Consider the following dynamic wage equation Wit = Xitß+ywi,t-1 + ai + Uit where wit denotes an individual's log hourly wage rate, Xit is a vector of personal and job characteristics (age, schooling, industry, etc), and a; is an unobserved individual heterogeneity component. Assume that uit is iid. (a) Explain in words why OLS applied to this model is inconsistent. (b) Explain in words why the fixed effects (FE) estimator applied to this model is inconsistent (for N → ∞ and fixed T). (c) Explain why the results from (a) and (b) also imply that the random effects estimator (RE) applied to this model is inconsistent (for N → ∞ and fixed T). (d) Describe a simple consistent (N ∞) estimator for 3, y assuming that ai and uit are independent of all xįts. (e) Describe a more efficient estimator under the same assumptions.

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