Instrumental Variables and Two Stage Least Squares 1. Review: Instrumental Variables vs. Measurement Error Bias2. Instrumental Variables vs. Endogeneity Bias3. IV in general4. IV vs. Heterogeneity Bias: Draft Lottery Example5. Two Stage Least Squares6. Weak Instruments7. OveridentificationCopyright © 2003 by Pearson Education, Inc. 10-2The EndogeneityProblem: When both supply and demand can shift the residual is correlated with price. Solution: A supply shifter is needed to estimate the slope of a demand curve.Copyright © 2003 by Pearson Education, Inc. 10-3IV vs. Endogeneity Bias: Cigarette Tax ExampleCopyright © 2003 by Pearson Education, Inc. 10-4Cigarette Tax ResultsCopyright © 2003 by Pearson Education, Inc. 10-53. IV in GeneralCopyright © 2003 by Pearson Education, Inc. 10-6Conditions for Valid InstrumentsCopyright © 2003 by Pearson Education, Inc. 10-74. Draft Lottery Example• How does military service affect earnings?Copyright © 2003 by Pearson Education, Inc. 10-8Copyright © 2003 by Pearson Education, Inc. 10-9Draft Lottery EstimatesCopyright © 2003 by Pearson Education, Inc. 10-10Differences in Earnings w/ trend removed [Reduced Form]Copyright © 2003 by Pearson Education, Inc. 10-11Effect of Eligibility on Service [1stStage]Copyright © 2003 by Pearson Education, Inc. 10-12Effect of Service on Earnings
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