INTRODUCTION TO ECONOMETRICS II
ECO 306
NOUN
84
…[2.73] And regress
on price. This is a simple regression, so multicollinearity has been eliminated. There are, however, two possible problems with this technique. First, the estimate of
depends on the accuracy of the estimate of b
2
', and this of course is subject to sampling error. Second, you are assuming that the income coefficient has the same meaning in time series and cross-section contexts, and this may not be the case. For many commodities, the short-run and long-run effects of changes in income may differ because expenditure patterns are subject to inertia. A change in income can affect expenditure both directly, by altering the budget constraint, and indirectly, through causing a change in lifestyle, and the indirect effect is much slower than the direct one. As a first approximation, it is commonly argued that time series regressions, particularly those using short sample periods, estimate short-run effects while cross-section regressions estimate long-run ones. For the indirect methods to alleviate multicollinearity problems. If the correlated variables are similar conceptually, it maybe reasonable to combine them into some overall index.
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