Exam 1 Solutions

Econ 3120 - Applied Econometrics

4 Cornell University

Spring 2014
J. Berry
Liyuan Cui
Xin Fan

Definitions (15 points)

1. (15 points) In three or fewer sentences, describe each of the following concepts. Do not use
or simply translate any formulas, although referring to random variables or events as letters
is fine.
(a) Sample variance
Solution: An unbiased estimator of the population variance, which is given by
s2 =

1 n
(Yi Y )2
n 1 i=1

(b) Sampling variance

Solution: The variance of an estimator. For example, the sampling variance of sample
2
mean Y is n .
(c) Conditional expectation function
Solution: The conditional expectation function gives an expression for the the mean of
Y as a function of random variable X.
(d) Type II error
Solution: A Type II error occurs if we fail to reject the null when the null is false.
(e) One-sided hypothesis test
Solution: Under a one-sided hypothesis test, the alternative hypothesis is that the value
is greater than the null or smaller than the null. We will only reject the null if the test
statistic is on one side of the hypthesized distribution.
Short questions (30 points)
2. (15 points) Suppose {X1 , ..., Xn } is an i.i.d. random sample of size n=100 drawn from a
population with a Normal (0,25) distribution. Define sample mean by
1 n
X = Xi
n i=1

(a) Find the distribution of X (type of distribution, mean, variance)

Solution:
E(X) = E( n1 ni=1 Xi ) = 1n ni=1 E(Xi ) = E(Xi ) = 0
25
= 14
Var(X) = Var( 1n ni=1 Xi ) = n12 ni=1 Var(Xi ) = 100
Using the fact that any linear comination of independent, identically distributed normal
distribution has a normal distribution, we have the following result:

X N(0, 1/4)
(a) Graph the PDF of X

(b) Graph the CDF of X

(c) Find P(X = 1), and draw the corresponding region on your graph from part (b).
Solution: The corresponding region of P(X = 1) is the vertical line drawn in part (a).
The area of a vertical line equals 0. Thus, we have:
P(X = 1) = 0.
3. (15 points) Suppose {X1 , ..., Xn } is an i.i.d random sample of size n drawn from a distribution
with mean and variance 2 . Define the following two estimators for :
b1 = X

b2 =

1 n
Xi
n 1 i=2

(a) Find whether or not these two estimators are unbiased.

Solution:
3

n
= 1 E(Xi ) =
b1 ) = E(X)
E(
n i=1

b1 ) = E(
b1 ) = 0
Bias(
b2 ) = E(
E(

1 n
1 n
n1
E(Xi ) =
X
)
=
E(Xi ) =
i

n 1 i=2
n 1 i=2
n1
b2 ) = E(
b2 ) = 0
Bias(

Thus, both two estimators are unbiased.

(b) Find the variance of these two estimators.
Solution:
b1 ) =
Var(
b2 ) =
Var(

n
2
Var(X
)
=
i
n2
n

n
1
2
n1
Var(X
)
=
Var(X
)
=
i
i

(n 1)2 i=2
(n 1)2
n1

(c) Find whether or not these two estimators are consistent. (Hint: it may be helpful to
n
b2 as n1
X Xn1 )
express
Solution:
=
plim(1 ) = plim(X)
n
X1
n1
plim( 1 )X1 =
plim( 2 ) = plim(
X) + plim( ) = plim(
)plim(X)
n1
n
n
n
Thus, both estimators are consistent.
(d) Which one do you prefer? Explain.
Solution: Given both estimators are both unbiased, we prefer the one that is more
efficeint. We consider an estimator is more efficient if it has smaller variance.
Bias(1 ) = Bias(2 )
Var(1 ) =

2
2
< Var(2 ) =
n
n1

Thus, we prefer the estimator 1 , which has smaller smaller variance and is more efficient.
4

Longer Questions (55 points)

4. (20 points) Consider the joint pdf for random variables X and Y :

(x + y) 0 x 1; 0 y 1
f (x, y) =
0
otherwise
Find the following, using symmetry of X and Y whenever possible:
(a) the cdf F(x,y) [You do not have to compute the integral, just set it up]
Solution:
10 10 (x+y)dxdy 0x1; 0y1
1
1x; 1 y
F(x, y) =

0
else
(b) the marginal pdfs g(x) and h(y)
Solution:

2
g(x) = 10 (x + y)dy = (xy + y2 )|10 = x + 21 0 x 1

By symmetry, h(y) = 10 (x + y)dx = y + 21 0 y 1

(c) the conditional pdf f (x|y)
Solution:
(x,y)
x+y
f (x|y) = fh(y)
0 x 1; 0 y 1
= y+
1
2

(d) E(X) and E(Y )

Solution:

3
2
E(X) = 10 x g(x)dx = 10 (x2 + 2x )dx = ( x3 + x4 )|10 =

7
By Symmetry, E(Y ) = 10 y h(y)dy = 12

7
12

(e) E(XY ) [You do not have to compute the integrals, just set them up]
Solution:

E(XY ) = 10 10 xy f (x, y)dxdy
(f) Cov(X,Y ) [Use the fact that E(XY ) = 13 ]
Solution:
7
7
1
Cov(X,Y ) = E(XY ) E(X) E(Y ) = 13 12
12
= 144
(g) Are X and Y independent random variables? Why or why not?
Solution:
No, they are not independent. f (x, y)6=g(x)*h(y)
5. (35 points) New Jerseys minimum wage rose from $4.25 to $5.05 per hour on April 1, 1992.
As an economist, you are hired by the state government to evaluate the impact of the law on
employment. To do this, you collect data on the employment of 321 fast-food restaurants in
5

Table 1: Sample Design

Stores in
NJ
PA
Change in full-time employees per restaurant
0.59 -2.16
Standard deviation change in full-time employees 9.67 11.11
Notes: Data are from David Card and Alan Krueger, Minimum Wages and Employment: A case
study of the fast-food industry in New Jersey and Pennsylvania, AER 1994.
New Jersey before and after the rise. You also collect data on 78 stores in eastern Pennsylvania, where no minimum wage increase was experienced. Here is a summary table of your
data.
(a) Suppose first you want to test whether full-time employees per restaurant changed between the two waves in New Jersey. Denote 4NJ as the change in full-time employment in NJ across the two waves. Conduct the test using a two-sided test and 5%
confidence level, by constructing the following. [Hint: this can be set up as the test of
a single mean, not a test of a difference in means.]
i. The null hypothesis
Solution:
H0 : 4NJ = 0
Ha : 4NJ 6=0
ii. The test statistic
Solution:
4NJ
0.590

r
t = 4NJ
= 1.09
= 9.67/
2
321
NJ
nNJ

iii. The distribution of the test statistic under the null

Solution:
The central limit theorem states that, regardless of the underlying distribution, a
standardized sample mean has a standard normal distribution as the sample size
gets large. Therefore, since the number of observations for New Jersey is large, the
distribution of the test statistic under the null has a standard normal distribution.
iv. The rejection rule
Solution:
Reject the null if |t| > z/2 = 1.96 or if p value < 0.05(note that you need to
times 2 when calculated p-value due to two-sided test)
v. The outcome of the test (whether you reject or fail to reject)
Solution:
Fail to reject the null hypothesis because |t| < z/2 = 1.96 or p value > 0.05
(b) Obtain the p-value for the test above test.
6

Solution:
Note that this is a double-sided test, the p value for t-statistic value,1.09, is0.8621.
Thus, the p-value is 2 (1 (1.09)) = 0.2758
(c) What must you assume for the difference in employment in NJ across the two waves to
be a causal estimate of the change in employment due to the minimum wage increase?
Solution:
We need to assume that all other factors need to remain unchanged and only the minimum wage changes affect the employment changes.
(d) In order to improve the causal interpretation of your estimates, you decide to test
whether the change in employment in NJ was different from the change in employment
in PA. Using a two-sided test and 5% confidence level, conduct the test, by constructing
the following:
i. The null hypothesis
Solution:
H0 : 4NJ = 4PA
Ha : 4NJ 6=4PA
ii. The test statistic
Solution:

rPA (4NJ 4PA ) =

t = 4NJ 4
2
2
NJ
nNJ

+ n PA
PA

[0.59(2.16)]0
q
11.112
9.672
321 + 78

= 2.01

iii. The distribution of the test statistic under the null

Solution:
The central limit theorem states that, regardless of the underlying distribution, a
standardized sample mean has a standard normal distribution as the sample size
gets large. Therefore, since the number of observations for New Jersey is large, the
distribution of the test statistic under the null has a standard normal distribution.
iv. The rejection rule
Solution:
Reject the null if |t| > z/2 = 1.96 or if p value < 0.05(note that you need to
times 2 when calculated p-value due to two-sided test)
v. The outcome of the test (whether you reject or fail to reject)
Solution:
Reject the null hypothesis because |t| > z/2 = 1.96 or p value < 0.05
(e) Construct a 95% confidence interval for the above test. Explain what this interval
represents.
Solution:
q 2
q
h
i
2
2
2
PA
NJ

CI: 4NJ 4PA z/2

+
= [0.59(2.16)]1.96 9.67 + 11.11 =
nNJ

nPA

[0.067, 5.43]
7

321

78

The confidence interval represents the range of values such that, in 95% of random
samples, the interval contains the true difference in means.