TYPES OF DATA:

Three types of data may be available for empirical analysis: time series, cross-section, and
pooled (i.e., combination of time series and cross-section) data.
Time Series Data
● A time series is a set of observations on the values that a variable takes at different
times. Such data may be collected at regular time intervals, such as daily (e.g., stock
prices, weather reports), weekly (e.g., money supply figures), monthly (e.g., the
unemployment rate, the Consumer Price Index [CPI]), quarterly (e.g., GDP), annually
(e.g., government budgets), quinquennially, that is, every 5 years (e.g., the census of
manufactures), or decennially, that is, every 10 years (e.g., the census of population).

● a time series is stationary if its mean and variance do not vary systematically over time.

With the advent of high-speed computers, data can now be collected over an
extremely short interval of time, such as the data on stock prices, which can be obtained
literally continuously (the so-called real-time quote).
 Cross-Section Data
● Cross-section data are data on one or more variables collected at the same point
in time,such as the census of population conducted by the Census Bureau every
10 years (the latest being in year 2000).
● cross-sectional data too have their own problems, specifically the problem of
hetero-geneity. From the data given in Table 1.1 we see that we have some
states that produce huge amounts of eggs (e.g., Pennsylvania) and some that
produce very little (e.g., Alaska). When we include such heterogeneous units in a
statistical analysis, the size or scale effect must be taken into account.
Pooled Data
In pooled, or combined, data are elements of both time series and cross-section data.
Panel Data
This is a special type of pooled data in which the same cross-sectional unit (say, a family or
a firm) is surveyed over time. For example, the U.S. Department of Commerce carries out
a census of housing at periodic intervals. At each periodic survey the same household
(or the people living at the same address) is interviewed to find out if there has been any
change in the housing and financial conditions of that household since the last survey. By
interviewing the same household periodically, the panel data provide very useful informa-
tion on the dynamics of household behavior.

WHAT IS ECONOMETRICS?

econometrics means “economic measurement.”

Econometrics, the result of a certain outlook on the role of economics, consists of the applica-
tion of mathematical statistics to economic data to lend empirical support to the models
constructed by mathematical economics and to obtain numerical results.

Econometrics may be defined as the social science in which the tools of economic theory,
mathematics, and statistical inference are applied to the analysis of economic phenomena.

Why a Separate Discipline?/Scope Of Econometrics

suggest, econometrics is an amalgam of economic theory, mathematical economics, economic
statistics, and mathematical statistics. Yet the subject deserves to be studied in its own right for
the following reasons.
● Economic theory makes statements or hypotheses that are mostly qualitative in nature.
For example, microeconomic theory states that, other things remaining the same, a reduc-
tion in the price of a commodity is expected to increase the quantity demanded of that com-
modity. Thus, economic theory postulates a negative or inverse relationship between the
price and quantity demanded of a commodity. But the theory itself does not provide any
numerical measure of the relationship between the two; that is, it does not tell by how much
the quantity will go up or down as a result of a certain change in the price of the commodity. It is
the job of the econometrician to provide such numerical estimates.
 ● The main concern of mathematical economics is to express economic theory in
mathematical form (equations) without regard to measurability or empirical verification of
the theory. the econometrician often uses the mathematical equations proposed by the
mathematical economist but puts these equations in such a form that they lend
themselves to empirical testing.

● Economic statistics is mainly concerned with collecting, processing, and presenting

economic data in the form of charts and tables. These are the jobs of the economic statisti-
cian. It is he or she who is primarily responsible for collecting data on gross national
product (GNP), employment, unemployment, prices, and so on. The data thus collected
constitute the raw data for econometric work. But the economic statistician does not go any
further, not being concerned with using the collected data to test economic theories. Of
course, one who does that becomes an econometrician.

Methodology of Econometrics
1. Statement of theory or hypothesis.
2. Specification of the mathematical model of the theory.
3. Specification of the statistical, or econometric, model.
4. Obtaining the data.
5. Estimation of the parameters of the econometric model.
6. Hypothesis testing.
7. Forecasting or prediction.
8. Using the model for control or policy purposes.

Statement of Theory or Hypothesis

Keynes stated:
The fundamental psychological law ... is that men [women] are disposed, as a rule and on
average, to increase their consumption as their income increases, but not as much as the
increase in their income.
In short, Keynes postulated that the marginal propensity to consume (MPC), the rate of
change of consumption for a unit (say, a dollar) change in income, is greater than zero but
less than 1.
Specification of the Mathematical Model of Consumption
● Although Keynes postulated a positive relationship between consumption and income,
he did not specify the precise form of the functional relationship between the two. For
simplicity, a mathematical economist might suggest the following form of the Keynesian
consumption function:
Y = β1 + β2X 0 < β2 < 1
where Y = consumption expenditure and X = income, and where β1 and β2, known as the
parameters of the model, are, respectively, the intercept and slope coefficients.

● Thus, in the Keynesian consumption function, Eq. (I.3.1), con-

sumption (expenditure) is the dependent variable and income is the explanatory variable.
Specification of the Econometric Model of Consumption

To allow for the inexact relationships between economic variables, the econometrician
would modify the deterministic consumption function in Eq. (I.3.1) as follows:
Y = β1 + β2X + u (I.3.2)
where u, known as the disturbance, or error, term, is a random (stochastic) variable that
has well-defined probabilistic properties. The disturbance term u may well represent all
those factors that affect consumption but are not taken into account explicitly.
WHY IS ERROR TERM NEEDED (EXAMPLE)?
if we were to obtain data on consumption expenditure and disposable (i.e., aftertax) income of a
sample of, say, 500 American families and plot these data on a graph paper with consumption
expenditure on the vertical axis and disposable income on the horizontal axis, we would not
expect all 500 observations to lie exactly on the straight line of Eq. (I.3.1) because, in addition to
income, other variables affect consumption expenditure. For example, size of family, ages of the
members in the family, family religion, etc., are likely to exert some influence on consumption.
Obtaining Data
To estimate the econometric model given in Eq. (I.3.2), that is, to obtain the numerical
values of β1 and β2, we need data.
Estimation of the Econometric Model
The numerical estimates of the parameters give empirical content to the consumption function.
the statistical technique of regression analysis is the main tool used to obtain the estimates.
Hypothesis Testing
● Assuming that the fitted model is a reasonably good approximation of reality, we have to
develop suitable criteria to find out whether the estimates obtained in, say, Equation I.3.3
are in accord with the expectations of the theory that is being tested.
● According to “positive” economists like Milton Friedman, a theory or hypothesis that is
not verifiable by appeal to empirical evidence may not be admissible as a part of
scientific enquiry.
● confirmation or refutation of economic theories on the basis of sample evidence is
based on a branch of statistical theory known as statistical inference (hypothesis testing).
Forecasting or Prediction
If the chosen model does not refute the hypothesis or theory under consideration, we may
use it to predict the future value(s) of the dependent, or forecast, variable Y on the basis of
the known or expected future value(s) of the explanatory, or predictor, variable X.

IMPORTANCE /SIGNIFICANCE OF ERROR TERM

the disturbance term ui is a surrogate for all those variables that are omitted from the model but
that collectively affect Y.
1. Vagueness of theory: The theory, if any, determining the behavior of Y may be, and
often is, incomplete.Therefore, ui may be used as a substitute for all the excluded or omitted
variables from the model.
2. Unavailability of data: Even if we know what some of the excluded variables are and
therefore consider a multiple regression rather than a simple regression, we may not have
quantitative information about these variables. It is a common experience in empirical
analysis that the data we would ideally like to have often are not available. For example, in
principle we could introduce family wealth as an explanatory variable in addition to the in-
come variable to explain family consumption expenditure. But unfortunately, information
on family wealth generally is not available. Therefore, we may be forced to omit the wealth
variable from our model despite its great theoretical relevance in explaining consumption
Expenditure.
3. Core variables versus peripheral variables:it is quite
possible that the joint influence of all or some of these variables may be so small and at best
nonsystematic or random that as a practical matter and for cost considerations it does not pay
to introduce them into the model explicitly. One hopes that their combined effect can be
treated as a random variable ui.
4. Intrinsic randomness in human behavior:Even if we succeed in introducing all the
relevant variables into the model, there is bound to be some “intrinsic” randomness in in-
dividual Y’s that cannot be explained no matter how hard we try. The disturbances, the u’s,
may very well reflect this intrinsic randomness.
5. Poor proxy variables:Although the classical regression model assumes that the variables Y
and X are measured accurately, in practice the data may be plagued by errors of measurement.
6. Principle of parsimony:Following Occam’s razor,12 we would like to keep our re-
gression model as simple as possible. If we can explain the behavior of Y “substantially”
with two or three explanatory variables and if our theory is not strong enough to suggest
what other variables might be included, why introduce more variables? Let ui represent all
other variables. Of course, we should not exclude relevant and important variables just to
keep the regression model simple.
7. Wrong functional form: Even if we have theoretically correct variables explaining a
phenomenon and even if we can obtain data on these variables, very often we do not know
the form of the functional relationship between the regressand and the regressors.
PROPERTIES OF LEAST-SQUARES ESTIMATORS:THE GAUSS–MARKOV
THEOREM
To understand this theorem, we need to consider the best linear unbiasedness property of an
estimator.18 As explained in Appendix A, an estimator, say the OS estimator βˆ2, is said to be a
best linear unbiased estimator (BLUE) of β2 if the following hold:
1. It is linear, that is, a linear function of a random variable, such as the dependent variable
Y in the regression model.
2. It is unbiased, that is, its average or expected value, E(βˆ2), is equal to the true value, β2.
3. It has minimum variance in the class of all such linear unbiased estimators; an unbiased
estimator with the least variance is known as an efficient estimator.

Primary Data: Primary data are measurements observed and recorded as a part of an
original study. When data reqd for particular study can neither be found in internal
records of enterprise nor in published sources, it becomes necessary to collect original
data.
Method of obtaining:
1. Questioning: data collected by asking ques from people who are thought to have
desired information.
2. Observation: when data is collected by observation. Investigator observes
objects or actions and records this observation.

Secondary Data: when investigators use data that has already been collected by others.
It can be obtained from journals, reports,govt publications, etc.
At the national deta, census, National Sample Survey Organisation (NSSO), Researve
Bank of India collects data. Source of the data must be given if using the secondary
data.

GOODNESS OF FIT
How “well” the sample regression line fits the data. The coefficient of determination r2
(two-variable case) or R2 (multiple regression) is a summary measure that tells how well the
sample regression line fits the data.
 CONFIDENCE INTERVAL
Confidence intervals are also called interval estimates because they provide a range of
likely values for the population parameter, and not just a point estimate.

the width of the confidence interval is proportional to the standard error of the estimator.

Estimation of Model by method of Ordinary Least Square

It is a method for estimating the unknown parameters in a linear regression model. This method
minimizes the sum of squared vertical distances between the observed responses in the dataset
and the responses predicted by the linear approximation.
It is quite possible that the algebraic sum of the uˆi is small (even zero) although the uˆi are
widely scattered about the SRF. We can avoid this problem if we adopt the least-squares
criterion where

The goal of the OLS method can be used to estimate the unknown parameters (b1, b2, …,
bn) by minimizing the sum of squared residuals (RSS). The sum of squared residuals is also
termed the sum of squared error (SSE).
This method is also known as the least-squares method for regression or linear regression.

TESTS OF HYPOTHESIS

A hypothesis is a supposition made as a basis of reasoning.