Chapter%2012%20-%20Extra%20Practice%20Problems - Econ 120B...

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Econ 120B Chapter 12 – Instrumental variables 1. Earnings functions, whereby the log of earnings is regressed on years of education, years of on-the-job training, and individual characteristics, have been studied for a variety of reasons. Some studies have focused on the returns to education, others on discrimination, union and non-union differentials, etc. For all these studies, a major concern has been the fact that ability should enter as a determinant of earnings, but that it is close to impossible to measure and therefore represents an omitted variable. Assume that the coefficient on years of education is the parameter of interest. Given that education is positively correlated to ability, since, for example, more able students attract scholarships and hence receive more years of education, the OLS estimator for the returns to education could be upward-biased. To overcome this problem, various authors have used instrumental variables estimation techniques. Given that = years of education and that includes individual ability, briefly X i u i discuss instrument validity, for each of the potential instruments ( ) listed below (recall and apply the 2 conditions for a valid instrument).
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This note was uploaded on 07/01/2008 for the course ECON 120B taught by Professor Jeon during the Spring '08 term at UCSD.

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Chapter%2012%20-%20Extra%20Practice%20Problems - Econ 120B...

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