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1. Using U.S.

economic data from 1976 through 2007 (found in this homework folder),
estimate a distributed lag model with consumption as a function of disposable
income (including 3 lags). Report the coefficients and p-values for each of the
independent variables. (3 points)

tsset year
regress consumption dispincome L1.dispincome L2.dispincome L3.dispincome

Coefficient P-value
dispincome 0.7314992 0.000***
L1.dispincome 0.3855763 0.037**
L2.dispincome 0.0055472 0.975
L3.dispincome -0.0837074 0.532

2. Using the same data, now estimate a dynamic model. Report the coefficients and
p-values for this model. (3 points)

regress consumption dispincome L1.consumption

Coefficient P-value
dispincome 0.4966752 0.000***
L1.consumption 0.532477 0.000***

3. Using the results of the dynamic model, calculate the following values for the
model: Yt 0 0 X t Yt1 ut (Show your work) (3 points)

1 = (0.532477)*(0.4966752)= 0.264468

2 = (0.532477)2*(0.4966752)= 0.140823

3 = (0.532477)3*(0.4966752)= 0.074985
4. Suppose that youre interested in the effect of price on the demand for a salon
haircut and that you collect the following data for four U.S. cities for 2003:

Location Year Average Price Per Capita Quantity


New York 2003 $75 2
Boston 2003 $50 1
Washington, D.C. 2003 $60 1.5
Philadelphia 2003 $55 0.8

and for 2008:

Location Year Average Price Per Capita Quantity


New York 2008 $85 1.8
Boston 2008 $48 1.1
Washington, D.C. 2008 $65 1.4
Philadelphia 2008 $60 0.7

a. Estimate a cross-sectional OLS regression of per capita quantity as a function of


average price for 2003. Is the slope positive or negative? Does that meet your
expectations? What is the coefficient and p-value? (3 points)

Using 2003 data only: regress quantity price

Coefficient P-value
price 0.0457143 0.082*

The slope is positivethis does not meet our expectations because we would
predict that as the price goes up, the quantity demanded would go down (negative
slope).

b. Now estimate a cross-sectional regression on the data for 2008. How is the result
different? Report the new coefficient and p-value. (3 points)

Using 2008 data only: regress quantity price

Coefficient P-value
price 0.0228611 0.243

The slope is positive again even though the coefficient has decreased this still does
not meet our expectations because we would predict that as the price goes up, the
quantity demanded would go down. Also, price is not statistically significant this time.

c. Now estimate a fixed effects model on the combined data and compare your
results with parts a and b. What is the coefficient and p-value? (3 points)

Create a panel including all cities for 2003 and 2008:


xtset id year
xtreg quantity price, fe

Coefficient P-value
price -0.0207792 0.005***

d. Whats your conclusion? Which model offers the best approach to answering your
question? (2 points)

We finally see the expected (negative) relationship between price and quantity when we
use the fixed effects panel model. We conclude that the panel model offers the best
approach to answering our questions because it incorporates both a time and a cross-
sectional component. Without both of these components, this is likely why we did not see
the expected relationships in the first two regressions.