Tài liệu KInh tế ứng dụng_ Lecture 4: Use of Dummy Variables docx

Applied Econometrics 1 Dummy Variables

Applied Econometrics

Lecture 4: Use of Dummy Variables

‘Pure and complete sorrow is as impossible as pure and complete joy’

1) Introduction

The quantitative independent variables used in regression equations, which usually take values over

some continuous range. Frequently, one may wish to include the quality independent variables, often

called dummy variables, in the regression model in order to (i) capture the presence or absence of a

‘quality’, such as male or female, poor or rich, urban or rural areas, college degree or do not college

degree, different stages of development, different period of time; (ii) to capture the interaction

between them; and, (iii) or to take on one or more distinct values.

2) Intercept Dummy

An intercept dummy is a variable, says D, has the value of either 0 or 1. It is normally used as a

regressor in the model.

For example, the consumption function (C) can be written as follows:

C = b0 + b1Y + b2D

where

Y is the gross national income

D is equal to 1 for developing countries and 0 for

developed countries

Then,

If D = 0, C = b0 + b1Y

If D = 1, C = b0 + b1Y + b2D = (b0+ b2)+ b1Y

b2 C = b0 + b1Y

C = (b0+ b2)+ b1Y

Y

C

Illustrative example 1 (Maddala, 308)

We suppose that we regress the consumption (C) on income (Y) for household. We include the

following quality variables in the form of dummy variables

Written by Nguyen Hoang Bao May 22, 2004