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1) Does including both part time and temporary work cause a dummy variable trap? If not, can we exclude temporary work as an explanatory variable to explain wages in a country as the nature of work is inconsistent, hence its power of predictability is also inconsistent?

2) Out of Degree, A-level, GCSE and none, which educational explanatory variable in explaining wages in a country is best suited to be the base variable for a dummy? When I run the regression using pc-give OxMetrics, excluding any of them gives me same RSS, R^2 and AdR^2 so I am a little confused.

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The dummy variable trap is concerned with cases where a set of dummy variables is so highly collinear with each other that OLS cannot identify the parameters of the model. That happens mainly if you include all dummies from a certain variable, e.g. you have 3 dummies for education "no degree", "high school", and "college". If you include all dummies in the regression together with an intercept (a vector of ones), then this set of dummies will be linearly dependent with the intercept and OLS cannot solve. For this reason dummies are automatically dropped by most statistical packages.

For question 1, having a part-time and a temporary work dummy should not have this problem because they are not mutually exclusive and exhaustive. For instance, people can work full-time but on a temporary basis. However, if in your sample (for whatever reason) all part-time employees are also temporary workers then again one of your dummies will be dropped. As a side note: the bigger problem with such a regression is an endogeneity problem due to self-selection, e.g. why are some individuals temporary workers? Depending on the reason and its relation to the outcome this may bias the results.

Regarding question 2, changing the baseline dummy is a matter of interpretation. Which baseline you choose depends on what you want to answer. If you want to see how much college graduates earn more than high-school graduates then choosing high-school graduates as the baseline makes sense. Then the coefficient of the graduate dummy can be interpreted as the difference in the outcome between college and high-school graduates.

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  • $\begingroup$ Thank you both for your answers. I basically want to determine the observed wages of employees in the UK, and more specifically, in the education. Does it make sense to include Degree, A-level and none whilst excluding GCSE to get an overall picture then? Because I personally think GCSE and Alevel are not going to have that dramatic change in wages as compared to none or to that with a degree? cheers $\endgroup$ – Sarin Apr 1 '15 at 16:14
  • $\begingroup$ Yes it makes sense but because your level of education and your wages are correlated with unobserved ability you cannot hope to identify the causal effect of a college degree (relative to whatever baseline) on wages. $\endgroup$ – Andy Apr 1 '15 at 18:10
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1) It is possible to be part-time permanently employed, full-time permananently employed, part-time temporarily employed, and full time temporatily employed. So, you can add both to your model without running into the dummy variable trap. You can include or exclude any varible you like. That is a substantive choice not a statistical one, so we cannot help you there.

2) The models are statistically equivalent: If someone with an A-level earns on average 3 euros more than someone without a degree, then someone without a degree will earn 3 euros less than someone with an A-level. So none of these is better than the others, and you can choose whichever one makes most sense to you.

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