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ECON2300: Introductory Econometrics – Mid-Semester Exam, 1st Semester, 2012

In what follows, the brief (and sufficient for 100% mark) solutions are given in blue and
some comments given in green. Also, the essential parts are highlighted in red.

Answer ALL questions in the booklet provided.

1. Several researchers were asked by the president of a large corporation to develop

an econometric model to analyze and forecast sales for its stores for a particular
product (Ypad), for the next month. Researcher A advocated using the following
econometric model:

where is the subscript of observation (store) in the sample, represents sales

(measured in thousands of dollars) in store , stands for price (measured in
dollars) for the product in store and is an error.

Researcher A decided to use the ordinary least squares (OLS) regression method
to estimate this model.

List the assumptions that Researcher A should admit to rely on his/her model?
(4 marks)

SR1. The true model is

SR2.
SR3.
SR4. ( )
SR5. is not random and takes at least two values.
SR6. is normally distributed

Note, it’s also ok (100% credit) if the above is stated informally, in words, e.g.,:

SR1. The true model is as given in Q1.

SR2. on average the error is zero
SR3. variance of the error is constant
SR4. errors are not correlated
SR5. is not random and takes at least two values.
SR6. is normally distributed

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ECON2300: Introductory Econometrics – Mid-Semester Exam, 1st Semester, 2012

2. After using some statistical software, Researcher A obtained the following results:

With the estimated covariance matrix for parameter estimates given by

[ ]

̂ (estimated variance of )
̂ ̂ (estimated variance of )
̅ (sample mean of )
(minimal or smallest in the sample)
(maximal or largest in the sample)

How should Researcher A interpret his/her results? In particular:

a) Comment and interpret on the influence of price on sales (e.g., significance,

meaning, limitations of interpretations.):
(6 marks)

The estimates suggest that, on average, $1 increase in price will cause an increase in
sales by $ per month.

It is significant at 1%, because

.
√ √

The regression results must be interpreted with caution, in a local sense: for small
changes of explanatory variables, and within the range of observed data that was used in
the estimation), and under assumptions of the model.

b) Indicate and briefly explain how well the estimated model explains the data
(compute relevant measures from the provided data, if needed).
(4 marks)

∑ ̅ ̂

∑ ̂ ̂ ̂

So,

This means that only about 35% of the total variation in is explained by the variation in
in the model of researcher A. (A relatively poor fit.)

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ECON2300: Introductory Econometrics – Mid-Semester Exam, 1st Semester, 2012

3. Forecasting (prediction).
a) Using results from Researcher A, forecast (predict) sales for a store that will set the
price at $1000 and briefly interpret it.
(4 marks)

i.e., the predicted sales, (on average), of a store charging price=$ for the product is
$ per month.

b) Estimate the prediction interval (for ) for your forecast above.

(4 marks)

(i) ̂
where
̂
(ii) √̂ ̅ ̂
(it is from Formula sheet, so if write immediately with numbers as below—also ok!)
√ ( )

and since , so, CI is

(iii) (or, is also ok)

c) Should Researcher A be cautious when interpreting predictions made in 3 a) and in

3 b) above? Why? Briefly explain.
(4 marks)

This forecast can hardly be trusted, because it attempts to forecast for the price beyond
the observed range of the price in the data.

(Notes: Students might also mention other valid (although not as critical) reasons to doubt
this forecast, such as (i) low , (ii) potentially omitted explanatory variables, (iii) relatively
low sample size, (iv) too restrictive assumptions (SR1-SR6), so they deserve partial credit
in the answer.)

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ECON2300: Introductory Econometrics – Mid-Semester Exam, 1st Semester, 2012

4. Researcher B advocated using the following model:

where stands for subscript of observation (store), is a dummy variable that is

equal to 1 if the store is in a big city and zero otherwise, is a dummy variable
that is equal to 1 if the store is located in a shopping center that also has at least
one of its major competitors selling similar product and zero otherwise, is the
local advertising cost for store for this product (measured in thousands of dollars),
while the other variables are the same as those used by Researcher A, i.e.,
represents sales of the company in store (measured in thousands of dollars), is
price for the product set in store (measured in dollars).

Researcher B also decided to use the OLS method to estimate the model. After
using some statistical software and the same data as that used by Researcher A,
Researcher B obtained the following results:

(se) (2) (1) (0.1) (0.001) (0.001) (200) (100) (0.5)

̂ (estimated variance of )
̂ ̂ (estimated variance of )

How should these results be interpreted? In particular:

a) Comment and interpret the influence of change in price of the product on sales,
considering only the variables with estimated coefficients that are significant at least
at 5% level, and indicate what type of relationship exists and if it is different for
different types of stores.
(4 marks)

Formally, the influence is the same for all types of the stores and is given by:

̂
(i)

(ii) i.e., the influence of price on monthly sales is diminishing or even an inverted U-shape
(i.e., at some point, increase in price could lead to decrease in sales).

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ECON2300: Introductory Econometrics – Mid-Semester Exam, 1st Semester, 2012

b) If an average store (i.e., with average level of price and advertising) were to
increase price for the product (YPad) by 1 dollar, other things being the same—
what would be the impact on sales? (e.g., positive or negative? Justify your
answer.)
(4 marks)
̂

̂
the average store has ̅ , so , i.e., this is where ̂
reaches maximum w.r.t. and so increase in price for such a store will cause decrease
in sales.

For markers, note, alternatively, one could arrive to the same conclusion without
derivatives, by noting:

̂ ̂

Meaning, the decrease in sales (ceteris paribus).

c) Interpret the influence of change in advertising on sales, considering only the

variables whose estimated coefficients are significant at least at 5% level and
indicate what type of relationship exists and if it is different for different types of
stores.
(6 marks)

(i) On average and ceteris paribus, for stores of type (i.e., located where there are
no major competitors) an additional $1000 of advertising induces an increase of about
$2000 in sales per month.

(ii) On average and ceteris paribus, for stores of type an additional $1000 of
advertising brings increase of about $4000 in sales per month.

For markers: note that, alternatively, a student might answer this question as:

̂
(i) for
and
̂
(ii) for

Or as

̂
,

with relevant explanations as above.

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ECON2300: Introductory Econometrics – Mid-Semester Exam, 1st Semester, 2012

d) Interpret the influence on sales from .

(6 marks)

The influence is:

(i) Via intercept dummy: On average and ceteris paribus, stores near competitors have
monthly sales that are about $300,000 smaller than in the other stores. It is significant (at
1%)

(ii) Via slope dummy: On average and ceteris paribus, for stores near competitors (i.e.,
) an additional $1000 of advertising brings increase of $2000 of sales per month on
the top of the $2000 effect for all stores. It is significant (at 1%)

For markers: note that, alternatively, a student might answer this question as:

with relevant explanations similar to above.

Multiple choice questions – clearly indicate your answer in the writing booklet.
(please select only one answer (out of a, b, c, d, e) per question)

5. What is the reference group in the model of Researcher B?

a. Model of Researcher A defines the reference group for model of Researcher B

b. Stores located in a shopping center that has at least one of major competitors
selling similar product
c. Stores located in big cities, in a shopping center that has at least one of major
competitors selling similar product
d. Stores located in big cities, but not in a shopping center that has at least one of
major competitors selling similar product
e. Stores located not in big cities, and not in a shopping center that has at least
one of major competitors selling similar product
(2 marks)

6. What would be the for the model of Researcher B?

a. 0.978
b. the same as for the model of Researcher A but adjusted- is smaller.
c. smaller than that for the model of Researcher A but adjusted- is larger.
d. larger than that for the model of Researcher A.
e. none of the above
(2 marks)

END OF PAPER

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