Econ 140 Section 2/8/12 Write your section number on your homework.

Since I have 3 sections, sorting a stack of papers is tedious without section number (9:30-11 is 102, 2-3:30 is 103, 5-6:30pm is 107). Starting next week if you dont do this, I will unapologetically give you a .

Independence In the book, when the occurrence of one event provides no information about the occurrence of another event, we say that the two events are statistically independent. Using events, this can be written as P (A B) = P (A)P (B). An example of this is rolling two dice, we would not expect the outcome of one die roll to inuence the other. When we are dealing with expectations, independence of two random variables X and Y implies that E[XY ] = E[X]E[Y ] and V ar[X + Y ] = V ar[X] + V ar[Y ].

Big Picture There are two important distinctions that we need to understand in this section. These are the sample vs population distinction and the distribution of a random variable vs distribution of the sample mean distinction. In order to explore these distinctions, we will rst discuss the normal distribution that everyone should be familiar with.

Normal Distribution
2 2 X N (X , X ) is read as X is distributed normally with mean and variance X

The values that X takes are all real numbers (R) and so X is a continuous random variable. The pdf: f (x) =
1 exp 2 2X

1 ( xX )2 2 X

We should all be familiar with the graph of a normal distribution:

Properties of the Normal Distribution 1. The equation for the pdf of the normal is general and represents a family of distributions. In order to specify the exact distribution from that family we need to specify the mean and vari2 ance (i.e. saying X N (x , x ) does not specify a particular distribution while X N (0, 1) does specify a particular distribution). 2. The normal distribution is symmetric with
1 2

of the probability on each side of the mean.

2 3. Any linear function of a normal random variable is distributed normally. So if X N (X , X ) 2 then Y = a + bX is a normal random variable also. Specically, Y N (a + bX , b2 X )

4. Any sum or linear combination of normal random variables is distributed normally. So if 2 2 2 2 X1 N (X1 , X1 ) and X2 N (X2 , X2 ) then X1 +X2 N X1 +X2 , X1 +X2 +2cov(X1 , X2 )

Implications How can we use property 3, in practice? First we need to notice that this property is really telling us 2 things. The rst is that if we have a normal random variable, lets call it Q, and we add a constant to Q then the resulting random variable will have very specic properties. Lets take a concrete example: Q N (2, 16) What is the distribution of Q+1?
2 More generally, if Q N (Q , Q ), what is the distribution of Q + a?

The 2nd thing that we get from property 3 is that if we have a normal random variable, lets call it W, and we multiply Q by a constant then the resulting random variable will have very specic properties. Again, lets take an example: W N (3, 9) What is the distribution of 5Q?
2 More generally, if W W (W , W ), what is the distribution of bW?

The more subtle point of these two ideas is that we can take any normal random variable and transform it into a new normal random variable with any mean and variance that we want. Suppose T N (1, 5). What transformation is needed to change T into a normal random variable with mean -1?

Again suppose T N (1, 5). What transformation is needed to change T into a normal random variable with mean -1 and variance 20? This one is harder.

Finally, suppose X N (5, 25) What transformation is needed to change X into a normal random variable with mean 0 and variance 1? In general, transforming a normal normal random variable into another normal with mean 0 and variance 1 is called standardizing. Also we general denote the normal random variable, with mean 0 and variance 1, Z.

Calculating Probabilities by Standardizing Suppose X N (1, 9). (This is from the notes from class.) What is P (0 x 4)? Well we have learned how to gure out probabilities of continuous random variables using integrals:

P (0 x 4) =
0 4

f (x)dx
0

1 x1 2 1 exp ( ) dx 2 3 29

Now there is probably a way to calculate that integral, but there is an easier way to gure out the probability. It involves transforming the random variable X into a standard normal and then using the table of the standard normal distribution on page 284. Step 1. Transform the random variable into a standard normal. X N (1, 9) X 1 N (0, 9) X1 3 = Z N (0, 1)

Step 2. Transform the probability statement. The question was given to us in terms of the original variable X. Now that we have transformed X, we must transform the probability question.

P (0 x 4) = P (0 1 x 1 4 1) 01 x1 41 ) 3 3 3 1 x1 = P ( 1) 3 3 1 = P ( z 1) 3 1 = P (z 1) P (z ) 3 = .8413 .3707 = P(

The Sample and The Population Before I begin my own discussion of this topic, I would suggest that you read pg. 74-78 in the textbook because the explanation isnt horrible. The dierence between the sample and the population seems trivial at rst glance. The population is the set of all things under consideration and the sample is a subset of the population selected for analysis. The population has some true distribution with some mean and variance. Usually, the mean of the population distribution is written using the Greek letter mu () whereas the true variance is written using the greek letter sigma ( 2 ). Now these numbers are unobservable because we do not have access to the true population distribution and so we take samples in order to get estimates of these unobservable numbers. The samples that are discussed in Chapter 6 are simple random samples. These are samples where each element of the population has an equal chance of being chosen and the selection of one element has no eect on the probability of another element being selected. The book also mentions that samples are taken from a population because a sample can provide useful information about a population at a much lower cost than a complete census. There is often confusion about the sample because in econometrics, and statistics in general, a sample is treated as a set of random variables. At rst this may seem counterintuitive because if we were to take a sample of heights from lecture, we could literally stare at a piece of paper with a bunch of heights - clearly when we are staring at the numbers from our sample it would be dicult
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to believe that we are staring at random variables. In this class, we think about a sample as a much more abstract object. One way to think about it is if we took a sample of 20 people from lecture and asked those people what their heights are, how would that sample look? Well, since we dont yet know who those 20 people are we can treat each persons height as a random variable with a distribution: Let H f (h) denote the true distribution of heights in Econ 140. Remember, we dont know f (h) but we do know that there is some distribution and there exists some mean and variance to that distribution. Now in terms of mathematical notation, what would our sample look like? Sample = {H1 , H2 , H3 , ..., H19 , H20 } Here our sample is just a set of random variables, where each random variable represents the height of one person in our sample. Now, what is the distribution of each of these random variables? Well, here is another source of confusion, we say that each of these random variables has the distribution f (h). One might ask, How can we say that, we dont even know what that distribution is? This is a completely fair point to make, but notice that we still did not say exactly what the distribution is; all we have done is said that whatever the population distribution is, that is the same distribution as the random variables in our sample. Its like saying, I dont know what the distribution of heights is, but if I chose someone at random from the population I would assume they would have the same distribution. Professor Moretti said something similar to this in his lecture: Suppose I go out, take a sample of a hundred people from a distribution and plot a histogram. Lets say the next day I go out and sample an entirely new sample of 100 people. I will likely see an entirely new histogram z1 , z2 , z3 , ..., z100 . What you will see is that each sample will have the same joint distribution, but their realized distributions will dier. This is again because the joint distribution is based on the fact that before you get each respondents answer, the distribution of their random variables are representative of the true population and thus the same for every random variable. When I draw the sample and record their responses, I get a realized distribution that mimics the true populations distribution, but is not identical. All of this may seem kind of weird and its natural to be confused. Try to look over the book pages and ask questions; hopefully any confusion will be cleared up.

The Distribution of a Random Variable and the Distribution of the Sample Mean In this course we have discussed random variables, but now lets try to put those ideas in terms of the population and sample. Lets keep our height example: Let H f (h) denote the true distribution of heights in Econ 140. So in the population there is some distribution of heights and we can draw it if we knew the function f (h) Also, we could take a simple random sample: = {H1 , H2 , H3 , ..., H19 , H20 } Since we dont know the mean of f (h), we would like an estimator that would give us an estimate of H (we are letting H denote the mean of H). Since we dont have access to the unobservable function f(h), we are restricted to using our sample to get at H . A mathematical way of saying this is that we need function of the random variables H1 , H2 , H3 , ..., H19 , H20 or a sample statistic that will give us an estimate of H .

A reasonable thing to do would be to take the mean of our sample. Even though we do not have actual numbers in our sample, since we are thinking about the sample abstractly, we can still construct this mean in a general way: Sample Mean: H =
1 n n i=1 Hi

It is very important to realize that we are thinking about each Hi as a random variable and because our sample mean H is a function of random variables, we are dealing with a random variable H. Here, too, is a place for possible confusion because we have seen samples in other classes with concrete numbers and when we add those numbers together and divide by the size of the sample we have a new concrete number that is our mean. In this case, we are not thinking about a mean in terms of concrete numbers - we are thinking about a mean as a function of random variables. It turns out that the random variable H has a mean and variance like all the other random variables we have dealt with in this class. (I realize this is getting a little convoluted, because we are talking about the mean of H which is a mean of our sample.) Before we do any calculations, what would we like our mean and variance to be? Remember that the mean is like the center of the distribution. We have taken the sample mean, H, as an estimate of H , so hopefully the mean of the distribution of H is H . [Draw a general density function for H with probability on the y-axis and support of H on the x-axis.]
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Actually the mean of H is H . In order to show this we must remember that we are assuming that each Hi is distributed according to f (h). Therefore the mean of each Hi is just the mean of the population, H .

1 E[H] = E n =E =

Hi
i=1

1 {H1 + H2 + ... + H20 } n

1 E {H1 + H2 + ... + H20 } n 1 = E[H1 ] + E[H2 ] + ... + E[H20 ] n n 1 = E[Hi ] n = = 1 n

i=1 n i=1

1 n H n = H

We can do a similar calculation for the variance: V ar[H] = V ar 1 n

2

1 n V ar

Hi
i=1 n

= = = = = = =

Hi
i=1

1 V ar H1 + H2 + ... + H20 n2 1 V ar[H1 ] + V ar[H2 ] + ... + V ar[H20 ] What Property was used here? n2 1 2 2 2 H + H + ... + H n2 1 2 n H n2 1 2 n H 2 H n

Central Limit Theorem Based on the above discussion, we know that the sample mean H is a random variable with a mean 2 H of H and a variance of n . Unfortunately we do not know what the distribution of H is. Enter the Central Limit Theorem: If X1 , X2 , ... constitute a simple random sample from a population with mean X and variance 2 X , then the random variable XX has an approximately normal distribution with mean 0 and 2
X n

variance 1. The approximation is improves as n increases. Another way of stating the central limit theorem is the following X N X ,
2 X n

How are these two forms of the central limit theorem equivalent? Example: Consider the distribution of incomes in America. Let I denote the random variable for income. Assume (implausibly) that I is uniformly distributed from 0 to 60,000. Note the mean for this 2 2 distribution is 30,000 and just denote the variance as I (the variance is actually 60,000 whatever 12 that is...). Now suppose you take a simple random sample of 100 people. Draw and label a pdf of the random variable I and the sample mean I.
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