8/23/2019

ECONOMETRICS NOTES
BY
Akhtar Saba khan
(Master in Economics, GPGC Bannu)
&
Tanbila Ghafoor
(M. Phil Economics University of Agriculture, Faisalabad

AKHTAR &
TANBILA ECONOMETRICS NOTES

Economics Department of GPGC Bannu, & Economics Department University of

Agriculture, Faisalabad |
REGRESSION ANALYSIS 1

What is regression? Who first time used regression? What is simple regression? What are
multiple regressions?
Regression is most popular data analysis technique in econometric .First of all we will start from
the start point and that is what is regression? So the simple answer of this question is that
regression analysis technique deals with the describing and evaluating relationship between
projected variables (dependent and independent).We commonly denote dependent variable with
Y while independent variables with X1,X2 etc. Who first time used regression ?, this term is
used by Sir Francis Galton 1822-1911.He studied relationship between parents height and
children height in England and that time he examined that tall parents have tall children’s .So
come back toward our discussion ,we were talking about that dependent variable is denoted by Y
while independent variable demonstrated by X1.X2 etc., Hence if K=1 means independent
variable is only and we often called it simple regression ,on the other hand if k>1 , means we
have ,more than one X variables ,its means we have more than one independent variables , and
we call it multiple regression . The crux of above discussion is that if we have one independent
variable then we call it simple regression, while more than one independent variable we call it
multiple regression.

Regression line

Y Positive errors = 0+ 1 1

Original Data

. . . . Error term
Error term is the
. . .. . ∆ difference
. β=Slope = between actual
∆ values and
Negative error estimated values
− β0

0 X

Means: here positive and negative are cut to each other remain its means its equal to
zero
Original data
1
The Compiled & added by Akhtar Saba Khan & Tanbila Ghafoor.
 This Mean we take for understanding to values.

Example of simple regression

Let suppose we want to know what impact of advertising on sale is. We have only one
explanatory variable; hence it is called simple regression.
Simple Regression Model:
Any population regression Function consists of two parts:
Part1: Systematic or Deterministic component or systematic variation.
Part2: Non-systematic or Random component Variation.

Independent variable

Y = β0+β1X1+ µ error term

Dependent variable y-intercept

slope

Noted: µ (Greek letter Mu) its represent error due to population.

ε (Greek letter sigma) it’s represent error due to sample.

Y= β0+β1X1 + µ
Variation Systematic or Non-systematic or
in Yi deterministic Random component
component or variation
systematic variation

OR OR OR

Total Explained Variation Unexplained Variation

Variation
Which only give as Which give as the difference
the expected values of between expected value of y and
y at that Xi? real value of y?

β0, βi, are population parameter.

 β0 is the Y-intercept of the Regression line.

 βi is the slope of the regression line.
 β0, β1, named differently in various sciences as:
Subject β0 , βi
Mathematic Intercept Slope
Statistic Regression constant Regression Coefficient
Economics Autonomous Induced
Accounting Fixed Variable

Y=sale
X= advertisement
And we will denote it like this
Y=f(X)
Where f(x) is function of x
Example of Multiple regressions
We will discuss multiple regressions with the help of this example, let suppose we want to know
relationship between family consumption expenditure and family size, family financial assets
and family income.
Here we have
Y =family consumptions expenditure
X1 =Family size
X2 =Family financial assets
X3 =family income
In above example we can see we have more than one independent variable so we will call it
multiple regressions.
Classification of variables in regression
Predictand Predictors
Regressand Regressor
Explained variable Explanatory variables
Dependent variable Independent variables
Effect variable Casual variables
Endogenous variable Exogenous variables
Target variable Control variables

Specification of relationships
When we run a regression then we find two types of relationships, which are following
1. Deterministic or mathematical relationship
2. A statistical relationship
1. Deterministic relationship
In deterministic relationship we can find exactly effect of X on Like following example will
show how to deterministic relationship work.
This is the example of deterministic relationship we will demonstrate it with the help of this
equation
Y= 2500+ 100(X)-X2
 This is equation is develop by using Y dependent variable(sale) and X independent variable
(advertising), here is following table of unit of y and X

X(independent variable) Y(dependent variable)

0 2500
20 4100
50 5000
100 2500
From above table we can easily calculate effect of advertising on sale
3. Statistical relationship
So first of all we will develop an equation for statistical relationship like
Y=2500+100(x)-x2+u
Where we suppose
U =+ 500 with probability of ½
=-500 with probability of ½
So here we are not sure about the exact effect of advertising on sale it may be 500 excess or less,
but in deterministic trend we have exact values. And U is called error term or disturbance.
WHY WE USE ERROR TERM?
1. Unpredictable elements of randomness in human responsiveness
e.g dependent variable is consumption expenditure while independent variable is disposable
income of household , here household not behave like an machine , may be in one month
peoples spend spree while in other or next they spend tightfisted.
2. Effect of large number of omitted variables
Like in our example disposable income is not the only factor which effect consumption
expenditure, like family test, family size etc. so error term is catchall for the effect of all these
variables.
3. Measure error in Y.
ASSUMPTIONS OF A GOOD REGRESSION
Ø There should not be Multicolinearity in our data.
Ø Error term should not correlate with other error terms or with leg error terms (autocorrelation)
Ø Regression line must be fitted with data strongly
Ø Independent variables can significantly effect to dependent variable individually
Ø And all independent variables jointly also effect dependent variable
Ø All the sign of coefficient must follow literature of theory.
Ø Residual must be normal distributed
Ø For time series analysis data must be stationary at level
What happen if we don’t fulfill above assumptions? The answer is that we can’t rely on results
because of these results will be spurious, for the reliable results u must fulfill above mention
assumptions.

Noted that;
A linear regression model with two predictor variables can be expressed with the following equation:

Y = B0 + B1*X1 + B2*X2 + E.
The variables in the model are Y, the response variable; X1, the first predictor variable; X2, the
second predictor variable; and E, the residual error, which is an unmeasured variable. The parameters
in the model are B0, the Y-intercept; B1, the first regression coefficient; and B2, the second
regression coefficient.