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(EKN309)

Required textbook:

Gujarati, D. N. (2003), Basic Econometrics, McGraw-Hill, Inc., 4th

Edition.

Optional textbook:

Kennedy, P. (2003), A Guide to Econometrics, Blackwell Publishing, 5th

Edition.

Wooldridge, J. M. (2006), Introductory Econometrics: A Modern

Approach, Thomson South-Western, 3rd Edition.

INTRODUCTION

I.1 WHAT IS ECONOMETRICS?

Literally, economic measurement.

Econometrics, () consists of the application of mathematical statistics to

economic data to lend empirical support to the models constructed by

mathematical economics and to obtain numerical results.

Econometrics may be defined as the social science in which the tools of

economic theory, mathematics, and statistical inference are applied to the

analysis of economic phenomena.

econometrics is a combination of economic theory, mathematical

economics, economic statistics, and mathematical statistics.

Economic theory:

same) a reduction in the price of a commodity is expected to increase the

quantity demanded of that commodity - ,

Not providing any numerical measure of the relationship between the two,

however econometrics does.

Mathematical economics:

regard to measurability or empirical verification of the theory.

Economic statistics:

the form of charts and tables (i.e. data on GNP, employment, etc.);

But does not concern with using the collected data to test economic

theories.

Mathematical statistics:

Provide many of the tools used in trade, and do not normally deal with the

special problems of the data;

with the problems of the data i.e. errors of measurement.

(that cannot be controlled directly; thus called nonexperimental data)

(how do econometricians proceed in their analysis of an economic problem?)

1. Statement of theory of hypothesis

2. Specification of the mathematical model of the theory

3. Specification of the econometric model of the theory

5. Estimation of the parameters of the econometric model

6. Hypothesis testing

7. Forecasting or prediction

consumption:

Keynes (1936: 96) stated:

The fundamental psyschological law is that men [women] are disposed, as

a rule and on average, to increase their consumption as their income

increases, but not as much as the increase in their income.

Marginal propensity to consume (MPC): the rate of change of

consumption for a unit (say a dollar) change in income is greater than

zero but less than 1.

BUT not the precise form of functional relationship between the two.

Y = 1 + 2 X,

0 < 2 < 1

(I. 3.1)

: intercept AND : slope coefficients

The slope coefficient - - measures the MPC.

Y = 1 + 2 X,

0 < 2 < 1

I. 3.1

The variable(s) on the right-hand side are called the independent

(explanatory) variables.

Here:

The dependent variable: consumption (expenditure)

The independent/explanatory variable: income

AND a single equation model (where the model has only one equation)

- Multiple equation model if the model has more than one equation -

Y = 1 + 2 X,

0 < 2 < 1

I. 3.1

(income) and Y (consumption).

However, relationships between economic variables are generally inexact.

To allow for the inexact relationship between economic variables, the

econometrician would modify the function in (I.3.1) as follows:

Y = 1 + 2 X + u

: disturbance or error term

(I.3.2): an example of a linear regression model

(I. 3.2)

as shown in Figure I.2:

4. Obtaining data:

numerical values of 1 and 2 ; we need DATA.

Lets look at the data given in Table I.1 for US economy where

Y: the aggregate personal consumption expenditure,

X: Gross Domestic Product (a measure of income)

Both given in real terms being measured in constant (1992) prices -

Domestic Product), 1982-1996, all in 1992 billions of dollars

3.

For now; the main tool used to obtain the estimates=the statistical technique of

regression analysis

Using this technique AND the data in Table I.1; we obtain

Y = 184.08 + 0.7064

(I. 3.3)

From eq. (I.3.3), we can say that

1 = 184.08 2 = 0.7064

Since 2 is the slope coefficient, for the sample period an increase in the real

income of one dollar led, on average, to incerases of about 70 cents in the real

consumption expenditure.

To find out whether the estimates obtained in, say, eq. (I.3.3) are in accord

with the expectations of the theory that is being tested?

HERE: we start with the Keynesion theory of consumption AND 0<MPC<1;

What we have found: MPC=2 =0.7064; but before we accept this finding as

a confirmation of Keynesian consumption theory:

WE NEED ASK: is 0.70 statistically less than 1?

Because this result might be as aresult of chance OR we come across with this

result because of the peculiarity of the data we used.

consideration,

we may use it to predict the future value(s) of the dependent variable on

the basis of known or expected future value(s) of the explanatory variable

X.

In that case:

the future value(s) of the dependent variable=forecast variable

variable

Using eq. (I.3.3) to predict the mean consumption expenditure for 1997

where the GDP in 1997 is expected to be (was) 7269.8:

Since GDP=7269.8;

(. 3.4)

4913.5 billion dollars.

the estimated model (I.3.3) overpredicted the actual consumption

expenditure by about 37.82 billion dollars OR

the forecast error is about 37.82 billion dollars (0.76 percent of the

actual GDP value for 1997)

However, such forecast errors are inevitable given the statistical nature

of our analysis.

Y = 184.08 + 0.7064

(I. 3.3)

The question: What will be the effect of such a policy

and on employment?

economy is as folllows:

1

= =

1

where MPC=0.70 in (I.3.3), then M=3.33

That is, an increase (decrease) of a dollar in investment will eventually lead to more than

a threefold increase (decrease) in income.

The question: Suppose the government believes that consumer

expenditure of about 4900 (billions of 1992 dollars) will keep the

unemployment rate at its current level of about 4.2 percent (early 2000).

SO, what level of income will guarantee the target amount of consumption

expenditure?

(I. 3.6)

That is, an income level of about 7197 (billion) dollars, given an MPC of

about 0.70, will produce an expenditure of about 4900 billion dollars.

As these calculations suggest, an estimated model may be used for

control,or policy, purposes.

TO SUM UP:

phenomena.

We have worked with the Keynesian consumption theory; but there are

others, such as:

Could one or both of these models also fit the data in Table I.1? So, what to

do? Work with the one that fits the data better.

has two traditions, namely, classical and Bayesian tradition.

Here: the emphasis is on the classical approach. Not a book of applied

econometrics.

Appendix C: the summary of basic regression theory in matrix notation.

Appendix B: a summary of the main results from matrix algebra

ET, LIMPED, SHAZAM, MICRO TSP, E-VIEWS, MINITAB, SAS, SPSS, STATA, BMD,

Microfit, PcGive.

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