Various Functional

Forms in Economics
Kushagra - 21112317
Gargi - 21112309
Khushi - 21112315
 Table of content

01 Various Types 02 Coefficient

interpretation

03 Uses of Functional
Forms
 Log-Log

I Log Log Model or

Constant Elasticity
Models
Both the independent and dependent
variables are transformed by taking their
logarithm

lny= β₀ + β₁lnx₁ + u
 Log Log Model
We consider the celebrated Cobb–Douglas (CD) production
function, which may be expressed as:

Taking natural log on both sides

ln Qᵢ = ln B₁ + B₂ ln Lᵢ + B₃ ln Kᵢ

Taking ln B₁ = A

ln Qᵢ = A + B₂ ln Lᵢ + B₃ ln Kᵢ
 Log Log Model
An interesting feature of the log-log model is that the slope
coefficients can be interpreted as elasticities.

ln Qᵢ = A + B₂ ln Lᵢ + B₃ ln Kᵢ

B₂ is the (partial) elasticity of output with respect to the labor input

1 percent change in the independent variable will lead to

B₂ percent change in the quantity produced, ceteris
paribus
 Log Log Model
Elasticities are pure numbers

In the CD function when double log is applied the sum of the partial
slope coefficients, (B2 + B3), gives information about returns to
scale :-

B₂ + B₃ = 1
B₂ + B₃ < 1
B₂ + B₃ > 1

ln Qᵢ = ln B₁ + B₂ ln Lᵢ + B₃ ln Kᵢ
 Log Log Model

Constant Elasticity Model

ln Qᵢ = ln B₁ + B₂ ln Lᵢ + B₃ ln
Kᵢ
Double log models are considered constant elasticity
models because they have a constant elasticity of the
dependent variable (B₂) with respect to the independent
variable.
Log Log Model
 Log-Lin

II Log Lin or Growth

Model
The dependent variable is transformed by
taking their logarithm while the independent
variable remains the same

lny= β₀ + β₁x₁ + u
 Log Lin Model
To see how the growth rate of an economic variable can
be measured, we can measure the rate of growth of real
GDP
RGDPₜ = RGDP₁₉₆₀ (1 +r)ᵗ

Taking natural log on both sides

ln RGDPₜ = ln RGDP₁₉₆₀ + t ln(1+r)

Now let B₁ = ln RGDP₁₉₆₀ & B₂ = ln

(1+r)
ln RGDPₜ = B₁ + B₂t + uₜ
 Log Lin Model

ln Qᵢ = ln B₁ + B₂ ln Lᵢ + B₃ ln
Kᵢ
 Log Lin Model
ln RGDPₜ = B₁ + B₂t + uₜ

We multiply B₂ by 100 to compute the percentage change, or

the growth rate; 100 times B₂ is also known as the semi-
elasticity of the regressand with respect
to the regressor.

B2 = relative change in regressand

absolute change in regressor
 Log Lin Model

USA’s real GDP has been increasing at the rate of

3.15% per year
 Log-Lin

III Lin Log

The independent variable is transformed by
taking their logarithm while the dependent
variable remains the same

y= β₀ + lnβ₁x₁ + u
 Lin Log Model
In lin-log, we are interested in finding the percent growth in the
regressand for a unit change in the regressor.

Yᵢ = B₁ + B₂ ln Xᵢ + uᵢ
We multiply the value of the estimated slope coefficient by
multiplying it with 0.01

Absolute change in Y
B2 =
Relative change in X
 Lin Log Model

If total expenditure increases

by 1%, on average, the share of expenditure on food and nonalcoholic
beverages goes down by about 0.0008 units
 Coefficient Interpretation
In econometrics, coefficients are numerical values that are
estimated from statistical models. These coefficients represent
the relationships between variables in the model and provide
information about the strength and direction of those
relationships. The interpretation of coefficients depends on the
specific context of the model and the variables included
 Functional Form & Interpretation
A functional form refers to the algebraic form of a relationship between a dependent variable and
regressors or explanatory variables.

Functional forms in regression analysis include:

Semi-log: Either the dependent variable or the independent variables are transformed using the
natural logarithm transformation.
Double-log: Variables are transformed using the natural logarithm transformation.
Reciprocal: Independent variables (one or more) are represented as the reciprocal (that is, for
variable x, the transformation is 1/x).
These functional forms allow the analyst to represent a wide range of shapes.
 INTERPRETATION
The interpretation of coefficients is different in alternative functional
forms. In the following formulations Y represents the dependent
variable, x the independent variable, a is the y-intercept, b is the slope
coefficient, ln(y) and ln(x) represent the natural logarithm of y and x,
respectively and e is an error term.
(1) Linear: y = a + b x + e
In this functional form b represents the change in y (in units of y) that
will occurs as x changes one unit.
2) log-lin: ln(y) = a + b x + e
In this functional form b is interpreted as follows. A one unit change in x
will cause a b(100)% change in y, e.g., if the estimated coefficient is 0.05
that means that a one unit increase in x will generate a 5% increase in y.

3) Lin-Log: We interpret the value of the estimated slope coefficient by

multiplying it with 0.01

4) Double-log: ln(y) = a + b ln(x) + e

In this functional form b is the elasticity coefficient. A one one percent
change in x will cause a b% change in y, e.g., if the estimated coefficient
is -2 that means that a 1% increase in x will generate a -2% decrease in
y.
 Example of Log-Log Model
Both dependent variable and independent variable(s) are log-transformed.
We interpret the coefficient as the percent increase in the dependent
variable for every 1% increase in the independent variable. Example: the
coefficient is 0.198. For every 1% increase in the independent variable,
our dependent variable increases by about 0.20%.
 Example of Log-Lin Model
Labor economists are also interested in similar
functions because individuals usually have some
initial earning power that can be supplemented with
investments in skill acquisition. These human capital
functions deal with the amount of money an individual
can expect to earn depending on his or her initial
abilities and investments in education, training,
experience, and so on.
 Example of Log-Lin Model
● For example, if you put some
cash in a saving account,
you expect to see the effect
of compounding interest with
an exponential growth of
your money! The original
model in these types of
scenarios isn’t linear in
parameters, but a log
transformation generates the
desired linearity.
● Consider the following model
of value in a savings fund that
depends on your initial
investment, your return, and
the length of time in which the
funds are invested: Yt = Y0(1
+ r)t, where Yt represents the
value of the fund at time t, Y0
is the initial investment in the
savings fund, and r is the
growth rate.
Example of Log-Lin Model
If you begin with an exponential growth model
and take the log of both sides, you end up with ln
Y = ln Y0 + Xln (1 + r), where ln Y0 is the
unknown constant and ln (1 + r) is the unknown
growth rate plus 1 (in natural log form). You end
up with the following model:

Compound interest rate has

been increasing at the rate of
B1*100 % per year
 SUMMARY OF COEFFICIENT
INTERPRETATION
Log Log:
1 percent change in the independent variable will lead to B2 percent
change in the dependant variable

Log lin:
We multiply B₂ by 100 to compute the percentage change

Lin Log:
We multiply the value of the estimated slope coefficient by multiplying it
with 0.01
 CHOICE OF MODELS
● Slope of
regressand with ● Priori ● R2 < Theory
respect to expectation
regressor

● Underlying ● Box-cox
● R2
Theory Transformation
THANK
YOU!