Question

Question 1: William Comanor and Thomas Wilson1 specified the following regression in their study of advertising’s effect on the profit rates of 41 consumer goods firms: PRi = β0 + β1 ×ADVi/SALESi + β2 ×lnCAPi + β3 ×lnESi + β4 ×lnDGi + i where: PRi = the profit margin of the ith firm ADVi = the advertising expenditures in the ith firm (in dollars) SALESi = the total gross sales of the ith firm (in dollars) CAPi = the capital needed to enter the ith firm’s market at an efficient size ESi = the degree to which economies of scale exist in the ith firm’s industry DGi = percent growth in sales (demand) of the ith firm over the last 10 years a) Hypothesize expected signs for each of the slope coefficients. b) Note that there are two different kinds of nonlinear (in the variables) relationships in this equation. For each independent variable, determine the shape that the chosen functional form implies, and state whether you agree or disagree with this shape. Explain your reasoning in each case. c) Comanor and Wilson state that the simple correlation coefficient between ADVi/SALESi and each of the other independent variables is positive. If one of these other variables were omitted, in which direction would ˆ β1 likely be biased? Refer to your hypothesized signs of the coefficients in part (a).

Answer 1