1. (14 pts.) A researcher is interested in the effect of class size on students academic performance. She collects data from a random sample of 500 California school districts and runs the OLS regression

Y_i= ₀+ ₁ X_i + _i,

where Yi is average test score for each school district and Xi is a measure of class size, student-teacher ratio.

1. Explain why the OLS estimates are likely to be unreliable. (Hint: Which variables are omitted from the regression? Are they correlated with the class size?) (7 pts.)
2. Consider the following hypothetical example: some California schools are forced to close for repairs because of a summer earthquake. Districts closest to the epicenter are most severely affected. A district with some closed schools needs to double up its students, temporarily increasing class size. Explain how the distance from the epicenter might be used as an instrument to estimate the effect of class size on students test scores. (7 pts.)