Economics

Using N=428 women in the sample who are in labor force, the least squares estimates and their standard errors are:

In (wage)= -0.5220 + 0.1075 *EDU + 0.0416 * EXPER - 0.0008 * EXPER²

_{^{(se) 0.1986) (0.0141) (0.0132) (0.0004)}}

We estimate that an additional year of education increases wages approximately 10.75% holding everything else constant. If ability has a positive effect on wages, then this estimate is overstated, as the contribution of ability is attributed to the education variable.

Now the least squares estimation method cannot be used to estimate the wage equation. Explain how instrumental variables can be used to estimate this equation.