Please answer ALL LARTS of this question RECISELY!!! Please answer ALL LARTS of

Question

Please answer ALL LARTS of this question RECISELY!!! Please answer ALL LARTS of this question RECISELY!!!
7. You work for an airline and are trying to determine the effect that fuel prices and distance traveled have upon airline fares. You estimate the following model using regression analysis: log(fare) 4.5 0.36 log(fuel price) 0.68 log(distance). R3 0.90 (0.03) (1.3) (0.15) where the numbers in parentheses are the standard errors. The model was estim- ated on a cross-section of 100 routes flown by a major airline. (a) What is the economic model underlying the relationship between airline fares, fuel prices, and distance traveled? What are the qualitative hypotheses associated with this model? (b) Are the econometric results presented above consistent with the qualitative economic hypotheses? (c) Derive a 95% confidence interval for the true values of the coefficients of the two explanatory variables. What does this interval tell you? (d) According to the estimated equation, what eflect will a 1% lncrease in fuel prices have upon airline fares? In the early 1980s, fuel prices increased by 60%. Based upon the above equation, what effect would this have upon airline fares? (e) suppose that the average length of trip on a major airline is 1.000 miles. whereas the average trip length on a smaller regional airline is 400 miles. According to the above equation. what efect would this difference in trip length have upon airline fares?

Explanation / Answer

Part-a

The economic model is

log(fare)=0+1 log(fuel price)+ 2 log(distance) +

Here are independnetly and identically distributed errors with zero mean and constant variance.

The qualitative hypothesis are

i) fuel price has increasing effect on price

ii) distance has increasing effect on fare price

Part-b

The results are consistent as explained below:

i) Holding distance fixed, corresponding to 1% increase in fuel price there is 0.36% increase in fare price.

ii) Holding fuel price fixed, corresponding to 1% increase in distance travelled there is 0.68% increase in fare price.

Part-c

Sample Size n=100 is large so we may assume critical z-value=1.96 to construct the confidence intervals

95% confidence interval for log(fuel)

=0.36-1.96*0.15 , 0.36+1.96*0.15

=0.07 , 0.65

We are 95% cofnident that corresponding to 1% increase in fuel price, there is 0.07% to 0.65% increase in fare price.

95% confidence interval for log(distance)

=0.68-1.96*0.03 , 0.68+1.96*0.03

=0.62 , 0.74

We are 95% cofnident that corresponding to 1% increase in distance, there is 0.62% to 0.74% increase in fare price.

Part-d

Holding distance fixed, corresponding to 1% increase in fuel price there is 0.36% increase in fare price. For 60% increase there is 60*0.36=21.6% increase in airline fares.

Part-e

Increase from small to major = 600*100/1000=60%

So, fare would increase by 21.6% for majore airline.

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