Look back at Exercise 9 in Chapter 5, the equation on international price discrimination in pharmaceuticals. In that cross-sectional study, Schut and VanBergeijk estimated two equations in addition to the one cited in the exercise.13 These two equations tested the possibility that CV_i, total volume of consumption of pharmaceuticals in the ith country, and N_i, the population of the ith country, belonged in the original equation, Equation 5.15, repeated here:

Where:

P_i = the pharmaceutical price level in the ith country divided by that of the United States

GDPN_i = per capita domestic product in the ith country divided by that of the United States

CVN_i = per capita volume of consumption of pharmaceuticals in the ith country divided by that of the United States

PP_i = a dummy variable equal to 1 if patents for pharmaceutical products are recognized in the ith country, 0 otherwise

DPC_i = a dummy variable equal to 1 if the ith country applied strict price controls, 0 otherwise

PC_i = a dummy variable equal to 1 if the ith country encouraged price competition, 0 otherwise

a. Using Stata, or your own computer program, and datafile DRUG5 (or Table 5.2), estimate:

i. Equation 5.15 with CV_i added, and

ii. Equation 5.15 with N_i added

b. Use our four specification criteria to determine whether CV and N are irrelevant or omitted variables.

c. Why didn’t the authors run Equation 5.15 with both CV and N included?

d. Why do you think that the authors reported all three estimated specifications in their results when they thought that Equation 5.15 was the best?