IOS Homework 2 Naveen Bharathi

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Question 1
The data FERTIL2.RAW includes for women in Botswana during 1998, information on number of
children, years of education, age, religious and economic status variables.
1) Estimate the model



. . . .

. . . .

Education of a woman brings down the fertility rates. Another year of education,
holding age fixed, results in about .091 fewer children. In other words,for a group of
100 women, if each gets another of education, they collectively are predicted to
have about nine fewer children.

2) frsthalf is a dummy variable equal to one if the women was born during the first six
months of the year. Assuming that frsthalf is uncorrelated with the error term from part
(1), show that frsthalf is a reasonable IV candidate for educ.



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The reduced form of educ is:

;

We need

0. From the above regression we get

= -0.852. Therefore, women born

in the first half of the year are predicted to have almost one year less education, holding
age fixed. The t statistic on frsthalf is over 7.5 in absolute value, and so the identification
condition holds.

3) Add the binary variables electric, tv, bicycle to the model and assume these are
exogenous. Estimate the equation by OLS and 2SLS and compare the estimated
coefficients on educ. Interpret the coefficient on tv and explain why television viewing
has a negative effect on fertility.

4) Comment on identification using OLS verses 2SLS.


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Adding electric, tv, and bicycle to the model reduces the estimated effect of educ in both
cases, but not by too much. In the equation estimated by OLS, the coefficient on tv implies that,
other factors fixed, four families that own a television will have about one fewer child than four
families without a TV. Television ownership can be a proxy for different things, including
income and perhaps geographic location. A causal interpretation is that TV provides an
alternative form of recreation.
Interestingly, the effect of TV ownership is practically and statistically insignificant in the
equation estimated by IV (even though we are not using an IV for tv). The coefficient on electric
is also greatly reduced in magnitude in the IV estimation. The substantial drops in the
magnitudes of these coefficients suggest that a linear model might not be the functional form,
which would not be surprising since children is a count variable.










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Question 2
1. Estimate the equation by pooled OLS and report the results in standard form. What do
you make of the estimate on the 1990 dummy variable? What do you get for pctstu?

. . . .
.
The positive and very significant coefficient on y90 simply means that, other things in
the equation fixed, nominal rents grew by over 26% over the 10 year period. The coefficient
on pctstu means that a one percentage point increase in pctstu increases rent by half a
percent (.5%). The t statistic of five shows that, at least based on the usual analysis, pctstu is
very statistically significant.
2. Are the standard errors you report in part (1) valid? Explain.
The standard errors from part (1) are not valid, unless we thing ai does not really appear
in the equation. If ai is in the error term, the errors across the two time periods for each city
are positively correlated, and this invalidates the usual OLS standard errors and t statistics.
3. Now difference the equation and estimate by OLS. Compare your estimates of pctstu
with that from part (1). Does the relative size of the student population appear to affect
the rental prices?

log(rent) = 0.386 + 0.072 log(pop) + 0.310 log(avginc) + .0112 pctstu

In the below regression x = log(rent),
y = log(pop),
z = pctstu
x1 = log(avginc)
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The effect of pctstu is over twice as large as we estimated in the pooled OLS equation. Now,
a one percentage point increase in pctstu is estimated to increase rental rates by about 1.1%.
Not surprisingly, we obtain a much less precise estimate when we difference (although the OLS
standard errors from part (1) are likely to be much too small because of the positive serial
correlation in the errors within each city). While we have differenced away a
i
, there may be
other un-observables that change over time and are correlated with pctstu.

4. Estimate the model by fixed effects to verify that you get identical estimates and standard errors
to those in part (3).



The heteroskedasticity-robust standard error on pctstu is about .0029, which is
actually much smaller than the usual OLS standard error. This only makes pctstu even
more significant (robust t statistic 4). Note that serial correlation is no longer an issue
because we have no time component in the first-differenced equation.




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Question 3
1. How do you interpret 1 ?
If the given equation explains a causal relation, then smoking more cigarettes
should increase your income. 1001 is the approximate percentage change in income if
a person smokes one more cigarette per day.

2. Assuming these are exogenous to individual, what signs would you expect for 5 & 6 ?
If the price of the cigarettes rises, then the consumption should come down. So
the sign of 5 should be negative. If there are restrictions on smoking, the consumption
should decrease, hence 6 could be negative.

3. Under what assumption is the income equation from part (1) is identified?
We need 5 or 6 to be different from zero. That is, we need at least one
exogenous variable in the cigs equation that is not also in the log(income) equation.

4. Estimate the income equation by OLS and discuss the estimate of 1?
. . . . .

The coefficient on cigs implies that cigarette smoking causes income to increase,
although the coefficient is not statistically different from zero.

5. Estimate the reduced form for cigs (this entails regressing cigs on all exogenous
variables). Are log(cigpric) and restaurn significant in reduced form?
. . . .

.
.

While log(cigpric) is very insignificant, restaurn had the expected negative sign and a
t statistic of about 2.47. (People living in states with restaurant smoking restrictions smoke
almost three fewer cigarettes, on average, given education and age.)
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6. Now estimate the income equation by 2SLS. Discuss how the estimate of 1 compares
with the OLS estimate.


. . . . .

Now the coefficient on cigs is negative and almost significant at the 10% level
against a two-sided alternative. The estimated effect is very large: each additional
cigarette someone smokes lowers predicted income by about 4.2%.

7. Do you think cigarette prices and restaurant smoking restrictions are exogenous in the
income equation?
Assuming that state level cigarette prices and restaurant smoking restrictions are
exogenous in the income equation is problematical. Incomes are known to vary by
region, as do restaurant smoking restrictions. It could be that in states where income is
lower (after controlling for education and age), restaurant smoking restrictions are less
likely to be in place.