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Introduction to Econometrics

Econometrics is the application of statistical methods to economic data in order to give empirical content to economic relationships. It allows testing of economic theories with data, facilitating rational decision making. Econometrics became a separate discipline because economic theory, statistics, and mathematical methods alone could not fully address real-world economic problems. The traditional econometric methodology involves specifying an economic model based on theory, collecting relevant data, estimating model parameters, testing hypotheses, and using the model to forecast or inform policy decisions. The document provides an example of this methodology applied to estimating the consumption function based on Keynes' theory.

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82 views10 pages

Introduction to Econometrics

Econometrics is the application of statistical methods to economic data in order to give empirical content to economic relationships. It allows testing of economic theories with data, facilitating rational decision making. Econometrics became a separate discipline because economic theory, statistics, and mathematical methods alone could not fully address real-world economic problems. The traditional econometric methodology involves specifying an economic model based on theory, collecting relevant data, estimating model parameters, testing hypotheses, and using the model to forecast or inform policy decisions. The document provides an example of this methodology applied to estimating the consumption function based on Keynes' theory.

Uploaded by

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

Introduction to the Econometrics


Discipline

Muhammad Arsalan Hashmi


College of Management Sciences
PAF KIET
What is Econometrics
 Econometrics means “economic
measurement”.
 The scope of econometrics is very broad, i.e.
it has many uses.
 Among other things, we apply econometric
techniques on economic data, on the basis of
some economic theory to facilitate rational
decisions.
Why a separate discipline?
 Economic theory vs. Econometrics
 Mathematical economics vs. Econometrics
 Economic statistics vs. Econometrics
 Mathematical statistics vs. Econometrics
Methodology of Econometrics
 The traditional or classical methodology of
econometrics is as follows:
Econometric Methodology in
Action
 Economic Theory: J M Keynes suggests that
consumption has a tendency to rise with income.
 Mathematical Model:
Y = β1 + β2 X
where, 0< β2<1
Y = consumption expenditure
X = income
 Econometric Model:
Y = β1 + β2 X + u
where, u is the disturbance term. The disturbance
(error) term captures the influence of other factors
affecting consumption not accounted for in the model.
Econometric Methodology in
Action (Continued)
 Data: To estimate the parameters of the
regression model we employ data for
personal consumption expenditure and GDP
(income) from the US between 1982 and
1996.
 Estimation of Econometric Model: The use
of regression analysis gives the following
estimate of the consumption function
Y^ = -184.08 + 0.7064Xi
Econometric Methodology in
Action (Continued)
 Hypothesis Testing: Keynes expected MPC (β2 in
this example) to be positive but less than 1. We use
hypothesis testing to see if our estimate of 0.7064 is
statistically less than 1.
 Forecasting or Prediction: If the model does not
refute the hypothesis or theory, we can use it to
predict the future value of the dependent variable on
the basis of known (or expected future) value of the
explanatory variable. For e.g.
Y^1997 = -184.08 + 0.7064(7269.8)
Y^1997 = 4951.31 billion dollars.
Econometric Methodology in
Action (Continued)
 The actual consumption for 1997 was 4913.5
billion dollars, the difference of 37.82 billion is
the forecast error.
 Using the model for control or policy
purposes: The estimated consumption
function can be used to answer policy related
questions. For e.g. what level of income will
guarantee a targeted consumption
expenditure of 4900 billion dollars?
Types of Econometrics
Reading

 Gujarati, D (2003), “Basic Econometrics”, 4th


Edition, McGraw Hill, Introduction.

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