Use the entire panel data set in AIRFARE.RAW for this exercise. The demand equation in a simultaneous equations unobserved effects model is
Log(passenit) = θit + α1 log(fareit) + ait + uit,
where we absorb the distance variables into ait.
(i) Estimate the demand function using fixed effects, being sure to include year dummies to account for the different intercepts. What is the estimated elasticity?
(ii) Use fixed effects to estimate the reduced form
Log(fareit) θt2 + π21 concenit + ai2 + vit2,
Perform the appropriate test to ensure that concenit, can be used as an IV for log(fareit).
(iii) Now estimate the demand function using the fixed effects transformation along with IV, as in equation (16.42). Now what is the estimated elasticity? Is it statistically significant?