Question

1. A simple linear regression model relating a bank lending interest rate and investment in physical capital by companies is stated as:

Which variable (lending interest rate or investment in physical capital) do you think should be the dependent variable in this regression model? Please justify your answer.                                                        [2 points]

2. What sign would you expect for the slope of this regression model for interest rate and investment in physical capita? Please justify your answer.                    
3. What is the role of the error term in the simple linear regression model like the one stated above? Please state at least three examples of the factors that you think belong in the error term of the simple linear regression model stated above briefly justifying each example.                                                                                           [3 points]
4. Please explain how you would estimate the relationship between interest rate and investment specified above. [note: you do not need to write any formulas as an answer to this question. Just explain what you will need and the reasoning behind the method you would use to estimate the relationship].                               [3 points]
5. For what purpose could you use the estimated simple linear regression model for lending interest rate and investment in physical capital? Why could the simple linear regression model stated above be inadequate for the purpose?            [2 points]                       
6. Using an example, please explain why a statistically significant relationship in a regression model for two variables does not necessarily imply “cause” and “effect” relationship between the two variables.   

  

Answer 1