Introduction to Econometrics

rd
(3 Updated Edition, Global Edition)

by

James H. Stock and Mark W. Watson

Solutions to Odd-Numbered End-of-Chapter Exercises:

Chapter 7
(This version August 17, 2014)

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 7 1
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7.1

Regressor (1) (2) (3)

Graduated high school (X 1 ) 0.352** 0.373** 0.371**
(0.021) (0.021) (0.021)
Male (X 2 ) 0.458** 0.457** 0.451**
(0.021) (0.020) (0.020)
Age (X 3 ) 0.011** 0.011**
(0.001) (0.001)
North (X 4 ) 0.175**
(0.037)
South (X 5 ) 0.103**
(0.033)
East (X 6 ) −0.102*
(0.043)
Intercept 12.84** 12.471 12.390**
(0.018) (0.049) (0.057)

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 7 2
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7.3. (a) Yes, age is an important determinant of earnings. Using a t-test, the t-statistic is
0.011/.001 = 7.89, which is greater than 2.58, and hence significant at the 1%
level. The 95% confidence interval is 0.011 ± (1.96 × 0.001).

(b) ΔAge × [0.011 ± 1.96 × 0.001] = 10 × [0.001 ± 1.96 × 0.001] = 0.11 ± 1.96 × 0.001 =
[0.108, 0.112] or 10.8−11.2% increase in weekly earnings.

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 7 3
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7.5. The t-statistic for the difference in the college coefficients is

β̂ high school , 2007 − β̂ high school , 1993

t=
(
SE β̂ high school , 2007 − β̂ high school , 1993 )
Because β̂ high school , 2007 and β̂ high school , 1993 are computed from

(
cov βˆhigh school , 2007 − β̂ high school , 1993 =)
0. Thus,

var ( βˆhigh school , 2007 )

− β̂ high school , 1993
= ( ) ( )
var βˆhigh school , 2007 + var βˆhigh school , 1993 .

( )
This implies that SE β̂ high school , 2007 − β̂ high school , 1993 =(0.0212 + 0.019)1 2 =0.0283.
0.373 − 0.301
Thus, t
= = 2.54. Since the calculated t-statistic is greater than 1.96,
0.0283
the difference is significant at the 5% level.

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 7 4
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7.7. (a) The t-statistic is 0.567/1.23 = 0.461 < 1.96. Therefore, the coefficient on BDR is not
statistically significantly different from zero.

(b) The coefficient on BDR measures the partial effect of the number of bedrooms
holding house size (Hsize) constant. Yet, the typical 4-bedroom house is much
larger than the typical 3-bedroom house. Thus, the results in (a) says little about the
conventional wisdom.

(c) The 95% confidence interval for effect of lot size on price is 2500 × [0.005 ±
1.96 × 0.00072] or 8.972 to 16.028 (in thousands of dollars).

(d) Choosing the scale of the variables should be done to make the regression
results easy to read and to interpret. If the lot size were measured in thousands
of square feet, the estimate coefficient would be 5 instead of 0.005.

(e) The 10% critical value from the F2,∞ distribution is 2.30. Because 2.38 > 2.30,

the coefficients are jointly significant at the 10% level.

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 7 5
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7.9. (a) Estimate

Yi = β0 + γ X1i + β2 ( X1i + X 2i ) + ui

and test whether γ = 0.

(b) Estimate

Yi = β0 + γ X1i + β2 ( X 2i − aX1i ) + ui

and test whether γ = 0.

(c) Estimate

Yi − X1i = β0 + γ X1i + β2 ( X 2i − X1i ) + ui

and test whether γ = 0.

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 7 6
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7.11. (a) Treatment (assignment to small classes) was not randomly assigned in the
population (the continuing and newly-enrolled students) because of the
difference in the proportion of treated continuing and newly-enrolled students.
Thus, the treatment indicator X1 is correlated with X2. If newly-enrolled
students perform systematicallydifferently on standardized tests than continuing
students (perhaps because of adjustment to a new school), then this becomes
part of the error term u in (a). This leads to correlation between X1 and u, so that

E(u|Xl) ≠ 0. Because E(u|Xl) ≠ 0, the β̂1 is biased and inconsistent.

(b) Because treatment was randomly assigned conditional on enrollment status

(continuing or newly-enrolled), E(u|X1, X2) will not depend on X1. This means

that the assumption of conditional mean independence is satisfied, and β̂1 is

unbiased and consistent. However, because X2 was not randomly assigned
(newly-enrolled students may, on average, have attributes other than being

newly enrolled that affect test scores), E(u|X1, X2) may depend of X2, so that βˆ2
may be biased and inconsistent.

©2015 Pearson Education, Ltd.