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Understanding Linear Regression Models

The document discusses regression analysis with a focus on different functional forms involving logarithms and their interpretations. It emphasizes the importance of understanding the linearity of regression models in terms of parameters, while also noting that many relationships can be nonlinear. Additionally, it highlights the significance of interpreting coefficients in empirical work and sets the stage for further exploration of ordinary least squares (OLS) estimators.

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Steven MO16
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6 views1 page

Understanding Linear Regression Models

The document discusses regression analysis with a focus on different functional forms involving logarithms and their interpretations. It emphasizes the importance of understanding the linearity of regression models in terms of parameters, while also noting that many relationships can be nonlinear. Additionally, it highlights the significance of interpreting coefficients in empirical work and sets the stage for further exploration of ordinary least squares (OLS) estimators.

Uploaded by

Steven MO16
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© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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46 Part 1 Regression Analysis with Cross-Sectional Data

TABLE 2.3

Summary of Functional Forms Involving Logarithms

Dependent Independent Interpretation


Model Variable Variable of !1

Level-level y x #y ! !1#x

Level-log y log(x) #y ! (!1/100)%#x

Log-level log(y) x %#y ! (100!1)#x

Log-log log(y) log(x) %#y ! !1%#x

Example 2.11, in the log-log model, !1 is the elasticity of y with respect to x. Table 2.3
warrants careful study, as we will refer to it often in the remainder of the text.

The Meaning of “Linear” Regression


The simple regression model that we have studied in this chapter is also called the simple
linear regression model. Yet, as we have just seen, the general model also allows for certain
nonlinear relationships. So what does “linear” mean here? You can see by looking at equa-
tion (2.1) that y ! !0 " !1x " u. The key is that this equation is linear in the parameters !0
and !1. There are no restrictions on how y and x relate to the original explained and explana-
tory variables of interest. As we saw in Examples 2.10 and 2.11, y and x can be natural
logs of variables, and this is quite common in applications. But we need not stop there. For
example, nothing___ prevents us from using simple regression to estimate a model such as
cons ! !0 " !1√ inc " u, where cons is annual consumption and inc is annual income.
Whereas the mechanics of simple regression do not depend on how y and x are defined,
the interpretation of the coefficients does depend on their definitions. For successful empiri-
cal work, it is much more important to become proficient at interpreting coefficients than to
become efficient at computing formulas such as (2.19). We will get much more practice with
interpreting the estimates in OLS regression lines when we study multiple regression.
Plenty of models cannot be cast as a linear regression model because they are not
linear in their parameters; an example is cons ! 1/(!0 " !1inc) " u. Estimation of such
models takes us into the realm of the nonlinear regression model, which is beyond the
scope of this text. For most applications, choosing a model that can be put into the linear
regression framework is sufficient.

2.5 Expected Values and Variances


of the OLS Estimators
In Section 2.1, we defined the population model y ! !0 " !1x " u, and we claimed that
the key assumption for simple regression analysis to be useful is that the expected value
of u given any value of x is zero. In Sections 2.2, 2.3, and 2.4, we discussed the algebraic

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