Introductory Econometrics: A Modern Approach 6th Edition by Jeffrey M Wooldridge

Exercise 17

For this exercise, use the data in AIRFARE.RAW, but only for the year 1997.

(i)A simple demand function for airline seats on routes in the United States is

log(passenit) = ?10 + ?1log(fare) + ?11 log(dist) + ?12[log(dist)]2 + u1,

where

passen = average passengers per day.

fare = average airfare.

dist = the route distance (in miles). If this is truly a demand function, what should be the sign of ?1?

(ii) Estimate the equation from part (i) by OLS. What is the estimated price elasticity?

(iii) Consider the variable concen, which is a measure of market concentration. (Specifically, it is the share of business accounted for by the largest carrier.) Explain in words what we must assume to treat concen as exogenous in the demand equation.

(iv) Now assume concen is exogenous to the demand equation. Estimate the reduced form for log(fare) and confirm that concen has a positive (partial) effect on log(fare).

(v) Estimate the demand function using IV. Now what is the estimate price elasticity of demand? How does it compare with the OLS estimate?

(vi) Using the IV estimates, describe how demand for seats depends on route distance.

Step 1 of 7

(i)

The simple demand function for airline seats on routes in the Unites States is given by:

The sign of is expected to be negative as higher the average airfare, lower should be the passengers per day as with the increase in the average fare, the cost of air travel increases