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FUNCTIONAL FORMS
OF REGRESSION MODELS
Damodar Gujarati
Econometrics by Example
LOG-LINEAR, DOUBLE LOG, OR
CONSTANT ELASTICITY MODELS
The Cobb-Douglas Production Function:
Qi B1 Li KiB2 B3
Damodar Gujarati
Econometrics by Example
LOG-LIN OR GROWTH MODELS
The rate of growth of real GDP:
RGDPt RGDP1960 (1 r )t
can be transformed into a linear model by taking natural
logs of both sides:
ln RGDPt ln RGDP1960 t ln(1 r )
Letting B1 = ln RGDP1960 and B2 = ln (l+r), this can be
rewritten as:
ln RGDPt = B1 +B2 t
B2 is considered a semi-elasticity or an instantaneous growth rate.
The compound growth rate (r) is equal to (eB2 – 1).
Damodar Gujarati
Econometrics by Example
LIN-LOG MODELS
Lin-log models follow this general form:
Yi B1 B2 ln X i ui
Damodar Gujarati
Econometrics by Example
RECIPROCAL MODELS
Lin-log models follow this general form:
1
Yi B1 B2 ( ) ui
Xi
Note that:
1
As X increases indefinitely, the term B2 ( ) approaches zero and Y approaches
the limiting or asymptotic value B1. Xi
The slope is:
dY 1
B2 ( 2 )
dX X
Therefore, if B2 is positive, the slope is negative throughout, and if B2 is negative,
the slope is positive throughout.
Damodar Gujarati
Econometrics by Example
POLYNOMIAL REGRESSION MODELS
The following regression predicting GDP is an example of
a quadratic function, or more generally, a second-degree
polynomial in the variable time:
RGDPt A1 A2time A3time2 ut
Damodar Gujarati
Econometrics by Example
SUMMARY OF FUNCTIONAL FORMS
MODEL FORM SLOPE ELASTICITY
dY dY X
( ) .
dX dX Y
X
Linear Y =B1 + B2 X B2 B2 ( )
Y
Y
Log-linear lnY =B1 + ln X B2 ( ) B2
X
1 1
Lin-log Y B1 B2 ln X B2 ( ) B2 ( )
X Y
1 1 1
Reciprocal Y B1 B2 ( ) B2 ( ) B2 ( )
X X2 XY
Damodar Gujarati
Econometrics by Example
COMPARING ON BASIS OF R2
We cannot directly compare two models that have different
dependent variables.
We can transform the models as follows and compare RSS:
Step 1: Compute the geometric mean (GM) of the dependent
variable, call it Y*.
Step 2: Divide Yi by Y* to obtain: Yi Y~
i
Y*
Step 3: Estimate the equation with lnYi as the dependent variable
using Y~i in lieu of Yi as the dependent variable (i.e., use ln Y~ as
i
the dependent variable).
Step 4: Estimate the equation with Yi as the dependent variable
using Y~i as the dependent variable instead of Yi.
Damodar Gujarati
Econometrics by Example
STANDARDIZED VARIABLES
We can avoid the problem of having variables
measured in different units by expressing them in
standardized form:
_
Yi Y Xi X
Yi
*
; Xi
*
SY SX
where_ SY and SX are the sample standard deviations
_
and Y and X are the sample means of Y and X,
respectively
The mean value of a standardized variable is always
zero and its standard deviation value is always 1.
Damodar Gujarati
Econometrics by Example
MEASURES OF GOODNESS OF FIT
R2: Measures the proportion of the variation in the regressand explained
by the regressors.
2
Adjusted R2: Denoted as R , it takes degrees of freedom into account:
_
n 1
R 2 1 (1 R 2 )
nk
Akaike’s Information Criterion (AIC): Adds harsher penalty for
adding more variables to the model, defined as:
2k RSS
ln AIC ln( )
n n
The model with the lowest AIC is usually chosen.
Schwarz’s Information Criterion (SIC): Alternative to the AIC
criterion, expressed as: k RSS
ln SIC ln n ln( )
n n
The penalty factor here is harsher than that of AIC.
Damodar Gujarati
Econometrics by Example