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1. The following sample on the level of education (measured by the number of years of schooling) and wages (hourly) earned by 15 individuals is as follows:

Education    Wages ($)        Education         Wages ($)
6                  4.45                 10                 7.31
7                  5.57                 12                  7.82
8                  5.97                 14                 11.02
9                  7.33                 15                 10.67
10                7.31                 16                 10.83
11                6.58                 17                 13.61
6                 4.45                  15                10.67
18              13.53

According to the human capital theory education increases a worker’s productivity and thus leads to higher wages. Consider the economic model Wages β0 + β1 Education.

a. What sign would you expect β0 and β1 to take? Draw a rough scatter graph of the data with wages on the vertical axis and education on the horizontal axis. Does it look like the data support the human capital theory?

b. Estimate Wages β0 + β1Education + u. Give a plot of Wagesi. Interpret the intercept and the slope coefficient.

c. find out the standard error of β0 and β1

d. find out the 99% confidence interval for β0 and β1.

e. Test the null hypothesis β1 = 0 at 1% level of significance.

f. find out and interpret R2

g. describe the assumption of homoscedasticity.

2. Under the OLS estimation the following hold:

∑ ui = 0, ∑ uiXi = 0, and ∑ ui Yi = 0.

Prove and describe the above properties.

3. Show that the OLS estimate of β0 and β1  is unbiased

4. Prove that the cov (β0, β1) =−X σ2/∑xi2

5. For the following model derive the least square estimator of α, Y = α + u

Show that the OLS estimator for α is BLUE under Gauss Markov Assumptions.

Which assumption is important for the estimator to be unbiased?

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