Reference no: EM13882120

Table 6.9 gives data on the GDP (gross domestic product) deflator for domestic goods and the GDP deflator for imports for Singapore for the period 1968-1982. The GDP deflator is often used as an indicator of in- flation in place of the CPI. Singapore is a small, open economy, heavily dependent on foreign trade for its survival.

TABLE 6.8
Industry	log(V/L)	log W
Wheat flour	3.6973	2.9617
Sugar	3.4795	2.8532
Paints and varnishes	4.0004	3.1158
Cement	3.6609	3.0371
Glass and glassware	3.2321	2.8727
Ceramics	3.3418	2.9745
Plywood	3.4308	2.8287
Cotton textiles	3.3158	3.0888
Woolen textiles	3.5062	3.0086
Jute textiles	3.2352	2.9680
Chemicals	3.8823	3.0909
Aluminum	3.7309	3.0881
Iron and steel	3.7716	3.2256
Bicycles	3.6601	3.1025
Sewing machines	3.7554	3.1354

TABLE 6.9
Year	GDP deflator for domestic goods, Y	GDP deflator for imports, X
1968	1000	1000
1969	1023	1042
1970	1040	1092
1971	1087	1105
1972	1146	1110
1973	1285	1257
1974	1485	1749
1975	1521	1770
1976	1543	1889
1977	1567	1974
1978	1592	2015
1979	1714	2260
1980	1841	2621
1981	1959	2777
1982	2033	2735

To study the relationship between domestic and world prices, you are given the following models:

1. Yt = α1 + α2 Xt + ut

2. Yt = β2 Xt + ut

where Y = GDP deflator for domestic goods and X = GDP deflator for imports.

a. How would you choose between the two models a priori?

b. Fit both models to the data and decide which gives a better fit.

c. What other model(s) might be appropriate for the data?