Youve been hired by Indo, the new Indonesian automobile manufacturer, to build a model of U.S. car

Question:

You’ve been hired by “Indo,” the new Indonesian automobile manufacturer, to build a model of U.S. car prices in order to help the company undercut U.S. prices. Allowing Friedmaniac zeal to overwhelm any patriotic urges, you build the following model of the price of 35 different American-made 2016 U.S. sedans (standard errors in parentheses):

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Where:

P_i = the list price of the ith car (thousands of dollars)

W_i = the weight of the ith car (hundreds of pounds)

T_i = a dummy equal to 1 if the ith car has an automatic transmission, 0 otherwise

C_i = a dummy equal to 1 if the ith car has cruise control, 0 otherwise

L_i = the size of the engine of the ith car (in liters)

a. Your firm’s pricing expert hypothesizes positive signs for all the slope coefficients in Model A. Test her expectations at the 5-percent level.

b. What econometric problems appear to exist in Model A? In particular, does the size of the coefficient of C cause any concern? Why? What could be the problem?

c. You decide to test the possibility that L is an irrelevant variable by dropping it and rerunning the equation, obtaining the following Model T equation. Which model do you prefer? Why?

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