Use the following prompt to answer questions 7 -8: You are interested in estimat
ID: 3360958 • Letter: U
Question
Use the following prompt to answer questions 7 -8: You are interested in estimating the causal effect of x on Iny) controlling for w Unfortunately, you have reason to believe that x is endogenous (specifically, you think that while Xi does in part cause y y also reverse-causes x). You consider running the following regression model using OLS In(y.) = 0 + .xi + 2wi + ui obtained by Explain using words that your uncle could understand why the estimated value of the above regression cannot be trusted (why is it biased)? 7, 8. Your friend suggests that you could use an instrumental variable, Z, to solve your problem. What criteria must this instrumental variable meet? How could you test these criteria? Could you test all criteria without additional instruments?Explanation / Answer
7. Beta1 cannot be trusted as the variable x is dependent on the result outcome. For example, consumption expenditure and income are endogenous and very much dependent on each other in the income determination.