Solutions Manual — Essentials of Econometrics, 5th Edition — Damodar N. Gujarati & Dawn C. Porter — ISBN 9781071850398 — Latest Update 2025/2026 — (All Chapters Covered 1–13)

Essentials of Econometrics
5th Edition
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SOLUTIONS
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MANUAL
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Damodar N. Gujarati
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Dawn C. Porter

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Comprehensive Solutions Manual for
Instructors and Students
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© Damodar N. Gujarati & Dawn C. Porter. All rights reserved. Reproduction or distribution
without permission is prohibited.
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, Solutions Manual for Essentials of Econometrics, 5e Damodar Gujarati,
Dawn Porter (All Chapters)
CHAPTER 1
THE NATURE AND SCOPE OF ECONOMETRICS



QUESTIONS
1.1. (a) Other things remaining the same, the higher the tax rate is, the lower
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the price of a house will be.
(b) Assume that the data are cross-sectional, involving several residential
communities with differing tax rates.
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(c) Yi = B1 + B2 X i
where Y = price of the house and X = tax rate
(d) Yi = B1 + B2 X i + ui
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(e) Given the sample, one can use OLS to estimate the parameters of the
model.
(f) Aside from the tax rate, other factors that affect house prices are
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mortgage interest rates, house size, buyers’ family income, the state of the
economy, the local crime rate, etc. Such variables may be included in a more
detailed multiple regression model.
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(g) A priori, B2 < 0. Therefore, one can test H0 : B2 ≥ 0 against H1 : B2 < 0.

(h) The estimated regression can be used to predict the average price of a
house in a community, given the tax rate in that community. Of course, it
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is assumed that all other factors stay the same.
1.2. Econometricians are now routinely employed in government and business
to estimate and / or forecast (1) price and cost elasticities, (2) production
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and cost functions, and (3) demand functions for goods and services, etc.
Econometric forecasting is a growth industry.
1.3. The economy will be bolstered if the increase in the money supply leads to
a reduction in the interest rate which will lead to more investment activity
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and, therefore, to more output and more employment. If the increase in the
money supply, however, leads to inflation, the preceding result may
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, not occur. The job of the econometrician will be to develop a model to
predict the effect of the increase in the money supply on inflation, interest
rate, employment, etc.
1.4. As a matter of fact, on October 1, 1993 the Federal Government did increase
the gasoline tax by 4 cents. Since gasoline and cars are complementary
products, economic theory suggests that an increase in the price of gasoline
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will not only lead to a decline in the demand for gasoline but also in the
demand for cars, ceteris paribus. The Ford Motor Companymay be advised
to produce more fuel-efficient cars to stave off a serious decline in the
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demand for its cars. An automobile demand function will provide numerical
estimates of the effect of gasoline tax on the demandfor automobiles.
1.5.
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There are many alternative designs possible. However, to keep things
simple, and discuss just a basic idea of the design, we could think of using
an econometric model known as Autoregressive Distributed Lag (ARDL)
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of the form:
∆yt = α + β∆yt −1 + θ 0 ∆gt + θ1∆gt −1 + γ 0 ∆τ tp + +γ 1∆τ tp−1 + δ 0 ∆τ tc + δ1∆τ tc−1 + ut

where
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Yt − Yt −1
yt = = real GDP growth rate in year t;
Yt −1

Gt − Gt −1
gt = = real government infrastructure investment growth rate in
Gt −1
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year t;
τ tp = personal income tax rate in year t;

τ tc = corporate income tax rate in year t;
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∆yt = yt − yt −1 = change in real GDP growth rate in year t;

∆g t = g t − g t −1 = change in real government infrastructure investment growth
rate in year t;
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∆τ tp = τ tp − τ tp−1 = change in personal income tax rate in year t;
∆τ tc = τ tc − τ tc−1 = change in corporate income tax rate in year t.

Expected signs and magnitudes of the parameters the regression model:
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, 0 ≤ β ≤ 1;
θ 0 ,θ1 > 0;
γ 0 , γ 1 , δ 0 , δ1 < 0.

Note that a more realistic model would include a larger number of lags of the
regressors than included in our model, and would also include additional
regressors known as control variables which could be determined based on
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economic theory.

Now, based on our specified model above, short run and long run economic
consequence of 1 unit increase in ∆g t , ∆τ tp , and ∆τ tc , respectively, can be
determined by using partial derivatives as follows.
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Short run economic consequences of a 1 unit increase in ∆g t are given by:
∂∆yt
= θ0 ;
∂∆gt
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∂∆yt +1 ∂ ( β∆yt + θ1∆g t )
= = βθ 0 + θ1;
∂∆g t ∂∆g t
∂∆yt + 2 ∂ ( β∆yt +1 )
= = β ( βθ 0 + θ1 );
∂∆g t ∂∆g t
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∂∆yt + 3 ∂ ( β∆yt + 2 ) ∂ (∆yt + 2 )
= =β = β 2 ( βθ 0 + θ1 );
∂∆g t ∂∆g t ∂∆g t
and so on.
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Long run consequence is the sum of short run consequences
= θ 0 + ( βθ 0 + θ1 ) + β ( βθ 0 + θ1 ) + β 2 ( βθ 0 + θ1 ) + ...
= θ 0 + βθ 0 + θ1 + β 2θ 0 + βθ1 + β 3θ 0 + β 2θ1 + ...
= θ 0 (1 + β + β 2 + β 3 + ...) + θ1 (1 + β + β 2 + ...)
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θ0 θ
= + 1
1− β 1− β
θ +θ
= 0 1.
1− β
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Analogously, short run economic consequences of a 1 unit increase in ∆τ tp are
given by:
∂∆yt
= γ 0;
∂∆τ tp
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∂∆yt +1 ∂ ( β∆yt + γ 1∆τ tp )
= = βγ 0 + γ 1;
∂∆τ tp ∂∆τ tp
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