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Econometric

Econometrics is the application of economic theory and statistical techniques to test hypotheses and forecast economic phenomena, focusing on empirical determination of economic laws. The methodology involves stating a theory, specifying mathematical and econometric models, obtaining data, estimating parameters, hypothesis testing, and making predictions. It encompasses both theoretical and applied econometrics, providing numerical estimates that give empirical content to economic theories.

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5 views8 pages

Econometric

Econometrics is the application of economic theory and statistical techniques to test hypotheses and forecast economic phenomena, focusing on empirical determination of economic laws. The methodology involves stating a theory, specifying mathematical and econometric models, obtaining data, estimating parameters, hypothesis testing, and making predictions. It encompasses both theoretical and applied econometrics, providing numerical estimates that give empirical content to economic theories.

Uploaded by

rajeshkumarjena2350
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We take content rights seriously. If you suspect this is your content, claim it here.
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1.

1 Introduction

1.1.1 WHAT IS ECONOMETRICS?


Econometrics refers to the application of economic theory and statistical techniques for the
purpose of testing hypothesis and estimating and forecasting economic phenomenon . Literally
interpreted, econometrics means “economic measurement.” Although measurement is an
important part of econometrics, the scope of econometrics is much broader, as can be seen
from the following quotations: Econometrics, the result of a certain outlook on the role of
economics, consists of the application 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 quantitative analysis of actual economic
phenomena based on the concurrent development of theory and observation, related by
appropriate methods of inference. Econometrics may be defined as the social science in which
the tools of economic theory, mathematics, and statistical inference are applied to the analysis
economic phenomena. Econometrics is concerned with the empirical determination of
economic laws.
1.1.2 BASIC ECONOMETRICS
The art of the econometrician consists in finding the set of assumptions that are both
sufficiently specific and sufficiently realistic to allow him to take the best possible advantage
of the data available to him. Econometricians are a positive help in trying to dispel the poor
public image of economics (quantitative or otherwise) as a subject in which empty boxes are
opened by assuming the existence of can-openers to reveal contents which any ten economists
will interpret in 11 ways. The method of econometric research aims, essentially, at a
conjunction of economic theory and actual measurements, using the theory and technique of
statistical inference as a bridge pier.

1.2 Objectives
1. Applications of economic theory need a responsible understanding of economic
relationships and econometrics method.

2. The econometrics theory thus becomes a very powerful tool for understanding of the
applied economic relationships and for meaningful research in economics.

3. In this unit we learn basic theory of econometrics and relevant application of the
method.

1.3 Methodology of Econometrics:


Broadly speaking, traditional econometric methodology proceeds along the following lines:
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.
To illustrate the preceding steps, let us consider the well-known Keynesian theory of
consumption:

1. Statement of theory or Hypothesis

Keynes postulated that Marginal propensity to consume (MPC), the rate of change of
consumption for a unit, change in income, is greater than zero but less than one. i.e., 0 < MPC
<1

2. Specification of the Mathematical Model of Consumption

Keynes postulated a positive relationship between consumption and income.


The slope of the coefficient 𝛽2 measures the MPC.

Keynesian consumption function

Y 1 2x O2 1


Y = Consumption expenditure

X = Income

1x2 are knows as the parameters of the model and are respective, the interest and slope of
coefficient.

Shows exact and determined relationship between consumption and income.


The slope of the coefficient 2 , measures the MPC.
Equation states that consumption is linearly related to income (Example of a mathematical
model of the relationship between consumption and income that is called consumption
function in economic).
Single or one equation is known as single equation model and more than one equation is
known as multiple equation model.
3. Specification of the econometric model of consumption.

The inexact relationship between economic variables, the econometrician would modify the
deterministic consumption function as.

Y 1 2xU
This equation is an example of the econometric model. More technically, it is an ex. of linear
regression model.

This you may be well represent all those factors that affect consumption but are not taken into
account explicitly.

The econometric consumption function hypothesizes that the dependent variable Y


(consumption) is linearly related to the explanatory variable X (Income) but that is the
relationship between. The two is not exact, it is subject to individual variation.
Q: Why inexact (not exact) relationship exits?

A: Because in addition to income, other variables affect consumption expenditure. For ex.
are of family, ages of members of family, religion etc are likely to exert some influence on
consumption.

4. Original Data

To obtain the numerical values of 1 &2 we need data.

{PCE Personal consumption expenditure)


Y variable in this table is the aggregate PCE &xis GDPa measure of aggregate income.
Note: MPC: Average change in consumption over to change in real income.

5. Estimation of the Econometric Model

The statistical technique of regression analysis is the main tool used to obtain the estimates.

The estimated consumption function

Yˆ ˆ1 ˆ2xi
Ŷ Estimate
ofYThe estimated consumption function (i.e., regress line).
Regression Analysis is used to obtain estimates.

6. Hypothesis Testing:

Keynes expected the MPC is positive but less than 1.

Confirmation or refulation of economic theories on the basis of sample evidence is based on a


branch of statistical theory known as statistical inference (hypothesis testing)

7. Forecasting or Prediction
If the chosen model does 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 known or
expected future value(s) of the explanatory, or predictor variable X.
Macroeconomic theory shows, the change in income following change in investment
expenditure is given by the income multiplier M.

M 1
1MPC
The quantitative estimate of MPC provider valuable information for policy purposes knowing
MPC, one can predict the future course of income, consumption expenditure, and employment
following a change in the government’s fiscal policies.

8. Use of the Model for control or Policy purpose

Economic theory

Anatomy of econometric modeling


Mathematical model of theory

Economic model of theory

Dates

Estimation of economic model

Hypothesis testing

Forecasting or prediction

Using the model for control or policy purpose

Note:
 Milton Friedmen has developed a model of consumption theory permanent income
hypothesis.
 Robert Hall has developed a model of consumption as life cycle permanent income
hypothesis

1.4 Types of Econometrics

Econometrics

Theoretical Applied

Classical Bayesian Classical Bayesian

 Theoretical econ is concerned with the development of appropriate methods of


measuring economic relationship specified by economic models.
 Applied econ uses the tool of theoretical econ to study some special fields of eco and
business, such as production function etc.

1.5 SUMMARY AND CONCLUSIONS:

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
reduction in the price of a commodity is expected to increase the quantity demanded of that
commodity. 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. Stated differently,
econometrics gives empirical content to most economic theory.
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.
Econometrics, as noted previously, is mainly interested in the empirical verification of
economic theory. As we shall see, then 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. And this conversion of mathematical into econometric
equations requires a great deal of ingenuity and practical skill.

1.6 LETS SUM IT UP :

In last ,we can say that the subject of econometrics deals with the economic measurement .
And further, it is defined as the social science in which the tools of economic theory,
mathematics, and statistical inference are applied to the analysis of economic phenomena. It is
also concerned with the empirical determination of economic laws
1.7 EXCERCISES:

Q.1What do mean by Econometrics?


Q.2 Explain the various steps involved in the methodology of Econometrics?

Q.3What are the various types of Econometrics?

Q.4 How Econometrics can be used as a tool for forcasting and prediction?

Q.5What is Theoretical Econometrics?

Q.6 What is Applied Econometrics?

1.8 Suggested Reading / References:

1. Baltagi, B.H.(1998). Econometrics, Springer, New York.

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