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Econometrics: Chapter 1: Introduction

Econometrics is used to estimate quantitative relationships between economic variables, test economic hypotheses, and forecast outcomes. It involves using statistical techniques to estimate parameters of economic models and test hypotheses about relationships. Key aspects of econometrics include specifying models with dependent and independent variables, estimating parameters using regression analysis which involves fitting a line to data points with an error term, and testing hypotheses about the signs and magnitudes of coefficients. Econometrics uses data that can be cross-sectional, time-series, or pooled longitudinal data.

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67 views30 pages

Econometrics: Chapter 1: Introduction

Econometrics is used to estimate quantitative relationships between economic variables, test economic hypotheses, and forecast outcomes. It involves using statistical techniques to estimate parameters of economic models and test hypotheses about relationships. Key aspects of econometrics include specifying models with dependent and independent variables, estimating parameters using regression analysis which involves fitting a line to data points with an error term, and testing hypotheses about the signs and magnitudes of coefficients. Econometrics uses data that can be cross-sectional, time-series, or pooled longitudinal data.

Uploaded by

Yasir Irfan
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© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Econometrics

Chapter 1: Introduction

Econometrics

Econometrics = economic measurement Used to:

Estimate the magnitude of quantitative relationships among economic variables Test economic hypotheses Forecast future outcomes

Uses of econometrics

econometric techniques are used in many fields besides economics:


political science, psychology, history, biology, medical research, and financial analysis.

Estimating the magnitude of quantitative relationships

Evaluating and comparing alternative economic models

are the predicted qualitative effects economically significant? Keynesian vs. monetarist vs. new classical models

Market research: finding the parameters of demand or supply curves to compute ownprice, cross-price, income, and supply elasticities

Estimating the magnitude of quantitative relationships


determining the return to a college degree How do alternative government policies affect economic outcomes?

How does labor supply, employment, and investment respond to changes in taxes and other policy variables How will a carbon tax affect pollution levels? How will changes in penalties or conviction rates affect crime rates? How will changing welfare rules affect income distribution, employment, poverty, and health care

Linear models

Initial model: bivariate linear model Parameters:


Intercept Slope

Example: lemonade demand

Scattergram
Scattergram = plot of observed data points

Error terms

observed data points do not fall exactly along a linear relationship an error term, ui, is introduced to account for these deviations from a linear relationship: Yi = bo+ b1Xi + ui

Why is an error term needed?

captures the effect of other variables not included in the model element of randomness in individual behavior incorrect measure of variables fitted equation may not reflect the actual functional relationship

Error terms

Dependent and independent variables

dependent variable is assumed to be determined by the independent variable(s) dependent variable is on the left-hand side of a regression equation independent variables appear on the right-hand side of a regression equation

Fitted values

Fitted value = value of the dependent variable predicted by the estimated regression line at a particular level of the independent variable Fitted values are denoted with a hat over the variable (e.g., )

Estimated parameters

Estimated parameters are also represented using a hat over the corresponding model parameter For example:

Observed error term

The observed error term can be expressed as:

Example: Consumption function

A simple Keynesian consumption function is given by:

Parameters of the consumption function

Intercept:

Slope:
= marginal propensity to consume

Consumption function scatterplot

Fitted consumption function

Hypothesis testing and the scientific method

Economists rely on the scientific method


Observe a phenomenon Formulate a hypothesis, and Test the hypothesis


If rejected, formulate a new hypothesis If the hypothesis fails to be rejected, test the hypothesis again

Hypothesis testing

Hypothesis testing generally involves testing predictions concerning the magnitude or signs of model coefficients

Demand equation

Each slope coefficient represents the ceteris paribus effect of a change in that particular variable. Possible hypothesis tests?

Are price and quantity demanded inversely related? Are goods X and Y (or X and Z) substitutes and complements? Is this a normal or inferior good?

Forecasting

Demand forecasting Macroeconomic forecasting Predicting the outcome of elections Predicting outcomes of alternative policies

Formulating an econometric model

Model specification

endogenous variables

determined within the model

exogenous variables

determined outside of the model

Initially, it is assumed that the dependent variable is the only endogenous variable (all right-hand side variables assumed to be exogenous).

Specification error

Omitting relevant variables Including irrelevant variables Incorrect functional form

Example: Inflation and money growth

MV = PY

Types of data

Cross-sectional

Individual observations measured at a given point in time

Time-series

Observations measured at different points in time


Mix of cross-sectional and time-series observations A cross-section of observations is followed through time

Pooled

Longitudinal (or panel)

Monetary growth/inflation model

Correlation and causation

Assignment

Pp. 27-29: 3, 4, 7, 11

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