Refer to the illustrative example of Chapter 7 where we fitted the Cobb– Douglas production function to the manufacturing sector of all 50 states and the District of Columbia for 2005. The results of the regression given in Eq. (7.9.4) show that both the labor and capital coefficients are individually statistically significant.
a. Find out whether the variables labor and capital are highly correlated.
b. If your answer to (a) is affirmative, would you drop, say, the labor variable from the model and regress the output variable on capital input only?
c. If you do so, what kind of specification bias is committed? Find out the nature of this bias.