20
i 1 i
2
y

Where S x2 and S y2 are the sample variances of X and Y respectively.

(a) What is the a priori expected relationship between Y and X?
(b) Estimate the sample production function of the firm and interpret your results.
(c) Does the intercept coefficient have any economic meaning in this case?

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(d) Compute the average elasticity of output with respect to labour and interpret your result.
(e) Find the standard errors of the coefficients of the production function.
(f) Assuming that inputs are paid their marginal products, how much does labour earn on
average?
(g) What is the estimated value of the conditional variance of output (Y )?
(h) What is the part of the variation in output produced which is not explained by the
regression?
(i) Assuming the firm adopts some labour augmenting technology, what happens to the slope
parameter?

Question 12
Below are regression results of a simple inflation model for Malawi where the exchange rate
(exrate) is the only independent variable. [25 Marks]

Source | SS df MS Number of obs = 262

-------------+------------------------------ F( 1, 260) = ( )
Model | 43206382.5 1 ( ) Prob > F = 0.0000
Residual | ( ) 260 14323.9125 R-squared = ( )
-------------+------------------------------
Total | 46930599.8 261 179810.727

------------------------------------------------------------------------------
Inflation | Coef. Std. Err. t [95% Conf. Interval]
-------------+----------------------------------------------------------------
exrate| ( ) .3759982 -1.49 ( ) ( )
Constant| 221.3612 8.838372 25.05 203.9573 238.7651
------------------------------------------------------------------------------
(a) Fill in the missing numbers denoted as ( ).
(b) Interpret the coe¢cients.
(c) Evaluate the results on the basis of a priori economic theory and goodness of fit.
(d) The means of inflation and exrate are 488 and 13 respectively. What is the elasticity of
inflation with respect to exchange rate? Interpret your result.
(e) Is the relationship between exchange rate movements and in.ation in Malawi
economically and statistically significant?
(f) Can we conclude that there is a one-to-one relationship between inflation and
the exchange rate?

13. Below are regression results of an inflation model with the price of petrol as the
only regressor.

Number of obs = 266

F statistic= ( )
R-squared = ( )
SE of regression=0.199770
RSS= ( )

------------------------------------------------------------------------------
Inflation | Coef. Std. Err. t P>|t|
-------------+----------------------------------------------------------------
petrol| 0.001436 0.000880 ( ) 0.1040
Constant| -0.010810 ( ) 0.744217 0.4574
------------------------------------------------------------------------------

i. Fill in the missing numbers.

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ii. Evaluate the results on the basis of a priori economic theory and goodness of fit.
iii. Interpret the coe¢cients.
iv. Comment on the statistical and economic significance of the results.
v. By using the test of significance and confidence interval approaches, test the hypothesis
that there is a one-to-one relationship between inflation and the price of petrol (Use   0.05
).