1. You have estimated a linear regression model relating Y to X. Your professor says, “I think that the relationship between Y and X is nonlinear.” Explain how you would test the adequacy of your linear regression.
2. Suppose that in Exercise 8.2 you thought that the value of β2 was not constant, but rather increased when K increased. How would you use an interaction term to capture this effect?
Exercise 8.2
A “Cobb-Douglas” production function relates production (Q) to factors of production, capital (K), labor (L) and raw an materials (M), and an error term u using the equation are production parameters. Suppose that you have data on production and the factors of production from a random sample of firms with the same Cobb-Douglas production function. How would you use regression analysis to estimate the production parameters?
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