The McGraw-Hill Series Economics essentials of economics brue, McConnell, and Flynn Essentials of Economics

FIGURE 11.5
Residuals from the
regression of 
(
a
) impressions
of advertising
expenditure and 
(
b
) impression on
Adexp and Adexp
2
.
4
David F. Hendry, 
Dynamic Econometrics,
Oxford University Press, 1995, p. 45.
guj75772_ch11.qxd 12/08/2008 07:03 PM Page 368

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Chapter 11
Heteroscedasticity: What Happens If the Error Variance Is Nonconstant?
369
Note that the problem of heteroscedasticity is likely to be more common in cross-
sectional than in time series data. In cross-sectional data, one usually deals with members of
a population at a given point in time, such as individual consumers or their families, firms,
industries, or geographical subdivisions such as state, country, city, etc. Moreover, these
members may be of different sizes, such as small, medium, or large firms or low, medium,
or high income. In time series data, on the other hand, the variables tend to be of similar or-
ders of magnitude because one generally collects the data for the same entity over a period
of time. Examples are gross national product (GNP), consumption expenditure, savings, or
employment in the United States, say, for the period 1955–2005.
As an illustration of heteroscedasticity likely to be encountered in cross-sectional analysis,
consider Table 11.1. This table gives data on compensation per employee in 10 nondurable
goods manufacturing industries, classified by the employment size of the firm or the estab-
lishment for the year 1958. Also given in the table are average productivity figures for nine
employment classes.
Although the industries differ in their output composition, Table 11.1 shows clearly that
on the average large firms pay more than small firms. As an example, firms employing one
to four employees paid on the average about $3,396, whereas those employing 1,000 to
2,499 employees on the average paid about $4,843. But notice that there is considerable
variability in earnings among various employment classes as indicated by the estimated