Problem 5.

18
The hamburger standard
Download: 0518.dat , 0518.xls

Big Mac prices

actual $ exchange Implied PPP of the
In local currency In dollars Local currency valuation
rate dollar
United States 2.3 2.3
Argentina 3.6 3.6 1 1.57 57
Australia 2.45 1.72 1.42 1.07 -25
Austria 34 2.84 12 14.8 23
Belgium 109 3.1 35.2 47.39 -35
Brazil 1500 1.58 949 652 -31
Britain 1.981 2.65 1.46 1.27 15
Canada 2.6 2.06 1.39 1.24 -10
Chile 948 2.28 414 412 -1
China 9 1.03 8.7 3.91 -55
Czech Rep 50 1.71 29.7 21.7 -27
Denmark 25.75 3.85 6.69 11.2 67
France 18.5 3.17 5.83 8.04 38
Germany 4.6 2.69 1.71 2 17
Greece 620 2.47 251 270 8
Holland 5.45 2.85 1.91 2.37 24
Hong Kong 9.2 1.19 7.73 4 -48
Hungary 169 1.66 103 73.48 -29
Italy 550 2.77 1641 1978 21
Japan 391 3.77 104 170 64
Malaysia 3.77 1.4 2.69 1.64 -39
Mexico 8.1 2.41 3.36 3.52 5
Poland 31000 1.4 22433 13748 -40
Portugal 440 2.53 174 191 10
Russia 2900 1.66 1775 1261 -29
Singapore 2.98 1.9 1.57 1.3 -17
S Korea 2300 2.84 810 1000 24
Spain 345 2.5 138 150 9
Sweden 25.5 3.2 7.97 11.1 39
Switzerland 5.7 3.96 1.44 2.48 72
Taiwan 62 2.35 26.4 26.96 2
Thailand 48 1.9 25.3 20.87 -17
 Consider the following regression model:
Yi = £]1+£]2Xi+ui
where Y = actual exchange rate and X = implied PPP of the dollar.
(a) If the PPP holds, what values of £]1 and£]2 would you expect a priori? (Suggested Answer)
(b) Does the regression support your expectation? (Eviews) (Rats)
What formal test do you use to test your hypothesis? (Suggested Answer)
(c) Should the Economist continue to publish the Big Mac Index? Why or why not?
(Suggested Answer)

Solutions::::
Suggested Answer:
(a) For the regression model where Yi represents the actual exchange rate and Xi represents the
implied purchasing power parity (PPP) of the dollar, one would expect the intercept to be zero
and the slope coefficient to be one if, in the long run, currencies tend to move toward their PPP.
(b) Procedures in the Eviews:
Step 1 ------ Choose Estimate Equation from the Quick option

Step 2 ------ Enter the Dependent variable at first and type "c" as it represent the constant term
and then the rests are the independent variables

Step 3 ---- clik "OK" and you will see the following results:
Suggested Answer:
(b) To test whether or not the slope coefficient is statistically different from one
Let B = true parameter; b = estimator of true parameter
H0: B2 = 1
H1: B2 ≠1
t = ( B - b ) / Se( b ) = ( 1.651 - 1 ) / 0.025 = 26.04

Conclusion: Since the the computed t is much greater than 2. Therefore, reject H0.

Suggested Answer:
(c) Since the BigMAc Index is "crude and hilarious" to begin with, it probably doesn't matter.
However, for the sample data, the results do not support the theory.

Problem 7.20
The demand for roses. The following table gives quarterly data on these variables:
Download: 0720.dat , 0720.xls
 Yt = £]1 + £]2X2t + £]3X3t + £]4X4t + £]5lnX5t + Ut
lnYt = £]1 + £]2lnX2t + £]3lnX3t + £]4lnX4t + £]5lnX5t + Ut
(a) Estimate the linear model. Interpret the results.
(b) Estimate the log-linear model. Interpret the results.
(Eviews) (Rats)
(c) £]2, £]3 and £]4 give, respectively, the own price, the cross price and the income elasticities of
demand. What are their priori sign? Do the result concur with the priori expectation?
(Suggested Answer)
(d) How would you compute the own price, cross price and income elasticities for the linear
model?
(Suggested Answer)
(e) Based on your analysis, which model, if any, would you choose and why? (Suggested Answer)

Solutions:
For the linear model, use the "Estimate Equation" and type "y c x2 x3 x4 x5"
in the dialog box, and the results are as follows:
The coefficient for the price of a dozens rose is statistically significant at the 95% level.
It shows that, on average, the quantity of roses sold decreases by 2227.7 dozen as the price
increases by $1 during the sample period. The other coefficient are not statistically different from
zero; p-vaule for the carnation coefficient is 0.3027, for disposable income, p = 0.8412; for trend
p=0.078.

For the log-linear model, in the Equation Specification dialogue box type "log(y) c log(x2) log(x3)
log(x4) log(x5)" , then click OK button and the results are as follows:
The coefficient for the Lnprice of a dozens rose is statistically significant at the 95% level.
It shows that, on average, the quantity of roses sold decreases by 1.27% as the price increases by
1% during the sample period. The other coefficient are not statistically different from zero; p-vaule
for the carnation coefficient is 0.1828, for disposable income, p = 0.1815; for trend p=0.1833.
Suggested Answer:
(c) One would expect the own price elasticity (£]2) to be negative, the cross price elasticity (£]3) to
be positive for the substitute good carnations, and the income elasticity (£]4) to be positive,
since roses are a normal good. While all the signs meet the expectations.
Suggested Answer:
(d) The general formula for the elasticity from the linear equation is

Using the mean values for y and x.

Suggested Answer:
(e) Both models produce similar results. One advantage to the log-linear model is that the
elasticities
are easily found from the slope coefficients.

Problem 7.18
The following table gives data on real gross product, labor input, and real
capital input in the Taiwanese manufacturing sector.
Download: 0718.dat , 0718.xls
(a) Fit the following models to the preceding data:
Yt = £]1 + £]2X2t + £]3X3t + £]4X4t + £]5X5t + Ut
lnYt = £]1 + £]2lnX2t + £]3lnX3t + £]4lnX4t + £]5lnX5t + Ut
(Eviews) (Rats)
(b) Which model give a better fit and why? (Suggested Answer)
(c) For the log-linear model £]1 and £]2 give, respectively, the output elasticities with respect to
labor and capital. How would you compute similar elasticities for the linear model?
(Suggested Answer)
(d) How would you compare the R2 values of the two models? (Show your calculations)
(Suggested Answer)
(e) How do the result for the manufacturing sector differ from those for the agricultural sector
given
in table 7.3? (Suggested Answer)
(f) What assumption are made about the disturbance term in the log-linear model? How do you
test these assumptions? (Suggested Answer)
Solutions
For the linear model, use the "Estimate Equation" and type "y c x2 x3"
in the dialog box, and the results are as follows:

For the log-linear model, first use the "genr" command to generate log series.
e.g. "lny = log y" and do again for the rest.
Then use the "Estimate Equation" and type "y c lnx2 lnx3" in the dialog box,
and the results are as follows: