Undergraduate Econometrics:

First Midterm

Instructions.

• You have 65 minutes to complete this test.

• There are three questions and the exam is worth 65 points.

• Please write directly into the text packet. There is extra paper at the end of the exam. There
is also extra paper available in the room (staple this to the back of your exam at the end).

• Most questions can be answered independently of one another. For those that build, partial
credit is always available.

• Tables of critical values can be found at the end of the exam.

• To obtain full credit, make sure to explain your answers. Please write out numerical answers
in decimal form. In the calculations please keep at least two significant figures.

• The test is closed-book. You may use your “cheat-sheet” and a calculator during the exam.
You may not use any printed material except this exam. Using any other electronic devices
(such as cell-phones, smartphones, tablets, laptops, etc.) is not allowed.

NAME:

TA:

WILL YOU CHEAT? (circle one) YES NO

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1. (20 points) Suppose that to get into a certain school, a student need 75 points on an exam.
You have been hired to consult for a prep course academy that wants to advertise itself to parents.
Let S̄0 be the average test score of a sample of 50 students who do not take your client’s course
and let S̄1 be the average test score of 50 students that do. Similarly let σ̂k2 be the sample variance
in each group. Suppose you have the following data:

S̄0 = 78.0, σ̂02 = 100.0

S̄1 = 72.0, σ̂12 = 100.0

1. Perform a 2-sided 5% t-test comparing students who do and do not take the program. Can
you reject the null that students test scores are the same in each group?

Answer.

78 − 72
t =q
100 100
100 + 100

=3

This is larger than 1.96 in magnitude, so we reject the null. The programs appear different.

2. Based on the t-test above, does the program appear to be effective at raising test scores? (No
need for a one-sided test here, interpreting part (a) and a simple sentence on magnitude and
sign will suffice.)

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Answer. The program does not appear to be effective, it lowers test scores by 6 points on
average!

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 3. As a consultant, do you think the above data is enough to conclude whether the program
causally lowers or raises test scores? Why or why not? 2-3 sentences here will suffice.

Answer. No. This is unlikely to pick up the causal impact of the program. Probably only
weaker students sign up for the program in the first place.

2. (30 points) A certain state wants to understand the impact of health insurance on financial
security. To this end, they chose 900 people on Medicaid and randomized the level of benefits that
they received. Let Ci be the copay in dollars (how much a person must pay for a procedure) of
person i, and let Wi be the weekly wage, in dollars, of person i. The randomization was such that
1/3 of the people are fully covered (Ci = 0), 1/3 have to pay 50 dollars out of pocket, and the
remaining 1/3 pay 100 dollars out of pocket. You estimate the following regression:

Ŵi = 800 − 5 × Ci

a) Interpret the coefficient on Ci . Hint: pay attention to how Ci is determined.

b) What is the predicted income of someone whose copay is 50 dollars?

c) What is the predicted income of someone whose copay is 200s dollars? Is this a reasonable
prediction? Why or why not?

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 d) Suppose that you estimate that σ̂U2 = 100 and that σ̂C
2 = 100. Assuming homoscedasticity,

test if the coefficient on C is statistically significant from 0.

3. (15 points) Suppose that instead of E(U |X) = 0 you are told that E(U |X) = 5. We will prove
that in this case, β̂1 is still unbiased.

a) Show that E(Ū |X) = 5. Conclude that E(Ui − Ū |X) = 0.

Answer. First,

N
!
1 X
E(Ū |X) =E Ui |X
N
i=1
N
1 X
= E(Ui |X)
N
i=1
N
1 X
= 5
N
i=1

=5

And so,
E(U − Ū |X) = E(U |X) − E(Ū |X) = 5 − 5 = 0

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b) Using the fact above (even if you could not show it), show that β̂1 remains unbiased. Hint:
You may start from the following formula to make life easier
PN
i=1 (Xi − X̄)(Ui − Ū )
β̂1 = β1 + PN 2
i=1 (Xi − X̄)

Answer. Given the first part:

PN ! PN !
i=1 (Xi − X̄)(Ui − Ū ) i=1 (X i − X̄)(Ui − Ū )
E β1 + PN |X =β1 + E PN |X
2 2
i=1 (Xi − X̄) i=1 (Xi − X̄)
PN

i=1 (Xi − X̄)E (Ui − Ū )|X
=β1 + PN 2
i=1 (Xi − X̄)
PN
(Xi − X̄)0
=β1 + Pi=1
N 2
i=1 (Xi − X̄)

=β1

c) OPTIONAL BONUS! 5 POINTS! Use the above part (even if you could not show it) to
prove that β̂0 is biased.

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Table 1: N (0, 1) 2-Sided Critical Values
Level: 1% 5% 10%
2.83 1.96 1.64

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.