1.
Week 1
Introduction
Econometrics
Analysis
1. Economics Theory 1.2
“ Keynes postulated a positive relationship between consumption
and incomes”, i.e., people’s income
2. Mathematical Expression:
Consumption = f(Income) ==> C = f(Y)
MPC = dC/dY = f’(Y) > 0 ;assume 0 < MPC < 1
3. Statistics:
Year C Y
Find the mean, variance,
1980 2447.1 3776.3
1981 2476.9 3841.1 standard deviation,
…. …. …. correlation, etc.
2000 4651.8 5991.7
4. Econometric - Regression model
Ct = β1 + β2 Yt + ut => ΔC/ΔY = β2
=> estimating the relationship
1.3
The Role of Econometrics
Provide measurement and quantitative
analysis of actual economic
phenomena
or economic relationship based on
1. Economic theory
2. Economic data
3. Methods of model constructed
1.4
Economic Relationships:
Stock Market Index money supply
government
budget
Interest rate
Exchange
inflation trade Rate
deficit Properties Market
unemployment
Wage
capital gains tax
rent
control
crime rate laws
1.5
Economic Decisions
To use information effectively:
economic theory
economic data
} economic
decisions
*Econometrics* helps us combine
economic theory and economic data .
1.6
The Consumption Function
Consumption, C, is some function of income, Y :
C = f(Y)
For applied econometric analysis
this consumption function must be
specified more precisely.
1.7
demand, qd, for an individual commodity:
qd = f( p, pc, ps, y ) demand
p = own price; pc = price of complements;
ps = price of substitutes; y = income
supply, qs, of an individual commodity:
qs = f( p, pc, pf, ps ) supply
p = own price; pc = price of complement products;
ps = price of substitutes; pf = price of factor inputs
1.8
How much ?
Listing the variables in an economic relationship is not enough.
For effective policy we must know the amount of change
needed for a policy instrument to bring about the desired
effect:
• By how much should the Federal Reserve
raise interest rates to prevent inflation?
• By how much can the price of football tickets
be increased and still fill the stadium?
1.9
Answering the How Much? question
Need to estimate parameters
that are both:
1. unknown
and
2. unobservable
1.10
The Statistical Model
Average or systematic behavior
over many individuals or many firms.
Not a single individual or single firm.
Economists are concerned with the
unemployment rate and not whether
a particular individual gets a job.
1.11
The Statistical Model
Actual vs. Predicted Consumption:
Actual = systematic part + random error
Consumption, c, is function, f, of income, i, with error, u:
C = f(Y) + u
Systematic part provides prediction, f(i),
but actual will miss by random error, u.
1.12
The Consumption Function
C = f(Y) + u
Need to define f(i) in some way.
To make consumption, c,
a linear function of income, i Y:
C = f(Y)
C = β1 + β2Y
The statistical model then becomes:
C = β1 + β2Y + u
The Wage Function 1.13
W = f(X) + u
Where X can represent a group of variables such
“education”, “experience”, and “training”, etc.
f(X) = β1 + β2 educ + β3 experi + β4 training
The statistical estimation model then becomes:
W = β1 + β2 educ + β3 experi + β4 training + u
1.14
The Econometric Model
Y= y = β1 + β2 X2 + β3 X3+ u
Y
• Dependent variable, y, is focus of study
(predict or explain changes in dependent variable).
• Explanatory variables, X1 and X2, help us explain
observed changes in the dependent variable.
1.15
Terminology and Notation
Y = β1 + β2 X + u
Left hand-side Right hand-side
Variable: Variable:
Dependent Explanatory
Explained Independent
Predictand Predictor
Regressand Regressor
Response Stimulus or control
Endogenous Exogenous
1.16
Statistical Models
Controlled (experimental)
vs.
Uncontrolled (observational)
Controlled experiment (“pure” science) explaining mass, Y :
pressure, X1, held constant when varying temperature, X2,
and vice versa.
Uncontrolled experiment (econometrics) explaining consump-
tion, Y: price, X1, and income, X2, vary at the same time.
1.17
Econometric model
• economic model
economic variables and parameters.
• statistical model
sampling process with its parameters.
• data
observed values of the variables.
Time series data 1.18
Cross-section data and Pool (Panel) data 1.19
1.20
The Practice of Econometrics
• Statement of theory or hypothesis
• Specification of the mathematical model of the
theory
• Specification of the econometric model of the
theory
• Obtaining data for the analysis.
• Estimation with statistical properties.
• Hypothesis testing
• Analyze and evaluate implications of the results
• Forecasting or prediction
• Using the model for control or policy purpose
Economic Empirical Study 1.21
Economic Theory; Past Experience, studies
C = f(Inc) ==>
Formulating a model: Cause - effect Ct = β1 + β2Inct + ut
Gathering data: Statistics monthly, quarterly, yearly data
Estimating the model: Simple OLS method or other advances
H0: β2>0,
Testing the hypothesis: positive relationship or not If not true
Interpreting the results:
Forecasting Policy implication and decisions
