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Chapter 12 Answers 1. (a) The change in the regressor, - ,1995 ,1985 ln( ) ln( ), cigarettes cigarettes i i P P from a \$0.10 per pack increase in the retail price is ln 2.10 - ln 2.00 = 0.0488. The expected percentage change in cigarette demand is - 9.94 × 0.0488 × 100% = - 4.5872%. The 95% confidence interval is ( - 0.94 ± 1.96 × 0.21) × 0.0488 × 100% = [ - 6.60%, - 2.58%]. (b)With a 2% reduction in income, the expected percentage change in cigarette demand is 0.53 × ( - 0.02) × 100% = - 1.06%. (c)The regression in column (1) will not provide a reliable answer to the question in (b) when recessions last less than 1 year. The regression in column (1) studies the long-run price and income elasticity. Cigarettes are addictive. The response of demand to an income decrease will be smaller in the short run than in the long run. (d)The instrumental variable would be too weak (irrelevant) if the F -statistic in column (1) was 3.6 instead of 33.6, and we cannot rely on the standard methods for statistical inference. Thus the regression would not provide a reliable answer to the question posed in (a). 2. (a) When there is only one X , we only need to check that the instrument enters the first stage population regression. Since the instrument is Z = X

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