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# The University of New South Wales

School of Economics
ECON3208/ECON3291(ARTS)
ECONOMETRIC METHODS
MID-TERM EXAM

Semester 2, 2013

## Part A. Multiple choice questions [7 marks]

test will NOT be marked. Use a 2B pencil.
Each question is worth 1 point

1. If X has a negative effect on Y and Z has a positive effect upon Y , and X and Z are
negatively correlated, what is the expected consequence of omitting Z from a regression
of Y on X?

## a. The estimated coefficient on X will be biased downwards (too negative)

b. The estimated coefficient on X will be biased upwards (insufficiently negative)
c. The estimated coefficient on X will be biased upwards to the point of becoming posi-
tive
d. The estimated coefficient on X (which should be positive) will be biased downwards
to the point of becoming negative
e. None of the above

From the formula of the expected value of e1 in the short regression of Y on X: E(e1 ) =
1 + 2 COVV (x
(x1 ,x2 )
1)
, we have 2 (coefficient of Z in the long regression of Y on X and Z)
is > 0, and cov(X, Z) < 0. Thus, the bias 2 COVV (x
(x1 ,x2 )
1)
< 0.

## 2. In the linear probability model, OLS estimator is:

a. BLUE.
b. biased but not consistent.
c. unbiased, consistent but inefficient.

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d. None of the above.

## a. the s do not have a simple interpretation.

b. the slope 1 is the change in odds ratio associated with a unit change in X1 , holding
other regressors constant.
c. 0 cannot be negative since probabilities have to lie between 0 and 1.
d. 0 is the probability of observing Y when all Xs are 0.

## 4. Which of the following is correct concerning Logit and Probit models?

a. They use a different method of transforming the model so that the probabilities lie
between zero and one
b. The Logit model can result in too many observations falling at exactly zero or exactly
one
c. For the Logit model, the marginal effect of a change in one of the explanatory variables
is simply the estimate of the parameter attached to that variable, whereas this is not
the case for the probit model
d. The Probit model is based on a cumulative logistic function
e. None of the above

function

## a. is biased and inefficient.

b. is the most efficient estimator although it can be biased.
c. is always unbiased and efficient.
d. is BLUE.
E. None of the above

6. You are interested in the return to education and wondering if there is a gender differential.

\
log(wage) = .389 .227 f emale + .082 educ .0056f emale * educ
(.119) (.168) (.008) (.0131)

## + .029 exper .00058exper + .032 tenure .00059tenure2

2
(1)
(.005) (.00011) (.007) (.00024)

n = 526 R2 = .441

## Which of the following is correct,

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a. An extra year of education earns a man, on average, about .56% above a comparable
womans wage.
b. An extra year of education earns a man, on average, about 8.2% above a comparable
womans wage.
c. An extra year of education earns a woman, on average, about 7.6% below a comparable
mans wage.
d. The return to education is the same for men and women.
e. None of the above
d wage
Marginal effect of education is wage = (.082 .0056 female)deduc. For men, it is .082
and for women, .082 .0056, when the change in educ is deduc = 1.

7. Consider again the model estimated in Question (6), equation (1) above. Holding all other
factors constant, and for an education level educ = 10, which of the following is correct?

a. A womans wage is, on average, about 22.7% below a comparable mans wage.
b. A womans wage is, on average, 5.6% below a comparable mans wage.
c. A womans wage is, on average, 24.65% below a comparable mans wage.
d. A mans wage is, on average, 38.9% above a comparable womans wage.
e. None of the above

Let log(y)W be a woman log wage and log(y)M be a man log wage, we have

## \W = .389 .227 + .082 educ .0056educ + other factors (2)

log(y)
(.119) (.168) (.008) (.0131)

## \M = .389 + .082 educ + other factors

log(y) (3)
(.119) (.008)

\W log(y)
log(y) \ = .227 .0056 educ (4)
 M 
ybW
log = e.227.0056 educ (5)
yb
 M
ybW
log 1 = e.227.0056 educ 1 (6)
ybM
= e.227.005610 1 = .24648 = .2465 (7)

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Part B. Problem [8 marks]
A study tried to find the determinants of the increase in the number of households headed
by a female. Using 1940 and 1960 historical census data, a logit model was estimated to
predict whether a woman is the head of a household (living on her own) or whether she
is living within anothers household. The limited dependent variable takes on a value of
one if the female lives on her own and is zero if she shares housing. The results for 1960
using 6,051 observations on prime-age whites and 1,294 on nonwhites were as shown in
Table 1, where age is measured in years, education is years of schooling of the family
head, farm status is a binary variable taking the value of one if the family head lived on
a farm, south is a binary variable for living in a certain region of the country, expected
family earnings was generated from a separate OLS regression to predict earnings from a
set of regressors, and family composition refers to the number of family members under
the age of 18 divided by the total number of individuals in the family.
Table 1: Estimation results for the logit model. The binary variable models a females decision

## (1) White (2) Nonwhite

Regression Model Logit Logit
Age -0.275 0.048
(0.037) (0.068)
Age squared 0.00463 0.00021
(0.00044) (0.00081)
Education -0.171 -0.127
(0.026) (0.038)
farm status -0.687 -0.498
(0.173) (0.346)
South 0.376 -0.520
(0.098) (0.180)
expected family earnings 0.0018 0.0011
(0.00019) (0.00024)
family composition 4.123 2.751
(0.294) (0.345)
constant 1.459 -2.874
(0.685) (1.423)
Pseudo R2 0.266 0.189
Percent correctly specified 82.0 83.4

## Heteroskedasticity robust standard errors in parenthesis.

Let Wi be the binary variable that takes one if female i lives on her own and zero if she is
living within anothers household. Therefore,
E(Wi |xi ) = P (Wi = 1|xi ) = (0 + xi ) ,
where xi = (X1i , , X7i ), is the vector of regressors for female i, = (1 , , 7 )0 ,
(z) = ez /(1 + ez ) is the Logit function and its derivative (z) has the property (z) =

z
= (z)(1 (z)) (See also the formula sheet attached to this exam paper).

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Table 2: The mean values for the independent variables X

## Variable (1) White mean (2) Nonwhite mean

age 46.1 42.9
age squared 2,263.5 1,965.6
education 12.6 10.4
farm status 0.03 0.02
south 0.3 0.5
expected family earning 2,336.4 1,507.3
family composition 0.2 0.3

 
pi
In the logit model, the logarithm of the odds ratio satisfies: log 1pi
= 0 + xi

(a) [1 marks] What would be the effect on the odds ratio of a nonwhite woman living on
her own, of a unit change in education and family composition, while all other vari-
ables are held constant? Here the change is with respect to two variables. Since there
are no interation terms involving these two variables, we can just add the marginal
effects from the two. The s are directly linked to the log of odds ratio:

 
pi
log = 0 + xi
1 pi
 
pi
d 1p i
  = j dXj [0.5 Mark] (8)
pi
1pi

The first variable that is changing is, education, for which, a one unit corresponds to
a one year of education. A one year change in educ, results in a 12.7% decrease in
the odds ratio. The second variable is, family decomposition for which the unit of
measurement is a percentage. A one unit corresponds to a 1%, which results in 2.75%
increase in the odds ratio. The cumulative marginal effect is therefore:

 
pi
d 1p i
  = 12.7% + 2.751% = 9.949 [0.5 Mark] (9)
pi
1pi

An estimated 10% decrease in the odds ratio of a nonwhite woman living on her own.

(b) [2 marks] Calculate the difference in the predicted probability between whites and
nonwhites at the sample mean values of the explanatory variables. Why do you think
the study did not combine the observations and allowed for a nonwhite binary variable

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to enter?

e0 +x
b b
P (Wi = 1|xi = x) = (b0 + x)
b =
1 + eb0 +x
b

White: b0 + x
b = 1.459 + (0.275)(46.1) + + (0.2)(4.123)
= 2.2292
Nonwhite: 0 + x =
b b 2.874 + (0.048)(42.9) + + (2.751)(0.3)
= 0.4905
[0.5 mark] for computing b + xb
P (Wi = 1|xi = x, white) = 0.9028[0.5mark]
P (Wi = 1|xi = x, N onwhite) = 0.6202.[0.5mark]

For whites, the probability is 0.90, while for nonwhites, it is 0.62. An average
white female is 28.2% more likely to head a household than an average Nonwhite
female.
- In the above approach, all coefficients are allowed to vary, whereas in a combined
sample, the coefficients on the variables other than the binary race variable will be
identical. To allow for slope coefficients that depend on race, the regression will have
to add interaction terms, which will increase dramatically the number of coefficients,
and thus decrease the degrees of freedom.[1 mark]
(c) [2 marks] What is the partial effect of age on the probability of a nonwhite woman
living on her own, if education and family composition were changed from their
current mean to the mean of whites, while all other variables were left unchanged at
the nonwhite mean values?
The partial effect of age, d( 0 +xi )
d age
= (0 + x)[.048
b + 2(.00021)age] [0.5 mark]

(0 + x)
b = [1 ] (10)
0 + x = 2.874 + .048(42.9) + .00021(1965.6) .127(12.6) .498(.02)
b b
.520(.5) + .0011(1507.30) + 2.751(.2) = .06395[0.5mark]
(b0 + x)
b = 0.4840 (11)
(b0 + x)
b = .4840(1 .4840) = .2497[0.5mark] (12)
d(0 + xi )
= .2497[.048 + 2(.00021)(42.9)] = .0660 (13)
d age
A one unit increase in age increases the probability of a nonwhite woman leaving on
her own by 6.6%. [0.5 mark]

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(d) [3 marks] Compute the elasticity (at the sample means) of a white womans deci-
sion to head a household with respect to family composition and interpret your result.
The elasticity we seek is:

P (Wi = 1|xi = x) X 7
eyx = (1 mark)
X7 y

## where y is equal to P (Wi = 1|xi = x, white) = 0.9028, and X 7 = 0.2. Because

family composition is a continuous (over its support), then we can use the logit partial
effect expression:

## P (Wi = 1|xi = x) b b7 = (0.9028)(1 0.9028)(4.123) = 0.3616 (1 mark)

= (b0 + x)
X7
eyx = (0.3616)(0.2/0.9082) = 0.0801 (1 mark)

This means that for the average white female, a one percent increase in the family
decomposition leads to 0.08 percentage change in the probability of her living alone.

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LIST OF USEFUL FORMULAE

## 1. In the regression model y = ) + 1 x1 + 2 x2 + , the OLS estimate for 1 :

Pn
(y y)(xi1 x1 )
b1 = Pn i
i=1
2
(14)
i=1 (xi1 x1 )
2
V (b1 ) = (15)
SST1 (1 R12 )
Xn
SST1 = (xi1 x1 )2 /n (16)
i=1
(17)

## where E(2 ) = 2 and R12 is the R-squared from a regression of x1 on x2 .

- If x2 is omitted from the regression, then the OLS estimator e1 for 1 has an expected
value,
E(e1 ) = 1 + 2 COVV (x
(x1 ,x2 )
and variance, V (e1 ) = 2 +22 V (x2 ) .
1) SST1

## 2. The standard normal probability density function (z) is:

1 z2
(z) = e 2 ,
2
where ' 3.14 and ez stands for the exponential function evaluated at z.

3. RThe cumulative distribution function for a standard normal (a) is defined (a) =
a

(z)dz. The values of (a) are obtained from the standard normal table.

4. The probability density function is equal to the first derivative of the cumulative distribu-
tion function: (z) = (z)
z
.

5. The probability density of a normal random variable X with mean and variance 2 is
defined:
1 (x)2
f (x) = e 22
2
6. For a Binary random variable Yi with P (Yi = 1) = pi , the probability mass function is
defined as:
P (Yi = yi ) = pyi i (1 pi )1yi

## G(0 + xi ) = 1+ee(0 0 +xi i )

( +x )
Logit:
Probit: G(0 + xi ) = (0 + xi )

## 8. The partial effect of a variable Xj in the binary choice model is:

G(0 + xi ) (0 + xi )
= g(0 + xi )
Xj Xj

8
where

## Logit: g(0 + xi ) = e0 +xi

2
[1+e0 +xi ]
= (0 + xi ) [1 (0 + xi )]
Probit: g(0 + xi ) = (0 + xi )

9. The elasticity eyx of y with respect to x measures the percentage change in y for a percent
change in x. In other words:
y x
eyx = (18)
x y
y x
= (19)
x y
%y
= (20)
%x