Suppose the relationship between temperature and demand for electricity is non-linear, due to the high demand for electricity when it is both very cold and very hot outside. What is the risk of estimating the effect of price on demand for electricity by the regression equation: Electricity Consumption_t = α₀ + α₁Price_t + α₂Temperature_t + U_t? A) The estimate of α₁ will be biased. B) The sample will not be representative. C) Electricity consumption will be censored from above. D) None of the answers is correct.

Question

Quizplus · Accepted Answer

The non-linear relationship between temperature and demand for electricity will cause the estimate of the effect of price on demand (represented by α₁) to be biased. This is because the effect of temperature on demand is also included in the regression equation and may be correlated with the effect of price.

Suppose the Relationship Between Temperature and Demand for Electricity Is