c1.introduction to eco no metrics

8/14/2019 C1.Introduction to Eco No Metrics

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Introduction

to

Econometrics


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What is econometrics? Econometrics is a set of research tools employed in various

economic fields (accounting, finance, marketing and

management) and also in history, political science, and

sociology.

Econometrics means economic measurement> from the

Greek words: eikonomia economy andmetren measure.

It plays a special role in the training of the economists by:

quantifying the economic reality

bridging the gap between economic theory and the real

world.


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Econometrics may be defined as the social science that applies

the tools ofeconomic theory,mathematicsandstatistics for

estimating economic relationships, testing the validity of

economic theories and validating the government policies.

Example.

The Central Bank rises the discount rate by 3%economic theory suggests this will influence the interest rates of

the commercial banks, the credits, the investments, the inflation

but how much?Only econometrics can answer this question by combining

economic theory, statistical data and mathematical tools!


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Why study econometrics?

Economic theory makes statements about how important

variables are related to one another, but:

does not provide the necessary measure of strength of the

relationship or

the magnitudes involved (how much a change in one

variable affects another).

Example

The law of demand: a reduction in price of a commodity isexpected to increase the quantity demanded of that

commodity (but how much?).


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Economic model vs econometric model

An economic model is a set of assumptions that aproximately

describes the behaviour of an economy.

An econometric model gives:

the form of the algebraic relationships among the economicvariables involved and

a specification of the errors (due to the factors omitted from

the model)


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1.Quantity demanded, qd, for an individual commodity (Ford cars):

qd = f( p, pc, ps, i )

p = price of the car; pc = price of complements (like gasoline);

ps = price of substitutes (other similar cars); i = income

demand

2. Quantity supplied, qs (beef):

qs = f( p, pc, pf, ps )

p = price of beef; pc = price of complements ;

ps = price of substitutes (pork); pf = price of inputs (e.g. corn)

supply

The economic model(describes the way in which economic variables are interrelated).


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The econometric model

qd = f( p, pc, ps, i ) + e

The random error accounts for the many factors that affectsales and miss from this model; it is a noise component thatobscures our understanding of the relationships.

Assuming quantity demanded is a linear function of prices, theeconometric model of the demand for Ford cars is :

qd = 1+ 2p+ 3pc+ 4p

s+ 5i + e,

where i are unknown parameters to be estimated usinga sample of economic data.

The systematic part(the average behavior)

Therandomerror(theunpredictablepart)


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Limits of econometrics

any econometric model can capture only a part of thereal economic world => a simplified image of the reality;

qualitative variables (like motivation, satisfaction,

management) are difficult to incorporate in aneconometric model;

imperfect identification of the contribution of each factor

of influence (because factors interact and influences aredifficult to separate);

forecasting based on past trends is uncertain.


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1 2 2

2


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1 2

dependent

(endogeneous)

variable explanatory (exogeneous) variable

parameters


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1 2

1 1

2 2 2


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God created the econometricians to makeGod created the econometricians to make

weather forecasts look good .weather forecasts look good .

The value of the explanatory variable (Yd) is known

Estimated values of the parameters


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Economic Empirical Study


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Economic Empirical Study

(anatomy of econometric modeling)

Economic Theory; Past Experience, studies

Formulating a model: Cause - effect C = f(Y) ==>Ct = 1 + 2Y + et

Gathering data: Statistics monthly, quarterly, yearly data

Estimating the model: Simple OLS method or other advances

Testing the hypothesis:H0:2>0,

positive relationship or not If not true

Interpreting the results:

Forecasting Policy implication and decisions


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Types of econometric models

1. Considering the number of influence factors simple models are based on the assumption of a single

decisive factor of influence X, all the others havingrandom or fixed effects captured by the error term e.

y = f(x)+e

multiple models: use two or more factors of influence;better but more complicated => the number of factorshave to be limited.

y = f(x1,x

2,...,x

p)+e

2. Considering the form of the relationship betweenthe dependent variable y and the factors ofinfluence linear models

non-linear models: exponential, parabolic, etc.


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Types of econometric models (contd)

3. Considering the time factor- static models: the factors influence the dependentvariable y over the same period of time:

y = f(x1t,...,xjt,...,xkt) + et

- dynamic models include the time variable: the time variable is one of the factorsy = f(xt,t) + et

autoregressive models: the lagged dependent variablebecomes a factor of influence itself

y = f(xt,yt-k) + et lagged models: the factor x influences y over several

periods of time:

y = f(xt,xt-1,... xt-k) + et


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Types of econometric models (contd)

4. Considering the number of equations

- models having a single equation

- multiple equation models: consist of a system of

equations

-> structural form:

dependent (endogenous) variabiles

independent (exogenous) variabiles

===

nmnmnnnnn

mmnn

mmnn

UXcXcXcYYbYb

UXcXcXcYbYYb

UXcXcXcYbYbYb

......

......

......

22112211

2222212122121

112121111212111

niYi ,, 1

mjXj ,, 1

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