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Lawrence C. Marsh
Chapter 3
3.1
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Lawrence C. Marsh
3.2
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3.3
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Lawrence C. Marsh
3.4
f(y|x=480) f(y|x=480)
y|x=480
Figure 3.1a Probability Distribution f(y|x=480) of Food Expenditures if given income x=$480.
Copyright 1996
Lawrence C. Marsh
f(y|x)
f(y|x=480)
f(y|x=800)
3.5
y|x=480
y|x=800
Figure 3.1b Probability Distribution of Food Expenditures if given income x=$480 and x=$800.
Copyright 1996
Lawrence C. Marsh
3.6
Figure 3.2 The Economic Model: a linear relationship between avearage expenditure on food and income.
Homoskedastic Case
f(yt)
ex pe nd itu re
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Lawrence C. Marsh
3.7
yt
.
x1=480 x2=800
income
xt
Figure 3.3. The probability density function for yt at two levels of household income, x t
Heteroskedastic Case
f(yt)
nd pe x e ur it
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Lawrence C. Marsh
3.8
.
x1 x2 x3
.
income
xt
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Lawrence C. Marsh
3.9
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Lawrence C. Marsh
3.10
One more assumption that is often used in practice but is not required for least squares:
5. (optional) The values of y are normally distributed about their mean for each value of x: y ~ N [(1+2x), 2 ]
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Lawrence C. Marsh
3.11
y y4
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Lawrence C. Marsh
3.12
e4 {
E(y) = 1 + 2x
y3 y2
e2
. {
.} e3
y1
} e1 .
x1 x2 x3 x4 x
Figure 3.5 The relationship among y, e and the true regression line.
Copyright 1996
Lawrence C. Marsh
3.13
^ { e4
y4 .
^ y1. y1
.y2 ^ { e2 . ^ y
.} ^3 .e y
3
^ y3
.y ^
^=b +b x y 1 2
e } ^1 . x2 x3 x4 x
x1
^ Figure 3.7a The relationship among y, e and the fitted regression line.
Copyright 1996
Lawrence C. Marsh
3.14
^ y*. 1 ^* e1
. ^* { y e2 . 2
^ y* 2
. ^* { e3 . y
^ y* 3
^* e4
{.
y4 . ^ y* 4
^=b +b x y 1 2 ^*= b + b x y *1 *2
. y
1
x1
x2
x3
x4
Figure 3.7b The sum of squared residuals from any other line will be larger.
f(.)
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Lawrence C. Marsh
f(e)
f(y)
3.15
1+2x
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Lawrence C. Marsh
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Lawrence C. Marsh
3.17
1. Unspecified factors / explanatory variables, not in the model, may be in the error term. 2. Approximation error is in the error term if relationship between y and x is not exactly a perfectly linear relationship. 3. Strictly unpredictable random behavior that may be unique to that observation is in error.
Copyright 1996
Lawrence C. Marsh
Population regression values: y t = 1 + 2x t + e t Population regression line: E(y t|x t) = 1 + 2x t Sample regression values: e y t = b1 + b2x t + ^ t Sample regression line: ^ y t = b1 + b2x t
3.18
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Lawrence C. Marsh
3.19
y t = 1 + 2x t + e t e t = y t - 1 - 2x t
Minimize error sum of squared deviations:
S(1,2) =
t=1
(y t
- 1 - 2x t )2
(3.3.4)
Copyright 1996
Lawrence C. Marsh
3.20
(y t - 1 - 2x t
2 )
(3.3.4)
= - 2 (y t = -2
- 1 - 2x t )
S(.)
x t (y t - 1 - 2x t )
2
Set each of these two derivatives equal to zero and solve these two equations for the two unknowns: 1
Copyright 1996
Lawrence C. Marsh
3.21
t =1
(y t
- 1 - 2x t )2
S(.)
S(.) < 0 i
.
S(.) = 0 i
.S(.)
i
>0 i
bi
To minimize S(.), you set the two derivatives equal to zero to get: S(.)
Copyright 1996
Lawrence C. Marsh
3.22
= - 2 (y t = -2
- b1 - b2x t )
= 0
S(.)
x t (y t - b1 - b2x t )
= 0
When these two terms are set to zero, 1 and 2 become b1 and b2 because they no longer values that correspond to the minimum of S(.) . represent just any value of 1 and 2 but the special
Copyright 1996
Lawrence C. Marsh
- 2 (y t -2
- b1 - b2x t )
3.23
= 0 = 0
x t (y t - b1 - b2x t )
y t - Tb1 - b2 x t
= 0
2
x t y t - b1 x t - b2 xt
Tb1
b1
+ b2 x t + b2 xt
2
= 0
= =
yt xtyt
xt
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Lawrence C. Marsh
Tb1
b1
+ b2 x t + b2 xt
2
= =
yt xtyt
x
and
3.24
xt
b2 =
T x t yt - x t y t T x t - ( x t)
2 2
b1 = y - b2 x
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Lawrence C. Marsh
elasticities
y x y/y percentage change in y = = = x y percentage change in x x/x
3.25
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Lawrence C. Marsh
applying elasticities
E(y) = 1 + 2 x E(y) x = 2
3.26
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Lawrence C. Marsh
estimating elasticities
y x = x y
^ ^ y
t
3.27
x = b2 y
= b1 + b2 x t = 4 + 1.5 x t
x y
x = b2 y
^
8 = 1.5 = 1.2 10
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Lawrence C. Marsh
Prediction
Estimated regression equation: ^ yt = 4 + 1.5 x t
3.28
xt ^ yt
If If
xt xt
= 2 years, then yt = $7.00 per hour. = 3 years, then yt = $8.50 per hour. ^
Copyright 1996
Lawrence C. Marsh
log-log models
ln(y) = 1 + 2 ln(x) ln(y) = x 1 y y x = 2 2 ln(x) x 1 x x x
3.29
1 y y x x y y x
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Lawrence C. Marsh
= =
2 2
1 x x x
3.30