1.
Identify an economic theory or relationship you could estimate via OLS and describe the
hypothesis you would test for that theory or relationship.
Solution
OLS
The Production Possibilities Curve (PPC) models a two-good economy by mapping production
of one good on the x-axis and production of the other good on the y-axis. The combinations of
outputs produced using the best technology and all available resources make up the PPC. Points
inside the PPC result from inefficiency; output combinations outside the PPC are impossible to
produce. The guns and butter PPC, for example, illustrates tradeoffs between producing goods
for peaceful and military purposes. This PPC illustrates opportunity cost in that more guns
cannot be produced without reducing butter output; further, the slope of the PPC indicates the
nature of the tradeoff between guns and butter (that is, how many guns must be given up to
obtain an additional ton of butter).