Assumption 1 requires that the dependent variable is a linear combination of the explanatory variables and the error terms . Assumption 1 requires the specified model to be linear in parameters, but it does not require the model to be linear in variables. Equation 1 and 2 depict a model which is both, linear in parameter and variables. Note that Equation 1 and 2 show the same model in different notation.
Understanding investment activity in an economy is not trivial. The erratic nature of firm level investment activity is somewhat of a mystery to me and it took me quite some time to get a vague idea of what could be the generating process behind such an erratic behavior. I think understanding capital adjustment costs was the key to understand why it can be rational for firms to invest in a spasmodic way. In this post I would like to shortly summarize part of what I learnt so far and list different types of capital adjustment costs found in the literature.