ECON 2300: INTRODUCTORY ECONOMETRICS 

You should give your answer to each of the following questions following a similar format of the solutions to

 the tutorial problem sets. When you are required to use R, you must show your R command and

 R outputs (screenshots or figures gener- ated from R). You will lose 2 points whenever you fail to provide

 R commands and outputs. For each question, when you are asked to discuss or interpret, your answer has to

 be brief and compact. You will lose 2 points if your answer is needlessly wordy. You must upload your assignment 

on the course webpage (Blackboard) in PDF format. (Do not submit a hard copy.) This project has two research questions. 

You are required to investigate both of them. Problem 1: money, Growth, and Inflation (30 marks) Background To examine the quantity theory of money, Brumm (2005) [“Money Growth, Output Growth, and Inflation: A Reexamination of the Modern Quantity Theory’s Linchpin Prediction,” Southern Economic Journal, 71(3), 661–667] specifies the inflation equation inflat = β1 + β2money + β3output + u where inflat is the growth rate of the general price level, money is the growth rate of the money supply, and output is the growth rate of national output. Economic theory suggests that β2 = 1 and β3 = −1. The dataset brumm.dta consists of 1995 data on 76 countries. Research tasks 1. It is argued that output may be endogenous. Four instrumental variables are proposed, initial = initial level of real GDP , school = a measure of the population’s educational attainment, inv = average investment share of GDP , and poprate = average population growth rate. (a) Give an intuitive explanation as to why output can be endogenous (3 marks) (b) Explain why the proposed IVs can be valid. (6 marks, i.e., 1 mark for each IV) 2. Using the four IVs, obtain TSLS estimates of the inflation equation (4 marks), and test the economic theory using the IV estimates (4 marks). 3. Determine whether the IVs are strong or not (3 marks) and test if they are exogeneous (3 marks). 4. Present a short research note (less than a half page) of your findings. You are allowed to use your previous findings here again or to estimate again the model using a different set of IVs (7 marks). 1 Problem 2: Demand for Democracy (70 marks) Background: Do citizens demand more democracy and political freedom as their incomes grow? That is, is democ- racy a normal good? To investigate this issue, you will explore the dataset Income Democracy.dta which contains a panel data set from 195 countries for the years 1960, 1965, ... , 2000. A detailed description is given in Income Democracy Description.pdf.1 The dataset contains an index of politi- cal freedom/democracy for each country in each year, together with data on the country’s income and various demographic controls. (The income and demographic controls are lagged five years relative to the democracy index to allow time for democracy to adjust to changes in these variables.) Research tasks: 1. Is the data set a balanced panel? Explain. (5 marks) 2. The index of political freedom/democracy is labeled dem ind. (a) What is the value of dem ind for the United States in 2000? What is the average of dem ind for the United States over all years in the data set? (4 marks) Repeat this exercise for Libya (2 marks). (b) List five countries with an average value of dem ind greater than 0.95; less than 0.10; and between 0.3 and 0.7. (5 marks) 3. The logarithm of per capita income is labeled log gdppc . (a) Regress dem ind on log gdppc using standard errors that are clustered by country (3 marks). (b) How large is the estimated coefficient on log gdppc?

 Is the coefficient statistically signifi- cant? (2 marks) (c) If per capita income in a country increases by 20%, 

by how much is dem ind predicted to increase? What is a 95% confidence interval for the prediction? Is the 

predicted increase in dem ind large or small? Explain what you mean by large or small. (5 marks) (d) Why is it important 

to use clustered standard errors for the regression? Do the results change if you do not use clustered standard errors? (4 marks) 

4. (a) Suggest a variable that varies across countries but plausibly varies little–or not at all–over time and that could 

cause omitted variable bias in the regression in (c). (5 marks) (b) Estimate the regression in (c), allowing for country fixed effects. 

How do your answers to (c)(i) and (c)(ii) change? (5 marks) (c) Exclude the data for Azerbaijan and rerun the regression. 

Do the results change? Why or why not? (5 marks) (d) Suggest a variable that varies over time but plausibly varies 

little–or not at all–across coun- tries and that could cause omitted variable bias in the regression in (c). (5 marks) (e) 

Estimate the regression in (c), allowing for time and country fixed effects. How do your answers to (c)(i) and (c)(ii) change? (5 marks) (f) 

There are addition demographic controls in the data set. Should these variables be included in the regression? If so, 

how do the results change when they are included? (5 marks) 5. Based on your analysis, what conclusions do 

you draw about the effects of income on democracy? (10 marks) 1These data were provided by Daron Acemoglu of M.I.T. 

and were used in his paper with Simon Johnson, James Robinson, and Pierre Yared, “Income and Democracy,” American Economic Review, 2008, 98:3, 808–842. 2