Lecture 1 On Econometrics

Basic Econometrics
Introduction:
What is Econometrics?
1
Economic Mathematical
Theory Economics
Econometrics
Economic Mathematic
Statistics Statistics
2
Introduction
Why a separate discipline?
 Economic theory makes statements that
are mostly qualitative in nature, while
econometrics gives empirical content to most
economic theory
 Mathematical economics is to express

economic theory in mathematical form without
empirical verification of the theory, while
econometrics is mainly interested in the later
3
Introduction
Why a separate discipline?
 Economic Statistics is mainly concerned with
collecting, processing and presenting economic
data. It does not being concerned with using the
collected data to test economic theories
 Mathematical statistics provides many of

tools for economic studies, but econometrics
supplies the later with many special methods of
quantitative analysis based on economic data
4
Economic Theory
Mathematic Model Econometric Model Data Collection
Estimation
Hypothesis Testing
Application
in control or
Forecasting policy
studies
5
Data Analysis
• Correlation
• Causation
• Regression
1-4. Regression vs. Causation:
Regression does not necessarily imply
causation. A statistical relationship
cannot logically imply causation. “A
statistical relationship, however strong
and however suggestive, can never
establish causal connection: our ideas of
causation must come from outside
statistics, ultimately from some theory or
other” (M.G. Kendal and A. Stuart, “The
Advanced Theory of Statistics”)
7
1-5. Regression vs. Correlation
• Correlation Analysis: the primary objective is
to measure the strength or degree of linear
association between two variables (both are
assumed to be random)
• Regression Analysis: we try to estimate or
predict the average value of one variable
(dependent, and assumed to be stochastic) on
the basis of the fixed values of other variables
(independent, and non-stochastic)
8
Introduction
Methodology of Econometrics
(1) Statement of theory or hypothesis:
Keynes stated: ”Consumption increases as

income increases, but not as much as the
increase in income”. It means that “The
marginal propensity to consume (MPC) for
a unit change in income is grater than zero
but less than unit”
9
Introduction
(2) Specification of the

mathematical model of the theory
Y = ß1+ ß2X ; 0 < ß2< 1
Y= consumption expenditure
X= income
ß1 and ß2 are parameters; ß1 is
intercept, and ß2 is slope coefficients
10
Introduction
(3) Specification of the econometric model
of the theory
Y = ß1+ ß2X + u ; 0 < ß2< 1;
Y = consumption expenditure;
X = income;
ß1 and ß2 are parameters; ß1is intercept and ß2 is slope
coefficients; u is disturbance term or error term. It is a
random or stochastic variable
11
Introduction
(4) Obtaining Data
Year X Y
1980 2447.1 3776.3

1981 2476.9 3843.1
1982 2503.7 3760.3
1983 2619.4 3906.6
1984 2746.1 4148.5
1985 2865.8 4279.8
1986 2969.1 4404.5
1987 3052.2 4539.9
1988 3162.4 4718.6
1989 3223.3 4838.0
1990 3260.4 4877.5
1991 3240.8 4821.0
12
Introduction
(5) Estimating the Econometric Model
Y^ = - 231.8 + 0.7194 X (1.3.3)
MPC was about 0.72 and it means that
for the sample period when real
income increases 1 USD, led (on
average) real consumption expenditure
increases of about 72 cents
13
Introduction
(6) Hypothesis Testing
Are the estimates accord with the
expectations of the theory that is being
tested? Is MPC < 1 statistically? If so,
it may support Keynes’ theory.
Confirmation or refutation of
economic theories based on
sample evidence is object of Statistical
Inference (hypothesis testing)
14
Introduction
(7) Forecasting or Prediction
 With given future value(s) of X, what is the
future value(s) of Y?
 GDP=$6000Bill in 1994, what is the forecast
consumption expenditure?
 Y^= - 231.8+0.7196(6000) = 4084.6
 Income Multiplier M = 1/(1 – MPC) (=3.57).
decrease (increase) of $1 in investment will
eventually lead to $3.57 decrease (increase)
in income
15
Types of Data
• Primary vs. Secondary
• Method of collection: Surveys
• Cross sectional
• Time series
• Panel data
Types of Data – Cross Sectional
• Cross-sectional data is a random sample
• Each observation is a new individual, firm,

etc. with information at a point in time
• If the data is not a random sample, we have a

sample-selection problem
17
Types of Data – Panel
• Can pool random cross sections and treat
similar to a normal cross section. Will just
need to account for time differences.
• Can follow the same random individual

observations over time – known as panel data
or longitudinal data
18
Types of Data – Time Series
• Time series data has a separate observation
for each time period – e.g. stock prices
• Since not a random sample, different

problems to consider
• Trends and seasonality will be important
19
Cross Sectional
Time Series
Year Stock Price
1991 101.3
1992 102.6
1993 104.9
1994 502.6
1995 503.6
1996 455.9
1997 458.7
Panel
1) The key idea behind regression analysis
is the statistic dependence of one
variable on one or more other variable(s)
2) The objective of regression analysis is to
estimate and/or predict the mean or
average value of the dependent variable
on basis of known (or fixed) values of
explanatory variable(s)
23

Lecture 1 On Econometrics

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Basic Econometrics

 Mathematical economics is to express

 Mathematical statistics provides many of

Mathematic Model Econometric Model Data Collection

Keynes stated: ”Consumption increases as

(2) Specification of the

1980 2447.1 3776.3

• Each observation is a new individual, firm,

• If the data is not a random sample, we have a

• Can follow the same random individual

• Since not a random sample, different

• Trends and seasonality will be important

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