Econ 140

Multiple Regression Applications

Lecture 14

Lecture 14

Todays plan

Econ 140

Relationship between R2 and the F-test.

Restricted least squares and testing for the imposition of a
linear restriction in the model

Lecture 14

R2

Econ 140

We know
R2

Explained S of S
Total S of S

We can rewrite this as

^ x y b^ x y
b

2 2
R2 1 1
2
y

Remember:
If R2 = 1, the model explains all of the variation in Y
If R2 = 0, the model explains none of the variation in Y
Lecture 14

R2 (2)

Econ 140

We know from the sum of squares identity that

^
^
^2

^2

y b1 x1 y b2 x2 y e

Dividing by the total sum of squares we get

^
y2 b
x y b^
x y

2
y

Lecture 14

^e

2
y

R2 (3)

Econ 140

Thus
2
2
e

2
2
or
or
1 R
R 1
2
2
y
y

2
e

1 R2
2
y

If we divide the denominator and numerator of the F-test by the

total sum of squares:

b1 x1 y b2 x2 y
2
2
y

F
2
e

n3
2
y
Lecture 14

F-stat in terms of R2

Econ 140

The F-test for the joint hypothesis: H0: b1 = b2 = 0 can be

written in terms of R2:

R2 2
F
(1 R 2 ) n 3
Recalling our LINEST (from L12.xls) output, we can substitute R 2 = 0.188

We would reject the null at a 5% significance level and accept the null at the 1% significance level

0.188 2
F
3.82
1 0.188 33

Lecture 14

Relationship between R2 & F

Econ 140

When R2 = 0 there is no relationship between the Y and X

variables
This can be written as Y = a
In this instance, we cannot reject the null and F = 0
When R2 = 1, all variation in Y is explained by the X
variables
The F statistic approaches infinity as the denominator
would equal zero
In this instance, we always reject the null
Lecture 14

Restricted Least Squares

Econ 140

Imposing a linear restriction in a regression model and re-examining the

relationship between R2 and the F-test.
Example of Cobb-Douglas production function
In restricted least squares we want to test a restriction such as

H0 : 1
Where our model is

ln Y a ln L ln K e

We can write = 1 - and substitute it into the model equation so that:

(lnY - lnK) = a + (lnL - lnK) + e

Lecture 14

Restricted Least Squares (2)

Econ 140

We can rewrite our equation as: G = a +Z + e*

Where: G = (lnY - lnK) and Z = (lnL - lnK)
The model with G as the dependent variable will be our restricted model
the restricted model is the equation we will estimate under the
assumption that the null hypothesis is true

Lecture 14

Restricted Least Squares (3)

Econ 140

How do we test one model against another?

We take the unrestricted and restricted forms and test them
using an F-test
The F statistic will be

2*
2

e
q

F
e2 n k

* refers to the restricted model

q is the number of constraints
in this case the number of constraints = 1 ( + = 1)
n - k is the df of the unrestricted model

Lecture 14

10

Testing linear restrictions

Econ 140

Estimation when imposing a linear restriction in the CobbDouglas log-linear model:

ln Y a ln L ln K e
Test for constant returns to scale, or the restriction:
H0: + = 1
We will use L13_1.xls to test this restriction - worked out
in L14.xls

Lecture 14

11

Testing linear restrictions (2)

Econ 140

The unrestricted regression equation estimated from the

data (L13_1.xls) is:
ln Y 0.488 0.674 ln L 0.447 ln K e

(0.185)

0.026

0.030

Note the t-ratios for the coefficients:

: 0.674/0.026 = 26.01
: 0.447/0.030 = 14.98
compared to a t-value of around 2 for a 5% significance level, both & are very precisely determined
coefficients

Lecture 14

12

Testing linear restrictions (3)

Econ 140

adding up the regression coefficients, we have:

0.674 +0.447 = 1.121
how do we test whether or not this sum is statistically
different from 1?
Note the restriction: = 1-
Our restricted model is:
(lnY - lnK) = a + (lnL - lnK) + e
or
G = a +Z + e*
Lecture 14

13

Testing linear restrictions (4)

Econ 140

The procedure for estimation is as follows:

1. Estimate the unrestricted version of the model
2. Estimate the restricted version of the model
2
2*
3. Collect e for the unrestricted model and e
for the restricted model
2*
2
e

e
q

4. Compute the F-test

F

e2 n k

where q is the number of restrictions (in this case q = 1)

and (n-k) is the degrees of freedom for the unrestricted
model

Lecture 14

14

Testing linear restrictions (5)

Econ 140

On L14.xls our sample n = 32 and an estimated

unrestricted model provides the following information:

ln Y 0.488 0.674 ln L 0.447 ln K e

0.030
(0.185) 0.026
R 2 0.996
2
e

.351

Lecture 14

15

Testing linear restrictions (7)

Econ 140

The restricted model gives us the following information:

G 1.061 0.679 Z

1.061

(0.048)

R 2 0.871
2*
e

1.228

We can use this information to compute our F statistic:

F* = [(1.228 - 0.351)/1]/(0.359/29) = 72.47

Lecture 14

16

Testing linear restrictions (8)

Econ 140

The F table value at a 5% significance level is:

F0.05,1,29 = 4.17
Since F* > F0.05,1,29 we will reject the null hypothesis that there are constant returns to scale
Note that the test rejects constant return. As + > 1, we might conclude there are increasing returns to scale.
NOTE: the dependent variables for the restricted and unrestricted models are different
dependent variable in unrestricted version: lnY
dependent variable in restricted version: (lnY-lnK)

Lecture 14

17

Testing linear restrictions (9)

Econ 140

We can also use R2 to calculate the F-statistic by first

dividing through by the total sum of squares

Using our definition of R2 we can write:

1 R 1 R q R R q
F

1 R n k
1 R n k
2*

Lecture 14

2*

18

Testing linear restrictions (10)

Econ 140

NOTE: we cannot simply use the R2 from the unrestricted model since it has a different dependent variable
What we need to do is take the expectation E(G|L,K)
We need our unrestricted model to have the same dependent variable G, or:

G a Z 1 ln K e
Where G = (lnY - lnK), Z = (lnL - lnK)
We can test this because we know that + - 1 = 0.121 since + = 1
Estimating this unrestricted model will give us the unrestricted R2

Lecture 14

19

Testing linear restrictions (11)

Econ 140

From L14.xls we have :

R2* = 0.871
R2 = 0.963
Our computed F-statistic will be

0.963 0.871 1 0.092

F

72.47
1 0.963 29 0.0013

Lecture 14

20

Testing linear restrictions (12)

Econ 140

On L14.xls we have 32 observations of output, employment, and capital

The spreadsheet has regression output for the restricted and unrestricted models
The R2 and sum of squares are in bold type
F-tests on the restriction are on the bottom of the sheet
We find that Excel gives us an F-statistic of 72.4665
The F table value at a 5% significance level is 4.1830
The probability that we could not reject the null given this F-statistic is very small

Lecture 14

21

Testing linear restrictions (13)

Econ 140

From this we can conclude that we have a model where there are increasing returns to scale.
We dont know the true value, but we can reject the restriction that there are constant returns to
scale.

Lecture 14

22