1) A market analyst once attempted to estimate a demand equation for financial assets that included the
following three explanatory variables: current wealth (Wt), wealth in the previous quarter (Wt-1), and the
change in wealth (ΔWt = Wt - Wt-1). What problem did this analyst encounter? What should have been
done to solve this problem?
2) The consequences of multicollinearity are that the OLS estimates:
a.) will be biased while the standard errors will remain unaffected
b.) will be biased while the standard errors will be smaller
c.) will be unbiased while the standard errors will remain unaffected
d.) will be unbiased while the standard errors will be smaller
e.) none of the above
3) You were hired by the Ministry of Agriculture as a consultant to do a cross-sectional study of weekly
expenditures for food consumer at home by the i-th household (Fi). You estimated the following equation
(standard errors in parentheses).
F̂i = −10.50 + 2.1Yi − 0.4Yi 2 + 13.0 H i − 2.0 Ai
(0.7) (0.5)
(2.0)
(2.0)
N = 235, R 2 = 0.46
Where: Yi = the weekly disposable income of the i-th household
Hi = the number of people in the i-th household
Ai = the number of children (under 19) in the i-th household
a.) Create and test appropriate hypotheses at the 10% level.
b.) What is up with the estimated coefficient for Y? Isn’t it impossible that people can spend
twice their income on food? Explain your answer.
c.) Which econometric problems (omitted variables, irrelevant variables, or multicollinearity)
appear to exist in this equations? Explain your answer.
d.) Suppose that you were now told that the VIFS for A and H were both between 5 and 10.
How does this change your answer to part c.)?
e.) Would you suggest changing this specification for one final run of this equation? How?
Why? What are the possible costs of estimating another specification?