Discuss which economic theories or relationships you have studied up until now (

Question

Discuss which economic theories or relationships you have studied up until now (not just in this class – in all your economics classes) that could be estimated using the multiple linear regression model. Explain your rationale. Select one or more of the theories or relationships you discussed above and determine what data you would need to estimate such a relationship. Provide examples to support your response. Discuss how the problem you research in the e-Activity was solved using estimation and hypothesis testing. Determine if you would have approached the problem in the same way, and if not, what you might have done differently.

Use the Internet to find and research a current example of how estimation and hypothesis testing were used to solve a problem. Be prepared to discuss. (e-Activity)

Explanation / Answer

Some of the economic theories that could be estimated using the multiple linear regression model are:

(1) The linear demand model : Here we model the quantity demanded as a function of price and household income; the dependant variable being quantity demanded and the independant variables price of the commodity and the income of the consumer.

(2) Neoclassical Keynesian consumption function : Here the quantity demanded depends upon the price of its own good, the price of its substitutes or complements, consumer income, number of consumers and so on.

(3) The labor-leisure model : To explain the number of hours an individual will work, the independant variables are the worker's wahe rate and the individual's access to non-labor income.

We discuss the estimation of Keynesian consumption function. The dependent variable is the personal consumption expenditure and the independent variables are personal disposable income, a low risk interest rate and a measure of consumer confidence.

The consumption expenditure depends positively on the personal disposable income- higher the personal income, higher will be the consumption; negatively on the interest rate- higher the expected rate of return, higher will be the saving and hence less consumtion and positively on the measure of consumer confidence. The intercept term is the average propensity to consume (a) and the marginal propensity to consume (b) is the slope term associated with the consumer's income. Formerly, the model can be framed as:

C = a + b*Y - r*R + k*K where R is the interest rate that depends on the sensitivity r and K is the consumer confidence.

Using Multiple regression we estimate the intercept term a and the slope parameters b, r and k. We then use these parameters to see how the consumption pattern is sensitive to the person's income, the changes in interest rate of the economy and the consumer's confidence.

The low risk interest rate can be obtained from the US three month treasury bill and the measure of consumer confidence can be obtained from the Michigan Index of consumer sentiment available in FRED.

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