Solutions, Chapter 2/HL

ANSWERS TO CHAPTER 2
The Simple Regression Model

Econometrics
Economics of Innovation and Growth

A = Problems
B = Examples (from chapter 2)
C = Cumputer Exercises

Solutions, Chapter 2/HL

A: Problems
2.1
Let kids denote the number of children born to a woman, and let educ denote years of
education for the woman. A simple model relating fertility to years of education is
kids = 0 + 1educ + u
where u is the unobserved error.
(i)
(ii)

What kind of factors are contained in u? Are these likely to be correlated with
level of education?
Will a simple regression analysis uncover ceteris paribus effects of education on
fertility? Explain.

(i) Income, age, and family background (such as number of siblings) are just a few
possibilities. It seems that each of these could be correlated with years of education. (Income
and education are probably positively correlated; age and education may be negatively
correlated because women in more recent cohorts have, on average, more education; and
number of siblings and education are probably negatively correlated.)
(ii) Not if the factors we listed in part (i) are correlated with educ. Because we would like to
hold these factors fixed, they are part of the error term. But if u is correlated with educ then
E(u|educ) 0, and so SLR.3 fails.
--------------------------------------------------------------------------------------------------------------2.2
In the simple linear regression model y=0+1x + u, suppose that E(u) 0. Letting
0=e(u), show that the model can always be rewritten with the same slope, but new
intercept and error, where the new error has a zero expected value.
Answers
In the equation y = 0 + 1x + u, add and subtract 0 from the right hand side to get y = (0 +
0) + 1x + (u 0). Call the new error e = u 0, so that E(e) = 0. The new intercept is 0 +
0, but the slope is still 1.

Solutions, Chapter 2/HL

2.3
The following table contains the ATC scores and the GPA (grade point average) for 8
college students. Grade point average is based on a four-point scale and has been rounded
to the one digit after the decimal.
Student
1
2
3
4
5
6
7
8

GPA
2.8
3.4
3.0
3.5
3.6
3.0
2.7
3.7

ACT
21
24
26
27
39
25
25
30

(i) Estimate the relationship between GPA and ACT using ols; that is, obtain the
intercept and slope in the equation
GP A = 0 + 1 ACT

Comment on the direction of the relationship. Does the intercept have a useful
interpretation here? Explain. How much higher is GPA predicted to be if the ACT
score is increased by 5 points?
(ii) Compute the fitted valued and the residuals for each observation, and verify that
the residuals (approximately) sum to zero.
(iii) What is the predicted value of GPA when ACT =20?
(iv) How much of the variation in GPA for the 8 students is explained by ACT.
Explain.

2.3 (i) Let yi = GPAi, xi = ACTi, and n = 8. Then x = 25.875, y = 3.2125, (xi x )(yi
i=1
n

y ) = 5.8125, and (xi x )2 = 56.875. From equation (2.9), we obtain the slope as 1 =
i=1

5.8125/56.875 .1022, rounded to four places after the decimal. From (2.17), 0 = y
x 3.2125 (.1022)25.875 .5681. So we can write
1

GPA
= .5681 + .1022 ACT

n = 8.
The intercept does not have a useful interpretation because ACT is not close to zero for the
increases by .1022(5) = .511.
population of interest. If ACT is 5 points higher, GPA

Solutions, Chapter 2/HL

(ii) The fitted values and residuals rounded to four decimal places are given along
with the observation number i and GPA in the following table:

GPA

i GPA
1 2.8

2.7143 .0857

2 3.4

3.0209 .3791

3 3.0

3.2253 .2253

4 3.5

3.3275 .1725

5 3.6

3.5319 .0681

6 3.0

3.1231 .1231

7 2.7

3.1231 .4231

8 3.7

3.6341 .0659

You can verify that the residuals, as reported in the table, sum to .0002, which is pretty close
to zero given the inherent rounding error.
= .5681 + .1022(20) 2.61.
(iii) When ACT = 20, GPA
n

(iv) The sum of squared residuals,

u
i =1

and the total sum of squares,

(yi

2
i

, is about .4347 (rounded to four decimal places),

y )2, is about 1.0288. So the R-squared from the

i=1

regression is
R2 = 1 SSR/SST 1 (.4347/1.0288) .577.

Therefore, about 57.7% of the variation in GPA is explained by ACT in this small sample of
students.
--------------------------------------------------------------------------------------------------------------2.4
The data set BWGHT.DTA contains data on births to women in the United States. Two
variables of interest are the dependent variable infant birth weight on ounces (bwght), and an
explanatory variable, average number of cigarettes the mother smoked per day during
pregnancy (cigs). The following simple regression was estimated using data on n=1,388 births

bwght = 119.77 0.514cigs

(i) What is the predicted birth weight when cig s= 0? What about when cigs = 20?
Comment on the difference.
(ii) Does the simple regression necessarily capture a causal relationship between the
chids birth weight and the mothers smoking habits? Explain.

Solutions, Chapter 2/HL

(iii) The predict a birth weight of 125 ounces, what would cigs have to be? Comment.
(iv) What fraction of the women in the sample do not smoke while pregnant? Does this
help reconcile your finding from part (iii)?

= 109.49.
(i) When cigs = 0, predicted birth weight is 119.77 ounces. When cigs = 20, bwght
This is about an 8.6% drop.

(ii) Not necessarily. There are many other factors that can affect birth weight, particularly
overall health of the mother and quality of prenatal care. These could be correlated with
cigarette smoking during birth. Also, something such as caffeine consumption can affect birth
weight, and might also be correlated with cigarette smoking.
(iii) If we want a predicted bwght of 125, then cigs = (125 119.77)/( .524) 10.18, or
about 10 cigarettes! This is nonsense, of course, and it shows what happens when we are
trying to predict something as complicated as birth weight with only a single explanatory
variable. The largest predicted birth weight is necessarily 119.77. Yet almost 700 of the
births in the sample had a birth weight higher than 119.77.
(iii) 1,176 out of 1,388 women did not smoke while pregnant, or about 84.7%.
--------------------------------------------------------------------------------------------------------------2.5
In the linear consumption function
cons = 0 + 1inc

the (estimated) marginal propensity to consume (MPC) out of the income is simply the slope
1 , while the average propensity to consume (APC) is cons / inc = 0 / inc + 1
Using observations for 100 families, the annual income and consumption (both measured in
dollars), the following equation is obtained:
Cons(est)=-124.84 + 0.853 inc
N = 100, R2=0.692
(i) Interpret the intercept in this equation, and comment onb its sign and magnitude.
(ii) What is the predicted consumption when family income is $30,000?
(iii) Whit inc on the x-axis, draw the graph of the estimated MPC and APC

(i) The intercept implies that when inc = 0, cons is predicted to be negative $124.84. This, of
course, cannot be true, and reflects that fact that this consumption function might be a poor
predictor of consumption at very low-income levels. On the other hand, on an annual basis,
$124.84 is not so far from zero.
= 124.84 + .853(30,000) = 25,465.16 dollars.
(ii) Just plug 30,000 into the equation: cons

Solutions, Chapter 2/HL

(iii) The MPC and the APC are shown in the following graph. Even though the intercept is
negative, the smallest APC in the sample is positive. The graph starts at an annual income
level of $1,000 (in 1970 dollars).

MPC
APC

.9

MPC
.853

APC

.728
.7
1000

20000

10000

30000

inc

--------------------------------------------------------------------------------------------------------------2.6
Using data from 1988 for houses sold in Andover, Massachusetts, from Kiel and McClain
(1995), the following equation relates housing price (price) to the distance from the recently
built garbage incinerator (dist):
Log (price) = 0.9.40 + 0.213 log(dist)
N = 135, R2=0.162
(i) Interpret the coefficient on log (dist). Is the sign of this estimate what you expected it
to be?
(ii) Do you think simple regression provides an unbiased estimator of the ceteris paribus
elasticity of price with respect to dist? (Think about the citys decision on where to put
the incinerator.)

Solutions, Chapter 2/HL

(iii) What other factors about a house affect its price? Might these be correlated with
distance from the incinerator?

(i) Yes. If living closer to an incinerator depresses housing prices, then being farther away
increases housing prices.
(ii) If the city chose to locate the incinerator in an area away from more expensive
neighborhoods, then log(dist) is positively correlated with housing quality. This would
violate SLR.3, and OLS estimation is biased.
(iii) Size of the house, number of bathrooms, size of the lot, age of the home, and quality of
the neighborhood (including school quality), are just a handful of factors. As mentioned in
part (ii), these could certainly be correlated with dist [and log(dist)].

Solutions, Chapter 2/HL

B: Examples
Example 2.3: CEO Salary and Return on Equity
Data: CEOSAL1
sum salary roe
Variable |
Obs
Mean
Std. Dev.
Min
Max
---------+----------------------------------------------------salary |
209
1281.12
1372.345
223
14822
roe |
209
17.18421
8.518509
.5
56.3
reg salary roe
Source |
SS
df
MS
---------+-----------------------------Model | 5166419.04
1 5166419.04
Residual |
386566563
207 1867471.32
---------+-----------------------------Total |
391732982
208 1883331.64

Number of obs
F( 1,
207)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

209
2.77
0.0978
0.0132
0.0084
1366.6

-----------------------------------------------------------------------------salary |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------roe |
18.50119
11.12325
1.663
0.098
-3.428195
40.43057
_cons |
963.1913
213.2403
4.517
0.000
542.7902
1383.592
-----------------------------------------------------------------------------Salary for ROE = 0
display _b[roe]*0+_b[_cons]
963.19134

Salary for ROE = 30

display _b[roe]*30+_b[_cons]
1518.2269

Example 2.4: Wage and Education

Data WAGE1
summ wage
Variable |
Obs
Mean
Std. Dev.
Min
Max
---------+----------------------------------------------------wage |
526
5.896103
3.693086
.53
24.98
reg wage educ
Source |
SS
df
MS
Number of obs =
526
---------+-----------------------------F( 1,
524) = 103.36
Model | 1179.73204
1 1179.73204
Prob > F
= 0.0000
Residual | 5980.68225
524 11.4135158
R-squared
= 0.1648
---------+-----------------------------Adj R-squared = 0.1632
Total | 7160.41429
525 13.6388844
Root MSE
= 3.3784
-----------------------------------------------------------------------------wage |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------educ |
.5413593
.053248
10.167
0.000
.4367534
.6459651
_cons | -.9048516
.6849678
-1.321
0.187
-2.250472
.4407687
-----------------------------------------------------------------------------Wage for educ = 0
display _b[educ]*0+_b[_cons]
-.90485161
Wage for educ = 8
display _b[educ]*8+_b[_cons]
3.4260224
Return to 4 years education
display _b[educ]*4
2.165437

Solutions, Chapter 2/HL

Example 2.5: Voting Outcomes and Campaign Expenditures
Data
VOTE1
reg voteA shareA
Source |
SS
df
MS
---------+-----------------------------Model | 41486.4749
1 41486.4749
Residual | 6970.77363
171 40.7647581
---------+-----------------------------Total | 48457.2486
172 281.728189

Number of obs
F( 1,
171)
Prob > F
R-squared
Adj R-squared
Root MSE

=
173
= 1017.70
= 0.0000
= 0.8561
= 0.8553
= 6.3847

-----------------------------------------------------------------------------voteA |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------shareA |
.4638239
.0145393
31.901
0.000
.4351243
.4925234
_cons |
26.81254
.8871887
30.222
0.000
25.06129
28.56379
------------------------------------------------------------------------------

Example 2.6: CEO Salary and Return on Equity

Data: CEOSAL1
summ salary roe
Variable |
Obs
Mean
Std. Dev.
Min
Max
---------+----------------------------------------------------salary |
209
1281.12
1372.345
223
14822
roe |
209
17.18421
8.518509
.5
56.3
reg salary roe
Source |
SS
df
MS
---------+-----------------------------Model | 5166419.04
1 5166419.04
Residual |
386566563
207 1867471.32
---------+-----------------------------Total |
391732982
208 1883331.64

Number of obs
F( 1,
207)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

209
2.77
0.0978
0.0132
0.0084
1366.6

-----------------------------------------------------------------------------salary |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------roe |
18.50119
11.12325
1.663
0.098
-3.428195
40.43057
_cons |
963.1913
213.2403
4.517
0.000
542.7902
1383.592
-----------------------------------------------------------------------------Fitted Values and Residuals for the First 15 CEOs
predict salhat, xb
gen uhat=salary-salhat
list roe salary salhat uhat in 1/15

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

roe
14.1
10.9
23.5
5.9
13.8
20
16.4
16.3
10.5
26.3
25.9
26.8
14.8
22.3
56.3

salary
1095
1001
1122
578
1368
1145
1078
1094
1237
833
567
933
1339
937
2011

salhat
1224.058
1164.854
1397.969
1072.348
1218.508
1333.215
1266.611
1264.761
1157.454
1449.773
1442.372
1459.023
1237.009
1375.768
2004.808

uhat
-129.0581
-163.8542
-275.9692
-494.3484
149.4923
-188.2151
-188.6108
-170.7606
79.54626
-616.7726
-875.3721
-526.0231
101.9911
-438.7678
6.191895

Solutions, Chapter 2/HL

Example 2.7: Wage and Education
Data: WAGE1
summ wage educ
Variable |
Obs
Mean
Std. Dev.
Min
Max
---------+----------------------------------------------------wage |
526
5.896103
3.693086
.53
24.98
educ |
526
12.56274
2.769022
0
18
reg wage educ
Source |
SS
df
MS
Number of obs =
526
---------+-----------------------------F( 1,
524) = 103.36
Model | 1179.73204
1 1179.73204
Prob > F
= 0.0000
Residual | 5980.68225
524 11.4135158
R-squared
= 0.1648
---------+-----------------------------Adj R-squared = 0.1632
Total | 7160.41429
525 13.6388844
Root MSE
= 3.3784
-----------------------------------------------------------------------------wage |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------educ |
.5413593
.053248
10.167
0.000
.4367534
.6459651
_cons | -.9048516
.6849678
-1.321
0.187
-2.250472
.4407687
-----------------------------------------------------------------------------Wage for educ = 12.56
display _b[educ]*12.56+_b[_cons]
5.8824

Example 2.8: CEO Salary and Return on Equity

Data: CEOSAL1
reg salary roe
Source |
SS
df
MS
---------+-----------------------------Model | 5166419.04
1 5166419.04
Residual |
386566563
207 1867471.32
---------+-----------------------------Total |
391732982
208 1883331.64

Number of obs
F( 1,
207)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

209
2.77
0.0978
0.0132
0.0084
1366.6

-----------------------------------------------------------------------------salary |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------roe |
18.50119
11.12325
1.663
0.098
-3.428195
40.43057
_cons |
963.1913
213.2403
4.517
0.000
542.7902
1383.592
------------------------------------------------------------------------------

Example 2.9: Voting Outcomes and Campaign Expenditures

Data: VOTE1
reg voteA shareA
Source |
SS
df
MS
---------+-----------------------------Model | 41486.4749
1 41486.4749
Residual | 6970.77363
171 40.7647581
---------+-----------------------------Total | 48457.2486
172 281.728189

Number of obs
F( 1,
171)
Prob > F
R-squared
Adj R-squared
Root MSE

=
173
= 1017.70
= 0.0000
= 0.8561
= 0.8553
= 6.3847

-----------------------------------------------------------------------------voteA |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------shareA |
.4638239
.0145393
31.901
0.000
.4351243
.4925234
_cons |
26.81254
.8871887
30.222
0.000
25.06129
28.56379
------------------------------------------------------------------------------

10

Solutions, Chapter 2/HL

Example 2.10: A Log Wage Equation

Data:WAGE1
reg lwage educ
Source |
SS
df
MS
---------+-----------------------------Model | 27.5606296
1 27.5606296
Residual | 120.769132
524 .230475443
---------+-----------------------------Total | 148.329762
525
.28253288

Number of obs
F( 1,
524)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

526
119.58
0.0000
0.1858
0.1843
.48008

-----------------------------------------------------------------------------lwage |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------educ |
.0827444
.0075667
10.935
0.000
.0678796
.0976092
_cons |
.5837726
.0973358
5.998
0.000
.3925562
.774989
------------------------------------------------------------------------------

Example 2.11: CEO Salary and Firm Sales

Data CEOSAL1
reg lsalary lsales
Source |
SS
df
MS
---------+-----------------------------Model | 14.0661711
1 14.0661711
Residual | 52.6559988
207 .254376806
---------+-----------------------------Total | 66.7221699
208 .320779663

Number of obs
F( 1,
207)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

209
55.30
0.0000
0.2108
0.2070
.50436

-----------------------------------------------------------------------------lsalary |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------lsales |
.2566717
.0345167
7.436
0.000
.1886225
.324721
_cons |
4.821996
.2883397
16.723
0.000
4.253537
5.390455
------------------------------------------------------------------------------

Example 2.12: Student Math Performance and the School Lunch Program
Data: MEAP93
reg math10 lnchprg
Source |
SS
df
MS
---------+-----------------------------Model | 7665.26597
1 7665.26597
Residual | 37151.9145
406 91.5071786
---------+-----------------------------Total | 44817.1805
407 110.115923

Number of obs
F( 1,
406)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

408
83.77
0.0000
0.1710
0.1690
9.5659

-----------------------------------------------------------------------------math10 |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
---------+-------------------------------------------------------------------lnchprg | -.3188643
.0348393
-9.152
0.000
-.3873523
-.2503763
_cons |
32.14271
.9975824
32.221
0.000
30.18164
34.10378
------------------------------------------------------------------------------

11

Solutions, Chapter 2/HL

C: Computer exercises
Question 2.10*
Data: 401K.DTA

The data in 401K.DTA are a subset of data analysed by Papke (1995) to study the relationship
between participation in a 401and the generosity of the plan. The variable prate is the
percentage of eligible workers with an active account: This is the variable we would like to
explain. The measure of generosity is the plan match rate, mrate. This variable gives the
average amount the firm contributes to each workers plan for each $1 dollar contribution by
thw workers. For example, if mrate=0.50, then $1 contribution by the worker is matched by a
50 cents contribution by the firm
(i) Find the average participation rate and the average match rate in the sample of plan.
Answer
*i
sum prate mrate
Variable |
Obs
Mean
Std. Dev.
Min
Max
-------------+-------------------------------------------------------prate |
1534
87.36291
16.71654
3
100
mrate |
1534
.7315124
.7795393
.01
4.91

The average prate is about 87.36 and the average mrate is about .732.
(ii) Estimate the simple regression equation prate = 0 + 1mrate and report the results
along the sample size and R-squared.
*ii
reg prate mrate
Source |
SS
df
MS
-------------+-----------------------------Model | 32001.7271
1 32001.7271
Residual | 396383.812 1532
258.73617
-------------+-----------------------------Total | 428385.539 1533 279.442622

Number of obs
F( 1, 1532)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

1534
123.68
0.0000
0.0747
0.0741
16.085

-----------------------------------------------------------------------------prate |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------mrate |
5.861079
.5270107
11.12
0.000
4.82734
6.894818
_cons |
83.07546
.5632844
147.48
0.000
81.97057
84.18035
------------------------------------------------------------------------------

The estimated equation is

prate = 83.05 + 5.86 mrate

n = 1,534, R2 = .075
(iii) Interpret the intercept in your equation. Interpret the coefficient on mrate.

The intercept implies that, even if mrate = 0, the predicted participation rate is 83.05 percent.
The coefficient on mrate implies that a one-dollar increase in the match rate a fairly large
increase is estimated to increase prate by 5.86 percentage points. This assumes, of course,
that this change prate is possible (if, say, prate is already at 98, this interpretation makes no
sense).

12

Solutions, Chapter 2/HL

(iv) Find the predicted prate when mrate =3.5. Is this a reasonable prediction? Explain
what is happening here.

= 83.05 + 5.86(3.5) = 103.59. This is

If we plug mrate = 3.5 into the equation we get prate
impossible, as we can have at most a 100 percent participation rate. This illustrates that,
especially when dependent variables are bounded, a simple regression model can give strange
predictions for extreme values of the independent variable. (In the sample of 1,534 firms,
only 34 have mrate 3.5.)
(v) How much of the variation in prate is explained by mrate. Is this a lot in your
opinion?

(v) mrate explains about 7.5% of the variation in prate. This is not much, and suggests that
many other factors influence 401(k) plan participation rates.

Question 2.11

The data set in CEOSAL2.DTA contains information of chief executive officers for U.S
corporations. The variable salary is annual compensation, in thousand of dollars, and
ceoten is prior number of years as company CEO.
(i) Find the average salary and the average tenure in the sample
sum salary ceoten
Variable |
Obs
Mean
Std. Dev.
Min
Max
-------------+-------------------------------------------------------salary |
177
865.8644
587.5893
100
5299
ceoten |
177
7.954802
7.150826
0
37

Average salary is about 865.864, which means $865,864 because salary is in thousands of
dollars. Average ceoten is about 7.95.
(ii) How many CEOs are in their first year as CEO (that is, ceoten=0)?, what is the
longest tenure as CEO

There are five CEOs with ceoten = 0. The longest tenure is 37 years.
*ii
tab ceoten
years as |
ceo with |
company |
Freq.
Percent
Cum.
------------+----------------------------------0 |
5
2.82
2.82
1 |
19
10.73
13.56
2 |
10
5.65
19.21
3 |
21
11.86
31.07
4 |
21
11.86
42.94
5 |
10
5.65
48.59
6 |
11
6.21
54.80
7 |
6
3.39
58.19
8 |
11
6.21
64.41
9 |
8
4.52
68.93
10 |
8
4.52
73.45
11 |
4
2.26
75.71

13

Solutions, Chapter 2/HL

12 |
7
3.95
79.66
13 |
7
3.95
83.62
14 |
5
2.82
86.44
15 |
2
1.13
87.57
16 |
2
1.13
88.70
17 |
2
1.13
89.83
18 |
1
0.56
90.40
19 |
2
1.13
91.53
20 |
4
2.26
93.79
21 |
1
0.56
94.35
22 |
1
0.56
94.92
24 |
3
1.69
96.61
26 |
2
1.13
97.74
28 |
1
0.56
98.31
34 |
1
0.56
98.87
37 |
2
1.13
100.00
------------+----------------------------------Total |
177
100.00

(iii) Estimate the simple regression model log(salary ) = 0 + 1ceoten + u and report
your results in the usual form. What is the (approcimate) predicted percentage
increase in salary given one more year as CEO
*iii
reg lsalary ceoten
Source |
SS
df
MS
-------------+-----------------------------Model | .850907024
1 .850907024
Residual |
63.795306
175 .364544606
-------------+-----------------------------Total | 64.6462131
176 .367308029

Number of obs
F( 1,
175)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

177
2.33
0.1284
0.0132
0.0075
.60378

-----------------------------------------------------------------------------lsalary |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------ceoten |
.0097236
.0063645
1.53
0.128
-.0028374
.0222846
_cons |
6.505498
.0679911
95.68
0.000
6.37131
6.639686
------------------------------------------------------------------------------

(iii) The estimated equation is

log (salary ) = 6.51 + .0097 ceoten

n = 177, R2 = .013.
We obtain the approximate percentage change in salary given ceoten = 1 by multiplying the
coefficient on ceoten by 100, 100(.0097) = 0.97%. Therefore, one more year as CEO is
predicted to increase salary by almost 1%.

2.12
USE the data SLEEP 75.DTA to study whether there is a trade off between time spent
sleeping per week and the time spent in paid work. We could use either variable is the
dependent variable. For concreteness, estimate the model: sleep = 0 + 1totwrk + u where
sleep is minutes sleeping per week and totwrk is total minutes working during the week.
(i) Report your results in equation form along with the number of observations and R2.
What does the intercept in this equation mean?

14

Solutions, Chapter 2/HL

*i
reg sleep totwrk
Source |
SS
df
MS
-------------+-----------------------------Model | 14381717.2
1 14381717.2
Residual |
124858119
704 177355.282
-------------+-----------------------------Total |
139239836
705 197503.313

Number of obs
F( 1,
704)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

706
81.09
0.0000
0.1033
0.1020
421.14

-----------------------------------------------------------------------------sleep |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------totwrk | -.1507458
.0167403
-9.00
0.000
-.1836126
-.117879
_cons |
3586.377
38.91243
92.17
0.000
3509.979
3662.775
------------------------------------------------------------------------------

The estimated equation is

Sleep = 3,586.4 .151 totwrk

n = 706, R2 = .103.
The intercept implies that the estimated amount of sleep per week for someone who does not
work is 3,586.4 minutes, or about 59.77 hours. This comes to about 8.5 hours per night.
(ii) If totwrk increases by 2 hours, by how much is sleep estimated to fall? Do you find
this to be a large effect?

If someone works two more hours per week then totwrk = 120 (because totwrk is measured
= .151(120) = 18.12 minutes. This is only a few minutes a
in minutes), and so sleep
=
night. If someone were to work one more hour on each of five working days, sleep
.151(300) = 45.3 minutes, or about five minutes a night.
2.13
Use the data in WAGE.DTA to estimate a simple regression explaining monthly salary
(wage) in terms of IQ score (IQ)
(i) Find the average salary and average IQ in the sample. What is the standard deviation
of IQ? (IQ scores are standardized so that the average in the population is 100 with the
standard deviation equal to 15.)
sum wage IQ
Variable |

Obs

Mean

Std. Dev.

Min

Max

-------------+-------------------------------------------------------wage |
935
957.9455
404.3608
115
3078
IQ |
935
101.2824
15.05264
50
145

Average salary is about $957.95 and average IQ is about 101.28. The sample standard
deviation of IQ is about 15.05, which is pretty close to the population value of 15.

15

Solutions, Chapter 2/HL

(ii)
Estimate the simple regression model where a one-point increase in IQ change wage by a
constant dollar amount. Use this model to find the predicted increase in wage for an
increase in IQ of 15 points. Does IQ explain most of the variation in wage?
*ii
reg wage IQ
Source |
SS
df
MS
-------------+-----------------------------Model | 14589782.6
1 14589782.6
Residual |
138126386
933 148045.429
-------------+-----------------------------Total |
152716168
934 163507.675

Number of obs
F( 1,
933)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

935
98.55
0.0000
0.0955
0.0946
384.77

-----------------------------------------------------------------------------wage |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------IQ |
8.303064
.8363951
9.93
0.000
6.661631
9.944498
_cons |
116.9916
85.64153
1.37
0.172
-51.08078
285.0639
------------------------------------------------------------------------------

This calls for a level-level model:

= 116.99 + 8.30 IQ
wage

n = 935, R2 = .096.
An increase in IQ of 15 increases predicted monthly salary by 8.30(15) = $124.50 (in 1980
dollars). IQ score does not even explain 10% of the variation in wage.
(iii)
Now, estimate a model where each one-point increase in IQ has the same percentage
effect on wage. If IQ increases by 15 points, what is the approximate percentage increase
in the predicted wage?
reg lwage IQ
Source |
SS
df
MS
-------------+-----------------------------Model | 16.4150939
1 16.4150939
Residual | 149.241189
933 .159958402
-------------+-----------------------------Total | 165.656283
934 .177362188

Number of obs
F( 1,
933)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

935
102.62
0.0000
0.0991
0.0981
.39995

-----------------------------------------------------------------------------lwage |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------IQ |
.0088072
.0008694
10.13
0.000
.007101
.0105134
_cons |
5.886994
.0890206
66.13
0.000
5.712291
6.061698
------------------------------------------------------------------------------

This calls for a log-level model:

log (wage) = 5.89 + .0088 IQ

n = 935, R2 = .099.

16

Solutions, Chapter 2/HL

If IQ = 15 then log (wage) = .0088(15) = .132, which is the (approximate) proportionate
change in predicted wage. The percentage increase is therefore approximately 13.2.

2.14
For the population of firm in the chemical industry, let rd denote annual expenditures on
research and development, and let sales denote annual sales (both are in million of dollars).
(i) Write down a model (not an estimated equation) that implies a constant elasticity
between rd and sales. Which parameter is the elasticity?

The constant elasticity model is a log-log model:

log(rd) = 0 + 1 log(sales) + u,
where 1 is the elasticity of rd with respect to sales.
(ii) Now, estimate the model using RDCHEM.DTA. Write out the the estimated equation
in the usual form. What is the elasticity of rd with respect to sales? Explain what this
elasticity means.
i
reg lrd lsales
*ii
reg lrd lsales
Source |
SS
df
MS
-------------+-----------------------------Model | 84.8395785
1 84.8395785
Residual | 8.40768588
30 .280256196
-------------+-----------------------------Total | 93.2472644
31 3.00797627

Number of obs
F( 1,
30)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

32
302.72
0.0000
0.9098
0.9068
.52939

-----------------------------------------------------------------------------lrd |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------lsales |
1.075731
.0618275
17.40
0.000
.9494619
1.201999
_cons | -4.104722
.4527678
-9.07
0.000
-5.029398
-3.180047
------------------------------------------------------------------------------

The estimated elasticity of rd with respect to sales is 1.076, which is just above one. A one
percent increase in sales is estimated to increase rd by about 1.08

17