Applied Econometrics and Time Series Analysis Homework 3

Submitted by: Krishna Mohan Bibireddy, Mallikarjuna Kanala and Rajashri Roy
Problem 5.5
a) The median value of house is given by the following equation
Median value of house (in thousand $) = 28.4067 0.1834 x Crime (per capita crime
rate) 22.8108 x Nitox (Nitric oxide concentration ppm) + 6.3715 x Rooms (Average
number of rooms per dwelling) 0.0478 x Age (Proportion of owner occupied units built
prior to 1940) 1.3353 x Dist (Weighted distances to five Boston employment centers) +
0.2723 x Access (Index of accessibility to radial highways) 0.0126 x Tax (Full value
property-tax per 10000$) 1.1768 x Ptratio (Pupil-Teacher Ratio in Town) error
Crime The median value of house will decrease by $183.4 for every one unit increase
in per capita crime rate
Nitox - The median value of house will decrease by $22,810.8 for every 1 PPM increase
in Nitric Oxide
Rooms = The median value of house will increase by $6,371.5 for every one room
increase to the average number of rooms per dwelling
Age - The median value of house will decrease by $47.8 for every one unit increase to the
proportion of owner occupied units built prior to 1940
Dist - The median value of house will decrease by $1,335.3 for every one km increase to
the weighted distance to five Boston employment centers.
Access - The median value of house will increase by $2,723 for every one unit increase
to index of accessibility to radial highways.
Tax - The median value of house will decrease by $12.6 for every one unit increase to
full value property tax per 10000$
The median value of house will decrease by $1,177 for every one unit increase to PutilTeacher Ratio in town.
b) The confidence interval is given by the equation:
b (t(1-/2,Def of Freedom) x SE (b))
In this case = 0.05 and Degrees of Freedom = 497
Interval estimate = b 1.965 x SE (b)
Interval Estimate of Crime = - 0.1834 1.965 x 0.0365 = -0.1834 0.0717 = [-0.2551 0.1117]

Interval Estimate of Access = 0.2723 1.965 x 0.0723 = 0.2723 0.1421 = [0.1302

0.4144]
c) To test the hypothesis that increasing number of rooms by one increase the value of the
house by $7000
Null Hypotheses Rooms=7; Alternate Hypothesis Rooms7
t = (bRooms - Rooms)/SE(bRooms)
t = (6.3715 7)/0.3924 = -0.6285/0.3924 = -1.60.
At 95% confidence interval we will reject the null hypothesis using two tail test if the
absolute value of t is greater than 1.965.
In this case, absolute value of t = 1.60. Hence we will not reject the null hypothesis.
Therefore, the data is consistent with the fact that increases in rooms by one increase
the value of house by $7,000.
Alternate Way
Interval Estimate of Rooms for 95% confidence interval = 6.3715 1.965 x 0.3924 =
6.3715 0.7710 = [5.60 7.14].
The coefficient for Rooms must be 7 for the value of the increase by $ 7000 and the
coefficient 7 falls in the interval estimate for Rooms with 95% confidence interval.
Hence, using both the approaches data is consistent with the fact that increases in
rooms by one increase the value of house by $7,000.
d) To test hypothesis that reducing the pupil ratio by 10 will increase the value of a house by
more than $10,000
Null Hypothesis PT RATIO >= -1; Alternate Hypothesis RAT IO < -1
t = (bPT RAT IO PTRATIO)/SE(bPTRATIO)
t = (-1.1768 + 1)/0.1394 = -0.1768/0.1394 = -1.2683.
At 95% confidence interval we will reject the null hypothesis using single tail test if the
value of t is lower than -1.648 (t95,497 ). In this case the t value (-1.2683) is greater than 1.648. Hence we will not be able to reject the null hypothesis.
Alternate Way
Interval Estimate of Rooms for 95% confidence interval using single tail test = -1.1768
(-1.648 x 0.1394) = -1.1768 + 0.2297 = -0.9470. This is greater than -1. Hence, there is a
possibility that when pupil-tutor ratio is reduced by 10, the value of house will not
increase more than $10,000
Therefore, from both the approaches we cannot conclude that when pupil-tutor ratio is
reduced by 10, the value of house will increase more than $10,000.

Problem 5.9
The wage equation is given below:
Wage = -13.4303 + 2.774 Educ + 0.6821 Exp 0.0101 Exp2
a) Marginal effect of experience on wage is calculated by following equation:
Wage/Exp = 0.6821 0.0202 Exp
b) 2 should be positive as we expect the wage to increase with increase in education.
From the question it can be inferred that wage increase with experience and then
decreases after the middle age. This shows that wage as a function of experience is a
quadratic function. Also as wage increase initially and then decreases indicates that one
of the coefficient of exp term or exp 2 term is positive while that of the other is negative.
We need to have an absolute maximum in this case and that means that second derivate
of wage with respect to experience must be negative. This indicates that the coefficient of
exp2 is negative.
Therefore 3 is positive and 4 is negative.
c) Wage/Exp = 3 + 24 Exp
To arrive at the experience at which wage starts to decline we need to equate the first
derivative of wage with respect to experience to zero
Wage/Exp = 3 + 24 Exp Exp = -3 /(24 )
Therefore, the wage starts to decline after an experience of -3 /(24 ) years
e) The confidence interval is given by the equation:
Marginal Effect (t(1-/2,Def of Freedom) x SE (Marginal Effect))
In this case = 0.05 and Degrees of Freedom = 1000-4=996 t(97.5,996)= 1.962
(i)

Wage/Edu = 2
Var (Wage/Edu) = Var (2 ) = 0.019440281
SE (Wage/Edu) = sqrt (Var (2 )) = sqrt (0.019440281) = 0.1394
Marginal Effect of education on wages = Wage/Edu = 2 = 2.2774
95% Interval estimates = Marginal Effect (t(1-/2,Def of Freedom) x SE (Marginal
Effect))
95% Interval estimates = 2.2774 1.962 x 0.1394 = 2.2774 0.2735
95% Interval estimates for Marginal Effect of education on wages = [2.00389
2.5509]

(ii)

Wage/Exp = 3 + 24 Exp
Var (Wage/Exp) = Var(3 ) + 4 x Exp2 x Var(4 ) + 2 x 2 x Exp x Covar
(3 4 )
Given Exp = 4
Var (Wage/Exp) = 0.010987 + 4 x 16 x 0.000003476 + 4 x 4 x (0.0001893)
Var (Wage/Exp) = 0.010987 + 0.000222464 0.0030288
Var (Wage/Exp) = 0.008180664
SE (Wage/Exp) = sqrt (0.008180664) = 0.090447
Marginal Effect of experience on wages = Wage/Exp = 3 + 24 Exp
Marginal Effect of experience on wages = 0.6821 + 2 x (-0.0101) x 4 = 0.6013
95% Interval estimates = Marginal Effect (t(1-/2,Def of Freedom) x SE (Marginal
Effect))
95% Interval estimates = 0.6013 1.962 x 0.090447 = 0.6013 0.17474
95% Interval estimates for Marginal Effect of experience on wages = [0.42656
0.77606]

(iii)

Wage/Exp = 3 + 24 Exp
Var (Wage/Exp) = Var(3 ) + 4 x Exp2 x Var(4 ) + 2 x 2 x Exp x Covar
(3 4 )
Given Exp = 25
Var (Wage/Exp) = 0.010987 + 4 x 625 x 0.000003476 + 4 x 25 x (0.0001893)
Var (Wage/Exp) = 0.010987 + 0.00869 0.01893
Var (Wage/Exp) = 0.000747
SE (Wage/Exp) = sqrt (0.000747) = 0.02733
Marginal Effect of experience on wages = Wage/Exp = 3 + 24 Exp
Marginal Effect of experience on wages = 0.6821 + 2 x(-0.0101)x 25 = 0.1771
95% Interval estimates = Marginal Effect (t(1-/2,Def of Freedom) x SE (Marginal
Effect))
95% Interval estimates = 0.1771 1.962 x 0.02733 = 0.1771 0.05362
95% Interval estimates for Marginal Effect of experience on wages = [0.12348
0.23072]

Problem 5.12
A. Given the regression model is
Price = 1 + 2 Quant + 3 Qual + 4 Trend +e
In the above equation, we expect 2 to be negative. Here the quantity is number of grams in a
cocaine sale. Hence price per gram should decrease when large quantities are purchases due to
discount for larger sales.
With the quality we expect the coefficient to be positive as high quality will command higher
prices. Hence 3 is positive.
4 is the coefficient of trend. This coefficient can take positive or negative sign depending on
how demand and supply are changing over time. For example in future if we think that supply
will surpass the demand then 4 is negative indicating that price will decrease. In other case if we
think that the demand will surpass the supply in future then 4 is positive indicating that the price
will increase.
B. After importing the data file in stats, we have performed regression with the command
Regress Price Quant Qual Trend

From the above regression analysis we can write the regression equation as below
Price = 90.84669 -0.0599698 quant +0.1162052 qual -2.354579 trend
All the signs for coefficients have turned out as expected. The coefficient for trend is negative
indicating that supply surpasses the demand in future.

Interpretation of Coefficients

For increase in one unit of quantity the price decreases by 0.0599

For increase in one unit of quality the price increases by 0.1162
As time period increase by one year, the price decreases by 2.3554

C. The value of R-squared component in the regression analysis gives the proportion of
variation in cocaine price by variation in quantity, quality and time.
It is 0.5097 i.e. 50.97% of variation is due to these three variables.
D. Given claim is the greater the number of sales, higher the risk of getting caught.
H0 : The coefficient of quantity is greater than or equal to 0.
H1 : The coefficient of quantity is less than 0.
H0 is 2 0 and H1 = 2 < 0
Here, as per the regression analysis, the t value is -5.89 and the critical t-value for 95%
confidence and 52 (56-4) degrees of freedom is -1.67.
Here as the calculated t value is less than critical value we reject the null hypothesis that the
coefficient is greater than or equal to 0. Therefore, this indicates that the sellers are willing to
accept lower prices for sales in large quantities.
E. Alternative hypothesis is a premium paid for better quality of cocaine 3 > 0
Therefore H0 : 3 0 and H1 : 3 > 0
From regression analysis the t value is 0.57 which is less than the critical t-value at the df =52
and =0.05 is 1.67.
Hence we cannot reject the null hypothesis in this scenario. Thus we cannot conclude whether a
premium is paid for better quality of cocaine.
F. Average annual change in the cocaine price is given by the coefficient of trend i.e. -2.35 times
that of the previous year.
The reason for this could be increase in the number of merchants of cocaine i.e. increase in
illegal trade year on year is decreasing the prices as there is more supply compared demand.

Problem 5.19

From the regression analysis 2 = 0.0903 suggests that an increase of 1 year in education
increases the wage by 100* 2 % or 9.03%
Similarly 3 =0.00577 suggests that an increase of 1 year in experience increases the wage by
100* 3 % or 0.577%
4 =0.00894 suggests that an increase of 1 hours work increases the wage by 100* 4 % or 0.894%
b) Hypothesis: H0 : 2 >=0.10; Ha: 2 <0.10
The value of t-statistic is calculated below
t = (2 0.10)/SE = (0.0903 0.10)/0.0060781 = -1.59. The critical t value for 95% confidence
and 996 degrees of freedom is -1.646.
Therefore as calculated t value is less than critical t value we will not reject null hypothesis.

Using STATA
STATA Code:
* hypothesis H0: beta2>=0.10 vs H1: beta2<0.10:
scalar tstat1=(_b[educ]-0.10)/_se[educ]
di tstat1
lincom educ
scalar cv1=invttail(996,0.05)
di cv1

For left tailed test the critical t value is -1.64 and the calculate t value is -1.59.
As the tstat>critical value in left tail test, we dont reject the null hypothesis. Hence we cannot
conclude that extra year of education increases the wage rate by atleast 10%.

c) 90% interval estimate for 3

3 - tvalue*SE to 3 + tvalue*SE
0.0089411-1.646* 0.0015813 to 0.0089411+1.646* 0.0015813
0.006338 to 0.01154
Range of percentage increase =100* 3
0.6338% to 1.154%
d) gen educ_exper=educ*exper
gen educ_sq=educ*educ
gen exper_sq=exper*exper
regress ln_wage educ exper hrswk educ_exper educ_sq exper_sq

So from the re-estimated model coefficients of educ*exper and education are not significant at a
95% confidence but other new variables are significant at 95% confidence.
e) The new model is
Ln(wage)=1 + 2 *educ+ 3 *exper+ 4 *hrswk+ 5 *educ*exper+ 6 *educ*educ+
7 *exper*exper+e
ln(wage)/educ = 2 + 5 *exper+2* 6 *educ
ln(wage)/exper = 3 + 5 *educ+2* 7 *exper
f) Jill has 16 years of education and 10 years of experience
So Jills marginal effect of education is = 2 + 5 *exper+2* 6 *educ
= 2 + 5 *10+2* 6 *16
=0.049028-0.0009238*10+2*0.0023649*16
=0.049028-0.009238+0.07567
=0.1154
Wendy has 12 years of education and 10 years of experience
So Wendys marginal effect of education is
= 2 + 5 *exper+2* 6 *educ

= 2 + 5 *10+2* 6 *12
=0.049028-0.0009238*10+2*0.0023649*12 = 0.09611
So as the education increases it has positive impact on wage i.e as education increases the wage
increase. Also, the marginal effect for Jill is more than that of Wendy.
g) We need to test alternate hypothesis:
Jills marginal effect of education> Wendys marginal effect of education
2 + 5 *10+2* 6 *16> 2 + 5 *10+2* 6 *12
6>0
Hypothesis:
H0 : 6 0
Ha: 6 > 0
From regression analysis and above output table we observe that the t value is 2.14. The critical
value for 95% confidence and 996 degrees of freedom is 1.646. As calculate t value is greater
than the critical t value we will reject the null hypothesis and conclude that Jills marhinal effect
of education is greater than that of Wendy.
h) ln(wage)/exper = 3 + 5 *educ+2* 7 *exper
Chris has 16 years of education and 20 years of experience
So Chiss marginal effect of experience is
= 3 + 5 *educ+2* 7 *exper
=0.052745-0.0009238*16-2*0.0006287*20
=0.052745-0.01478-0.025148= 0.012817
Dave has 16 years of education and 30 years of experience
So Daves marginal effect of experience is
= 3 + 5 *educ+2* 7 *exper
=0.052745-0.0009238*16-2*0.0006287*30 =0.052745-0.0147808-0.037722= 0.0002422
The marginal effect of experience is greater for Chris compared to that of Dave. Also, the
marginal effect of experience decreases with increase in experience.