Applying the RESET test in allocation models: a cautionary note

Some of the issues which arise if the RESET test is used to validate the functional form of the equations in an allocation model are discussed. The simple application of this test, equation, by equation, is inappropriate on various grounds. The appropriate formulation of the RESET test in a full systems context requires care. This is discussed and illustrated with Engel curves for expenditure on alcoholic beverages in Australia. The same principles apply to other 'variable addition tests' used in econometrics.