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II. Suppose that the true consumption function for a certain district Yi = Bot BIX1+ B2X2 + B3X3 + ui. Where Y= total consumption; X,:
II. Suppose that the true consumption function for a certain district Yi = Bot BIX1+ B2X2 + B3X3 + ui. Where Y= total consumption; X,: income of rural areas; X2: income of urban areas; X,: income tax You establish that, a priori, the marginal propensity to consume is equally distributed between the urban and rural areas. How would you use the a priori information to estimate this model to avoid the problem of multicollinearity between X, and X2 [3 marks]
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