Exam (elaborations)

ECS3706 ASSIGNMENT 2 SEM 2 OF 2024 EXPECTED SOLUTIONS

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Econometrics (ECS3706)

Institution
University Of South Africa (Unisa)

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a)

To determine the expected signs of the variables in the econometric model, you should consider the
theore cal rela onship between each explanatory variable and the dependent variable (Gross Domes c
Product, GDP). Here's an explana on for each variable:

1. Lagged GDP (GDPt-1):

 Expected Sign: Posi ve (+)

 Explana on: The lagged GDP represents the previous period's GDP. A posi ve rela onship is
expected because economic growth tends to be persistent over me. If a country had a higher
GDP in the previous period, it is likely to con nue growing in the current period due to
momentum and the eﬀect of previous investments.

2. Capital Investment (CI):

,  Expected Sign: Posi ve (+)

 Explana on: Capital investment is typically a key driver of economic growth. Investments in
infrastructure, machinery, and technology increase the produc ve capacity of an economy,
leading to higher GDP. Therefore, a posi ve rela onship between capital investment and GDP is
expected.

3. Labour (L):

 Expected Sign: Posi ve (+)

 Explana on: Labour is a cri cal factor of produc on. An increase in the labour force or
improvements in labour produc vity should lead to an increase in GDP. More workers or more
eﬃcient workers can produce more goods and services, contribu ng posi vely to economic
growth.

4. Defence Expenditure (DE):

 Expected Sign: Ambiguous

 Explana on: The eﬀect of defense expenditure on GDP can be ambiguous. On one hand, higher
defense spending can s mulate economic ac vity through government contracts, employment,
and technological advancements (posi ve impact). On the other hand, if defense spending
crowds out other produc ve investments or leads to higher taxes, it could nega vely impact GDP
(nega ve impact).

5. Inﬂa on (INF):

 Expected Sign: Nega ve (-)

 Explana on: High inﬂa on is generally considered detrimental to economic growth. It erodes
purchasing power, creates uncertainty, and may lead to less investment. Therefore, a nega ve
rela onship between inﬂa on and GDP is expected.

6. Recession Dummy (REC):

 Expected Sign: Nega ve (-)

 Explana on: The recession dummy variable equals 1 during a recession and 0 otherwise. During
a recession, economic ac vity contracts, leading to lower GDP. Therefore, the coeﬃcient for this
variable is expected to be nega ve, indica ng that being in a recession reduces GDP compared
to periods of economic expansion.

b)

1. Capital Investment (CI): Coeﬃcient = -0.0025

 Interpreta on:

o The coeﬃcient for Capital Investment (CI) is −0.0025, which suggests that, holding all
other factors constant, a one-unit increase in Capital Investment is associated with a
decrease of 0.0025 units in GDP.

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