Econometrics

    at =130 +I31Lt +I32t+I33t•Lt +ut (equation 1) where Lt is a dummy equal to one for all t after the trade liberalization, and t is year. For convenience, for this exercise you should let t start at t = 1. The second measure will be constructed in the following way: Let sit be the average log per worker income over all countries in year t. Country i's distance to the average in year t is zi,t = yit - Let azi,t+1 = zi,t+1 -zi,t. You will estimate: Azi,t+1 =130 + 131zi,t + I32zi,t • Lt + ui,t (Equation 2) Equations 1 and 2 will not be sufficient to identify whether or not trade liberalisation has led to income convergence or income divergence. You will construct control groups: countries which have not been party to a trade liberalisation. Whether a country belongs to the liberalising or to the control group will be indicated by the superscript j. In particular, Dj is a dummy equal to one if the country (or country group) is a liberaliser, irrespective of when the country liberalised. You will estimate: at =130 +I31Lt +1320j +133Lt •Dj +I34t+I35t•Lt +I36t•Dj +I37t•Lt •Dj +ujt (equation 3) And azi,t+1 =130 +I31zi,t +I32zi,t •Lt +133zi,t -Dj +134zi,t •Lt •Dj +ui,t (Equation 4) 1. First of all, explain equations 1-4, the meaning of the coefficients, and why estimating only equations 1 and 2 is not sufficient to identify the effect of trade liberalization. (10 marks)