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THE UNIVERSITY OF
NEW SOUTH WALES

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SCHOOL OF ECONOt.. IICS
ECON 2206 / ECON 3290 (ARTS) INTRODUCTORY
FI NAL EXAMI NATION
SESSION 1, 2009
l. TIl\lE ALLOWED - 2 Hours .
2. READING TI1-.IE = 10 t. linutcs
3. THIS EXAl\HNATlON PAPER HAS 9 PAGES
4. TOTAL NUl\ IBER OF QUESTI ONS - 6.
5. ANSWER ALL QUESTIONS.
6. ALL QUESTIONS ARE OF EQUAL VALUE
7. TOTAL MAJ.lKS AVAILABLE FOR THIS EXM,II NATION - 60.
8. THE l\ I ARKS AWARDED TO EACH PART OF A QUESTION ARE I NDICATED.
9. CANDIDATES MAY BRING THEIR OWN CALCULATORS TO THE EXAl\1
10. STATISTICAL TABLES ARE PROVIDED AT T HE END OF THE EXAt..1 PAPER
11. ALL ANSWERS I\ IUST BE WRITTEN I N PEN. PENCILS I\ I AY BE USED ONLY FOR DRAWING,
SKETCHI NG OR GRAPHI CAL WORK.
12. THIS PAPER I\I AY BE RETAI NED BY THE CANDTDATE
Please see over
ANSWER ALL SIX QUESTIONS
REMINDER: When performing statistical tests, always state the null and alternative hypothe-
ses, the test statistic and it's distribution under the null hypothesis , the level of significance
and the conclusion of the t est.
Question 1. (lO Marks).
(i) Consider the multiple regression model:
y =fjo + PI Xl +fj'l:t2 +u
Briefly explain the consequences of measurement error in the dependent vari able, y, for the OLS estimators
of fjl and fj2 when:
(a) the measurement error is uncorrelated with the independent variables XI and X'l (2 marks)
(b) the measurement error is correlated with the independent variable XI (2 marks)
(ii) Consider the following model used to the salary of chief executive officers:
salary = Po + 13) sales + fj2 mktva/ + fj3 sales x m1},-val + u
where sales is the firm's total sales revenue for the previous year (measured in Smillions) and 1HT},;val is the
firm's market value (also measured in $millions) . III terms of the parameters of the population model, what
is t he effect on salary of all extra $lmillion of sales in the previous year? (2 marks)
(ii i) What is the meaning of t he term "contemporaneous exogeneity" as used in the context of time
series data? \Vhat is t he difference between contemporancous exogeneity and the zero conditional mean
(ZCM) ill the multiple model for time seri es data ? {2 marks}
(iv) What does it mean for an estimator to be "consistent" and does this differ from "ullbi asness" ? Explain.
(2 marks).
Please see over
2
I

Question 2. (lO Marks in total)
The vari able heavyd is a binary variable equal to one if a person is a heavy drinker (of alcoho\) , and zero
ot herwise. T he est imates for the linear probability model explai ning heavyd was:
heavyd = 0.467 - 0.007 log(price) + 0.056 log(i71come) + 0.028educ - 0.000geduc
2
- 0.014 age
(0.210) (0.034) (0.029) (0.006) (0.0003) (0.06)
[0.131[ [0.031[ [O.OI B[ [0.005] [0.0002] [0.05]
71 = 1403, n2 = 0.233
where price is the price of beer in the individual 's local a rea, income is monthly income, educ is years of
education and age is measured ill years. The usual OLS standard errors are reported in parentheses (. ), and
t he heteroskedasticity-robust standard errors are reported in brackets [.].
(i) At what point (i.e. specific number of years) does anot her year of education reduce the probability of
being a heavy drinker ? (l mark)
(ii) Are t here a ny important differences between the two sets of standard errors reported above? Briefl y
explain. (2 marks)
(iii) Outline t he steps involved in performing the White Test for the presence of heteroskedastici ty. (3 marks)
(iv) We know t hat heteroskedasticity is present in t he linear probabi lity model. What a rc the advantages of
using the Weighted Least Squares (WIS) estimator for the model rather than OLS (wit h robust standard
errors)? (1 mark)
(v) In t he linear probabili ty model t he condit ional variance of the dependent variable, y, is given by:
Va' (y lx ) _ p(x ll l - p(x) [
where p(x) /3
0
+ /3IXI + ... + f3"x/c
Outline t he procedure for estimating the linear probability model by WLS. (3 marks)
Please see over
3
Ques t ion 3. (10 Marks in total)
Let Quant denote the percentage of students at a NSW high school who get a passing grade 011 a
standll rdi sed mathematics tests. We are interested in estimating the impact of school spending on the
mathematical skills of students. A si mple model is
(3. 1)
where expend denotes school expenditures (per student) in S1000, enroll is t he number of students enrolled
a t the school and famine is the average family income of students at t he school. The following table
contains OLS estimates for this model:
Dependent Variable: Quant
Independent Variable
expend 7.75
(3.04)
enroll - 1.26
(0.58)
famine -0.324
(0.036)
intercept -23. 14
(24.99)
Observations 428
R' 0. 1893
(i) Construct a 99 % confidence inten'al for the effect of expend on Qtlant . Is 0 in the 99 % confidence
interval ?(2 marks)
(ii) Suppose we were not able to measure the average family income of the students enrolled at t he schools
in the sample. Discuss the potential problems of est imat ing the relationship between Quant and expend. in
(3. 1) but with famine omitted. (9 marks)
(iii) Suggest a potential proxy variable we may be abl e to use in place of faminc, and briefl y j\lstify your
suggestion based on economic theo!}' or intuition. What condi tions must a useful proxy variable satisfy? (9
marks)
(iv) Is the model of the determinants of Qu.ant ill (3. 1) a good model? Explain your rew;;oning. (2 marks)
Please see over
4
Question 4. (10 Marks in total) .
Let sa.ve denote t he amount of money a family savings during a year . \Ve are interested in determining
whether the rich save relatively more, other things equal. Consider the model
log(save) = f3
0
+ f3
1
age + f32 children + f3
3
wealth + u (2.1)
where age denotes the age of the ' family head' , children is the dependent children in t he household and
wealth is the total wealth (total asset s minus liabilities) of t he family (in SIOO,OOO).
(i) The following table contains OLS estimates for Illodels with and without wealth as an explanatory
variable:
Dependent Variable' log(save)
Independent Variable ( I ) (2)
age 0.062 0.038
(0.011) (0.017)
child)"en -0.065 -0.125
(0.04 1) (0.051)
Wealth 0.025
(0.001)
int.crcept 0.042 0.039
(0.D03) (0.004)
Ob8e1"1Ja"tion8 325 325
R' 0.057 0.226
Note. Sta ndard errors In () below t he coefficient esti mates.
Why is the erred of children on log(save) larger in magnitude in model (2) than (I )? Do families with
more children save less? Briefly explain. (2 marh)
(ii ) Test whet her model (2) has any explanatory power. Perform a test of the overall signifi cance of the
regression using a 1% level of significance. (2 marks)
(iii) J am concerned the model in column (2) Illay be misspecificd due to neglected Ilonlinearities. Outline
the steps required to carry out the RESET test , and clearly state the null and alternative hypotheses of the
test. (9 marks)
(iv) An alternative specification of the model in column (2) is to have the age and wealth variables enter in log
(rather than level) form. Outline one procedure which may help determine which is the better specification
of the model. What , if any, are the limitations of the procedure? (3 nW"k!)
NOTE: The F -test statistic is given by the formula:
p =
(SSR, - SSR",)/q
SSR",/(n k I)
(R;, - R ~ / q
( I R;,)/(n k I )
where SSR is the sum of squared residuals, q is the number of restrictions, and ur and r stand for unrestricted
and restricted models, respectively.
Please see over
5
Question 5. (10 Marks in total) .
To st udy the impact of a government policy on the fert ility rate of Australian women, the following static
model was estimated using anmlal data for t he period 1913 to 1984:
124.09 + 0.348 pct - 35.88ww21 (5.1)
(4.36) (0.040) (5.71)
n
:2 - 2 -
72, n = 0.727, R = 0. 106
The variable fr is the ferti lity rate (number of ch ildren born to every 1000 women of child-bearing age) , pe
is the economic variable of interest which measures t he real dollar val ue of t he ' personal exempt ion' (whi ch
is an income tax deduction for each dependent child: t he value of pe ranges frolll SO to S244, with an average
of S100 over the sample period), and 1l.;w2 is a dummy variable equal to one during t he years of t he second
world war.
(i) What is the interpretation of the coefficient on pe? Is pe practically (or 'economi call y') significant ? (2
marks) .
(ii) To allow for the possi bi lity that t he fertility rate may respond to pe wit h a tag, the following t hird order
Finite Distributed Lag model was est imated:
/r! = 95.87 + O.3 13 pej + 0.OO62pet _1 + 0.Q44pet _:2 + 0.034pet _3 -35.37ww2
t
(5. 2)
(3.28) (0. 126) (0. 1557) (0. 126) (0.102) (10.73)
n = 70, n
2
= 0. 821, fl2 = 0.773
What is the estimated Long Run Propensity (LRP) of pc Oil /T in this model ? What is the interpretation
of the LRP ? ( 1 mmk).
(ii i) What does it mean for a ti me series process (such as 11", ) to be covariance stationary ? Expl ai n. (2
marks ).
(iv) What does it mean for a t ime series process (such as /r, ) to be weakly d ep e nde nt , a nd how does this
differ from covariance stationary ? (2 marks).
(v) \Vhat is t he "spurious regression problem" ? How c/\ 11 I adjust t he model in (5. 1) to ensure the regression
results are not spurious? (3 marks).
Please see over
6
Question 6. (10 Marks in total).
We are interested ill allalysi ng t he effect of t he NSW government's Worker Compensation Laws int roduced
in 1996 on the duration of t ime workers receh'ed compensat ion for workplace injuries. The new laws reduced
the maximum amount of earnings that injured workers could be compensated for while off work. The
maximum amount of lost weekly earnings that an injured worker could receive compensation for decreased
from $2000 to $1000. The law had the effect of Ill a king it more costly for high income earners to remain on
workers compensation (since forgone income was now greater), while t he law had no effect on lower income
earners (who earot less than $1000 per week). Therefore workers with high weekly earnings represent the
treatment group and workers wit h lower income represent a control group. \Ve have a random sample
of data on workers in 1995 (the "before" period) and Mot her random sample on workers in 1997 (the "after"
period). The hypot hesis we wish to test is that t he new laws caused workers to spend less t ime off work in
recei pt of \Vorkers Compensat ion.
The data for each year includes the number of weeks the workers spent off work and in receipt of workers
compensation (duration) as well as t he worker' (pre-inj ury) weekly earnings (earnings) measured in S1995.
The earnings information was used to const ruct the dummy variable highinc which is equal to one if the
worker's weekly earnings were $1000 or more, and is equal to zero otherwise. The foll owi ng simple regression
model was estimated using only the year 1997 sampl e of data
= 14. 1307 - 5.0688 highinc
(0. 1241) (0.5314)
n = 2716, R'l = 0.0983
while t he following was estimated using only the 1995 sampl e of data
12.4517 - 3.0557 highinc
(0.2045) (0.3071)
n = 3018, n
2
= 0.0906
(6.1)
(6. 2)
(i) What is the interpretation of the coefficient on the intercept term in model (6.2) (t hat is, what does the
value 12.4517 mean )? What is the interpretation of the coefficient on highi71c in model (6.2) ? (2 marks)
(ii ) Explain why we cannot infer from t he estimates in (6.1) , based on the 1997 data, t hat the new Jaws
caused the duration of lime injured workers received Workers Compensation to fall by all average of 5.0688
weeks? What evidence from model (6.2) suppor ts this concl usion ? (2 marks)
(iii ) An alternati ve approach is to pool t he data for both yea rs and estimate the following mode!:
= J 2.4517 + 1.6790 dl997 - 3.0557 highinc - 2.0131 d1997 x highinc (6.3)
(0. 0973) (0.071 ) (0.1248) (0.864)
n = 5734, R1. = 0.0954
where d1997 is a dummy variable equal to one if t he observation is for the year 1997 (and is equal to zero if
t he observation is for the year 1995).
What is t he est imated impact of the new laws on the duration of ti me injured .... ,orkers receive Workers
Compensation based on the est imator ? Is the effect signifi cantly different from 0
at the 1% signifi cance le ....el ? (use the I-sided alternative hypothesis that t he coefficient is negative).
(2 marks)
(iv) Suppose that we are concerned that the workforce ill NSW may have changed between 1995 and 1997.
Outline how the mode! ill (6.3) may be adapted to allow for changes in the underlyi ng characteristics of the
population ill 1995 and 1997. (2 marks)
(v) What , if any, would be the advantages of coll ecting a nd using panel data to evaluate t he effect of the
change in t he laws? Explain. (2 marks)
End of Paper
7
Table 1 Critical Values ofthe t Distribution
Significance Level
i-Tailed: 0.10 0.05 0.025 0.01
2-TalJed: 0.20 0.10 0.05 0.02
1 3.078 6.314 12.706 31.821
2 1.886 2.920 4.303 6.965
3 1.638 2.353 3.182 4.541
4 1.533 2.132 2.776 3.747

1.476 2.015 2.571 3.365
6 1.440 1.943 2.447 3.143
7 1.415 1.895 2.365 2.998
8 1.397 1.860 2.306 2.896
9 1.383 1.833 2.262 2.821
D
10 1.372 1.812 2.228 2.764

11 1.363 1.796 2.201 2.718
9 12 1.356 1.782 2. 179 2.681
r
13 1.350 1.771 2. 160 2.650
14 1.345 1.761 2.145 2. 624
1. 1.341 1.753 2.131 2.602
5
16 1.337 1.746 2.120 2. 583
17 1.333 1.740 2. 110 2.567
0
18 1.330 1.734 2. 101 2.552
f
19 1.328 1.729 2.093 2.539
F
20 1.325 1.725 2.086 2.528
r
21 1.323 1.721 2.080 2.518
e
22 1.321 1.717 2.074 2.508
e
23 1.319 1.714 2.069 2.500
d
24 1.318 1.711 2.064 2.492
0
2. 1.31 6 1.708 2.060 2. 485
m 26 1.31 5 1.706 2.056 2.479
27 1.314 1.703 2.052 2.473
28 1.313 1.701 2.048 2.467
29 1.311 1.699 2.045 2.462
30 1.310 1.697 2.042 2.457
40 1.303 1.684 2.021 2. 423
60 1.296 1.671 2.000 2.390
90 1.291 1.662 1.987 2.368
120 1.289 1.658 1.980 2.358
~
1.282 1.645 1.960 2.326
Example. The 1 % c:ntical value for a one tailed test 'NIth 25 rJf IS 2.485. The 5% a ~ c a l value for a I'No-talled
test wi\tllarge (>120)df is 1.960.
8
0.005
0.01
63.657
9,925
5.841
4.604
4.032
3.707
3.499
3.355
3.250
3.169
3.106
3.055
3.012
2. 977
2.947
2.921
2.898
2.878
2.861
2.845
2.831
2.819
2.807
2.797
2.787
2.779
2.771
2.763
2.756
2.750
2.704
2.660
2. 632
2.617
2.576
Table 2. 1% Critical Values of the F Distri bution
Numerat or Degrees of Freedom
1 2 3 4

6 7 8 9
,.
D
,.
10.04 7.56 6.55 5.99 5.64 5.39 5.20 5.06 4.94 4.85

11 9.65 7.21 6.22 5.67

5.32 5.07 4.89 4.74 4.63 4.54
"
12 9.33 6.93 5.95 5.41 5.06 4.82 4.64 4.50 4.39 4.30
0
13 9.07 6.70 5.74 5.21 4.86 4.62 4.44 4.30 4.19 4.10
m
14 8.86 6.51 5.56 5.04 4.69 4.46 4.28 4.14 4.03 3.94
;
"
1. 8.68 6.36 5.42 4.89 4.56 4.32 4.14 4.00 3.89 3.80
,
16 8.53 6.23 5.29 4.77 4.44 4.20 4.03 3.89 3.78 3.69
t 17 8.40 6.1 1 5.18 4.67 4.34 4.10 3.93 3.79 3.68 3.59
0
18 8.29 6.01 5.09 4.58 4.25 4.01 3.84 3.71 3.60 3.51
,
1. 8.18 5.93 5.01 4.50 4.17 3.94 3.77 3.63 3.52 3.43
D
2. 8.10 5.85 4.94 4.43 4.10 3.87 3.70 3.56 3.46 3.37

21 8.02 5.78 4.87 4.37 4.04 3.81 3.64 3.51 3.40 3.31
9
22 7.95 5.72 4.82 4.31 3.99 3.76 3.59 3.45 3.35 3.26
,
23 7.88 5.66 4.76 4.26 3.94 3.71 3.54 3.41 3.30 3.21
24 7.82 5.61 4.72 4.22 3.90 3.67 3.50 3.36 3.26 3.17

2. 7.77

5.57 4.68 4.18 3.85 3.63 3.46 3.32 3.22 3.13
26 7.72 5.53 4.64 4.14 3.82 3.59 3.42 3.29 3.18 3.09
0 27 7.68 5.49 4.60 4.11 3.78 3.56 3.39 3.26 3.15 3.06
f
28 7.64 5.45 4.57 4.07 3.75 3.53 3.36 3.23 3.12 3.03
29 7.60 5.42 4.54 4.04 3.73 3.50 3.33 3.20 3.09 3.00
F
3. 7.56 5.39 4.51 4.02 3.70 3.47 3.30 3.17 3.07 2.98
,

4. 7.31 5.18 4.31 3.83 3.51 3.29 3.12 2.99 2.89 2.80

6. 7.08 4.98 4.13 3.65 3.34 3.12 2.95 2.82 2.72 2.63
d 9. 6.93 4.85 4.01 3.53 3.23 3.01 2.84 2.72 2.61 2.52
0
12. 6.85 4.79 3.95 3.48 3.17 2.96 2.79 2.66 2.56 2.47
m
6.63 4.61 3.78 3.32 3.02 2.80 2.64 2.51 2.41 2.32
.
Examplo. The 1% cnUcal value fQ( numerator df 3 and denomlna!or (ff--60 IS 4.13 .
9