1. CHAPTER 6 ECONOMETRICS x x x x x Dummy Variable Regression Models Dummy, or indicator, variables take on values of 0 or 1 to indicate the presence or absence of a quality. Y i = B 1 + B 2 D i + B 3 X i + u i D i =1 for female 0 for male They can be included in regressions just like quantitative variables. D i =1 for prior to 2001 0 for 2001 and later OR

2. A Dummy Variable Indicates Change in Intercept Y i = 60 + 30 D i - 0.4 X i + u i 20406080100120 20 40 60 80 100 120 X Y If D = 0 Y = 60 + 30 D - 0.4 X Y = 60 – 0.4 X D = 0 D = 1 If D = 1 Y = 60 + 30 D - 0.4 X Y = 90 - 0.4 X B 2 =30 is the differential intercept coefficient.

3. A Dummy Variable Can Allow for Change in Slope, Too Y i = 60 + 30 D i – 0.4 X i + 0.3(D i X i ) + u i 20406080100120 20 40 60 80 100 120 X Y If D = 0 Y = 60 + 30 D – 0.4 X + 0.3 DX Y = 60 – 0.4 X D = 0 D = 1 B 4 =0.3 is the differential slope coefficient. If D = 1 Y = 60 + 30 D – 0.4 X + 0.3 DX Y = 60 – 0.1 X

4. Y i = B 1 + B 2 D i + B 3 X i + u i D i =0 for first quarter2 for third quarter 1 for second quarter3 for fourth quarter Variables with More than Two Classes Don’t allow the dummy variable to take on multiple values:  This assumes a pattern in the effect that might not exist. Instead, use several indicator variables. D 2i =1 if 2 nd qrt 0 otherwise Y i = B 1 + B 2 D 2i + B 3 D 3i + B 4 D 4i + B 5 X i + u i D 3i =1 if 3 rd qrt 0 otherwise D 4i =1 for 4 th qrt 0 otherwise