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Questions › DSE › DSE 2011 › Q39
2 marksEconometrics › Misspecification and measurement error › Omitted variable biasHardabout 4 min

DSE 2011 Question 39: Misspecification and measurement error

Instead of estimating a production function y=a0+a1K+a2L+uy=a_{0}+a_{1}K+a_{2}L+uy=a0​+a1​K+a2​L+u (where yyy is output, KKK is capital input and LLL is labour input), a researcher estimates y=a0+a1K+uy=a_{0}+a_{1}K+uy=a0​+a1​K+u. It is known that in the true model a2>0a_{2}>0a2​>0 and KKK and LLL are complements. Which of the following is true?

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Instead of estimating a production function y=a₀+a₁K+a₂L+u (where y is output, K is capital input and L is labour input), a researcher estimates y=a₀+a₁K+u. It is known that in the true model a₂>0 and K and L are complements. Which of the following is true? (A) The estimated a₁ will be upwardly biased. (B) The estimated a₁ will have a downward bias. (C) The estimated a₁ will be biased, but the direction of bias cannot be determined. (D) The estimated a₁ will be unbiased, but a₀ will be biased.

Also written as: Instead of estimating a production function y=a_0+a_1K+a_2L+u (where y is output, K is capital input and L is labour input), a researcher estimates y=a_0+a_1K+u. It is known that in the true model a_2>0 and K and L are complements. Which of the following is true?

Misspecification and measurement error has come up 11 times in 4 exams since 2011.

What this question tests

This question is on Omitted variable bias, part of Misspecification and measurement error in Econometrics.

How leaving out a relevant variable biases the estimates, and in which direction.

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Question from the DSE 2011 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.