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Unformatted text preview: ECON 103, Lecture 11: Functional Form and Dummy Variables Maria Casanova February 18th (version 0) Maria Casanova Lecture 11 Requirements for this lecture: Chapter 8 of Stock and Watson Maria Casanova Lecture 11 1. Functional Form of Regression Models In this course we cover linear regressions . By linear we mean that they are linear in parameters They may or may not be linear in the X s The Y variable does not need to be linear either. Maria Casanova Lecture 11 1.1 Linear Model Ex1: Linear Model It is linear in variables Y = + 1 X + 1 gives the increase in Y given a unit increase in X Maria Casanova Lecture 11 1.2 LogLinear Model Ex2: LogLinear Model It is not linear in X Y = AX 1 However, we can linearize it by taking the natural ln on both sides: ln Y = ln ( AX 1 ) = ln A + 1 ln X ln Y = + 1 ln X If the least squares assumptions are satisfied, we can estimate and 1 by OLS from a regression like: ln Y = + 1 ln X + Maria Casanova Lecture 11 1.2 LogLinear Model In the loglinear model 1 measures the percentage change in Y for a given percentage change in X (that is, the the elasticity of Y with respect to X ). For example, in the following model 1 is the priceelasticity of demand : ln Y = + 1 ln X + , where: Y = quantity demanded X = price 1 = d ln Y d ln X = dY / Y dX / X = p Y Y X X = % increase in Y % increase in X ! In this model, when we conduct hypothesis tests about 1 we are testing hypothesis about the priceelasticity of demand. Maria Casanova Lecture 11 1.3 Semilog Model Ex3: Semilog Model Only one variable appears in log form. ln Y = + 1 X + In this model 1 measures the percentage change in Y given a unit change in X : 1 = d ln Y dX = dY / Y dX Y Y X = % increase in Y Increase in X ! When are we interested in computing the percentage change in one variable (e.g. Y ) per unit increase of other variable (e.g. X )? Maria Casanova Lecture 11 1.3 Semilog Model 1 Example: wage equation ln wage = + 1 educ + , where educ is measured in years. In this case, 1 measures the percentage change in income for a one year increase in education. Maria Casanova Lecture 11 1.3 Semilog Model 2 Example: demand equation ln Q = + 1 P + We know that 1 = d ln Q dP = dQ / Q dP Remember that the price elasticity of demand was: p = dQ / Q dP / P In this case the elasticity of demand is: p = 1 P that is, the elasticity varies for different price levels....
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This note was uploaded on 03/15/2010 for the course ECON 103 taught by Professor Sandrablack during the Winter '07 term at UCLA.
 Winter '07
 SandraBlack
 Econometrics

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