Lecture 1

Introduction to Econometrics

Dinh Thi Thanh Binh, PhD

Faculty of International Economics, FTU

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 INTRODUCTION
• Example:
– Statisticians: income (I) and consumption
expenditure (C) go in the same direction
– Economists: an increase in income will raise
consumption expenditure, other things being equal
(Keynesian consumption function)
– Econometricians: 1 USD increase in income will
result in 0.70 cent increase in consumption
expenditure, other things being equal

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 DEFINITION
• Econometrics is based on the development of statistical
methods for estimating economic relationships, testing
economic theories, evaluating government and business
policies.
• What is econometrics for?
– Quantifying relationships among economic variables
– Empirically testing economic theories: law of demand,
money supply and inflation…
– Evaluating the impact of a change in one variable on
another variable: measuring the Return to Education,
effect of the Minimum Wage on Unemployment
– Policy recommendation/ Forecasting (demand for goods,
stock/gold prices,…)
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 ANALYSIS STEPS
• Steps in empirical economic analysis
1. Question of interest
2. Mathematics model
3. Econometrics model
4. Data collection
5. Estimation of econometric model
6. Dianosing the model problem
(example:Multicollinearity;heteroskedasticity;
normality)
7. Hypotheses postulated
8. Result analysis and policy implications

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 Economic theory
Results of other research
Econometrics model
Data collection
Estimation of
parameters

Hypotheses test

If the
No estimated
results are
good? Yes

Forecast
Policy purposes

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Step 1. Question of interest based on economic theories

• The relationship among variables in theory

• Example: Keynes’s theory states that the consumption

of households has a positive relationship with their
income

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 Step 2. Set up mathematical model

Keynes’ theory in Step 1 can be modeled as following:

C= β0+ β1I ; β1 >0 (1)

In which
• C: Consumption of the households
• I: Income of the households
• β0 ; β1: Parameters/ coefficient
– β0: Constant / intercept parameter

– β1: Slope parameter

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 Step 3. Set up econometric model
• The mathematic model in Step 2 reflects the exact
relationship between variable consumption and
income of households.

• But the relationship among economic variables in

general is not perfectly exact.

• For example, beside variable “income”, there are

other variables that can affect the consumption of
households: numbers of family member, ages of the
family head…

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 Step 3. Set up econometric model
• To measure inexact relationships between variables 🡺
econometric model:
Ci = β0+ β1Ii+ ui (2)

• ui : error term or disturbance, represents factors

that are not income, but can affect consumption of the
households

• The choice of variables to include in the models bases

on economic theories and available data.
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 Step 3. Set up econometric model

The reasons for the existence of error term:

▪ The researchers cannot know all the factors that

affect dependent variable Y.

▪ If they know all the factors, it is impossible to get

data for all factors.

▪ It becomes very complicated if we include all the

variables in the models
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 Step 4. Data collection

• Primary vs secondary data

• The Structure of Economic Data

– Cross-sectional Data
• Pooled cross-sectional data
– Time-series Data
– Panel Data

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 Cross-sectional data
• A cross-sectional data set consists of a sample of
individuals, households, firms, cities… taken at a
given point of time.

• These data are obtained by random sampling from

the underlying population.

• Sometimes, different variables can correspond to

different time periods in cross-sectional data sets.

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A cross-sectional data set on individual characteristics
in 2010

No C I Gender Education Marriage

(female)
1 30 50 1 10 1
2 60 80 0 12 0
3 45 50 0 15 0
… … … … … …
25 230 250 1 13 1
26 85 115 1 17 1
27 65 95 0 12 1
28 45 75 0 12 0
29 30 45 1 9 0
30 29 40 0 11 1

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 A cross-sectional data set on provinces’
characteristics

No ID YEAR FDI ODA POPU IZ MOUTAIN

1 An Giang 2006 140 30,60 2210,4 0 0

2 Ba Ria Vung Tau 2006 106618 11,55 926,3 7 0

3 Bac Giang 2006 345 21,50 1594,3 2 1
4 Bac Kan 2006 226 13,09 301,5 0 1
… … … … … … … …
61 Tuyen Quang 2006 0 10,14 732,3 0 1
62 Vinh Long 2006 509 10,63 1057 1 0
63 Vinh Phuc 2006 12776 27,73 1180,4 3 0
64 Yen Bai 2006 113 9,80 740,7 0 1

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 Pooled cross sectional data

• Some data sets have both cross-sectional data and time

series features.
Obs Year hprice bedroom
1 1990 42000 4
2 1990 2000 2
.... …. …. ….
200 1990 4000 3
201 1995 3000 2
202 1995 6000 3
… …. …. ….
400 1995 2000 3

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 Time-series data
•  A time-series data set consists of observations on a
variable or several variables over time (stock price,
consumer price index, GDP…).

– The chronological ordering of observations conveys

important information.

– Economic observations can rarely, if ever, be assumed

to be independent across time.

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A time series data on consumption and income of a person

Year C I
1982 3081,5 4620,3
1983 3240,6 4803,7
1984 3407,6 5140,1
1985 3566,5 5323,5
1986 3708,7 5487,7
1987 3822,3 5649,5
1988 3972,7 5865,2
1989 4064,6 6062,0
1990 4132,2 6136,3
1991 4105,8 6079,4
1992 4219,8 6244,4
1993 4343,6 6389,6
1994 4486,0 6610,7
1995 4595,3 6742,1
1996 4714,1 6928,4
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A time-series data FDI and ODA of a country

 Year FDI ODA

1990 180 248,35
1991 375,19 308,6
1992 473,946 646,06
1993 926,304 373,34
… … …
2005 2021 2021,53
2006 2360 1960,61
2007 6739 2496,73

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 Panel data
• A panel data set consists of a time series for each
cross-sectional member in the data set.

• The same cross-sectional units are followed over a

given time period.

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 A panel data set on provinces’ characteristics

Panel ID YEAR FDI ODA POPU IZ MOUTAIN

1 An Giang 2004 145 40,61 2170,1 0 0
1 An Giang 2005 139 41,51 2194 0 0
1 An Giang 2006 140 30,60 2210,4 0 0
2 Ba Ria Vung Tau 2004 64776 1220,01 897,6 7 0
2 Ba Ria Vung Tau 2005 71441 157,99 913,1 7 0
2 Ba Ria Vung Tau 2006 106618 11,55 926,3 7 0
…. …. …. …. …. …. …. ….
63 Vinh Phuc 2004 7340 5,24 1154,8 2 0
63 Vinh Phuc 2005 9340 7,36 1169 2 0
63 Vinh Phuc 2006 12776 27,73 1180,4 3 0
64 Yen Bai 2004 96 3,04 723,5 0 1
64 Yen Bai 2005 103 6,13 731,8 0 1
64 Yen Bai 2006 113 9,80 740,7 0 1

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• The quality of data depends on:
– Errors in data collection
– Sampling methods

• Data sources:
– Experimental data
– Available data

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Step 5. Estimate parameters of the model
• Data 🡪 Stata, Eviews, SPSS 🡪 estimate parameters of
the model (2)

• β^0=-184,08 and β^1=0,7064

Ĉ= -184,08 + 0,7064Ii (3)

• The “hat” above the variable C show that this is an

estimator of this variable.

• Slope parameter = 0,70: if income increases by 1

billion USD, consumption will increase 706 million
USD. 22
 Step 6: Check for the problems the model

• To test if the assumptions of the models are

violated

- Multicollinearity

- Heteroskedasticity

- Normality of u

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 Step 7: Test hypotheses

• To test the appropriation of the model and

estimated parameters

• Tests: Fisher, Durbin- Watson, Lagrange,

Hausman….

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Step 8: Analyze the estimated results and
policy implication

• To see if the estimated results are consistent with/

supportive of the theories.

• If the model is appropriate and the estimated results

are consistent with the theories 🡺 Provide policy
implication

Step 9: Forecasting

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