SCHAUM’S oullines Second Edition POS ULAR Sau. a = Updated examples with the most current U.S. and world data Two complete self examinations = New chapter on Time Series Econometrics Perfect for pre-test review Use with these courses: A sisiics and Econometrics [7 Statistical Methods in Economics } Quantitative Methods in Economics (+! Mathematical Economies [ Micro-Eeanomics Macro-Econames Math for Economists: Math for Social ScieneesBS RTS Theory and Problems of STATISTICS AND ECONOMETRICS SECOND EDITION DOMINICK SALVATORE, Ph.D. Professor and Chairperson, Department of Economics, Fordham University DERRICK REAGLE, Ph.D. Assistant Professor of Economics, Fordham University Schaum’s Outline SeriesMcGraw-Hill hii Th Cara Hl Cogpeight ©2002 hy The MecranHill Compnins, fe. 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Nether MeGeaa-HIl mart lcensrs shal be Hable you ot anyone else for any im: ‘acy, em oc cto, regardies Oca, rhe WCE oe MH ages ren eTeOM. Mra Rae NO repo "Sil forihe conten of any infomation aveseed rough the work. Under no cumstances all McGraw-Hill nd its cen sense able ray inc, incident, peca pie. consegoeaia oe emir dares tha result fe he une €or nak ley w seat work, even ify of them hasbeen asc the posit of such damagex This ntation Vai sl apply to any claimer case whatsoever whether mach elaieer cause arises in ears, nto otherwise. DOK: 10.1m36u0TEDeS«S?This book presents a clear and concise introduction to statistics andl econometrics. A course in statistics tr casmunnctiice io wften ume uf the mest useful but abso ane of the ununtdillivalt ut Use reyined oun ses in colleges and universities. The purpose of this book is to help overcame this diliculty by using a problem-solving approuch, Each chapter begins with a statement of theory, principles, ar background information, fully lla strated with examples. Thies followed by numerous theoretical and practical problems with detailed, step-by-step solutions. While primarily intended as a supplement to all current standard textbooks of statistics andor ecomomettics, the haok can alse he uscd asan independent text. aswell as to urpplement class lectures, ‘The book is aimed at wollege students in economics. business aciministration, and the social sciences taking a one-semester or a one-year course in statistics andjor econometrics. It also provides a very iwseful source of reference for M.A. and M.B.A. students and For all those who use tor wold Hike to use) statistics and evonometries in their work, No prior statistical background is assumed, The book is completely self-contained in that it covers the statistics (Chaps. | to $) required for econometrics (Chaps. 6 0 11), It is applied in mature, and all proofs appear in the problems section rather than in the text itself. Real-world socioeconomic and business data are used, whenever possible, to demonstrate the more advanced econometne techniques and models. Several sources of online data are used, and Web addresses-are given for the student’ and researcher's further use (App. 12). Topics frequently cncoumered In econometrics, such as multicollincarity and autocorrelation, are clearly and concisely discussed as to the problems they create, the methods to test for their presence, and possible conection toclusigus. i this seam edition, we have expuanied the computer appliativis ty prusake a reneral introduction to data handling, and specific programming instruction to perform all estimations im this book by somputer (Chap. 12) using Microsoft Excel, Eviews, or SAS statist have also added sections on nonparametric testing. matrix notation, binary choice models, chapter on time sorics analysis (Chap. 11}, field of econometrice which has expanded at of late. A sample statistics and econometrics examination is also included. ‘The methodology of this hook and much of its coment has heen tested in undergrad graduate classes in statistics and econometrics at Fordham University. Students found the approach and content of the book extremely useful and made many valuable sugesstions for improvement. We have also received very useful advice from Professors Mary Beth Combs, Edward Dowling, and Damo- dar Gujarati. The following students carefully read through the entire manuseript and made many ‘useful comments: Luca Bonardi, Kevin Coughlin, Sean Hennessy, and James Santangelo. To all of them we ate deeply grateful, We owe a great intellectual det to our formar profesor of tatisies and econometrics: JS. Butler, Jack Johnston, Lawrence Klein, and Bernard. Okun ‘We are indebied to the Literary Executor of the Inie Sir Ronald A. Fisher, F. R.S., to Dr. Frank Yates, F. K.S.,and he Longman Group Ltd., London, for permussion to adapt and reprint 1apiss IL and IV from their hook, Statistical Tables for Biolagical, Agricultural and Medical Research. In addition 10 Statistics and Econometrics, the Schaum's Outline Serles in Economies includes Microeconomic Theory, Macroecanomic Theory, International Economics, Mathematics for Economists, sand Principles of Ecomrnies Dosmack SxLvarone Derrick Rescu New York, 2001 ‘Copyright 2002 The McGraw-Hill Companies, Inc, Click Here for Terms of Use,CHAPTER 1 CHAPTER 2 CHAPTER 3 CHAPTER 4 CHAPTER 5 Introduction LL The Nature of stausbes 12 and Econometrics 13 ‘Methadalogy of Econometries Descriptive Statistics 2A Frequency Distributions 22 Measures of Central Tenvleney 23° Measures of Dispersion 24 Shape of Frequency Distributions Probability and Probability Distributions 31 Probability of a Single Event 2 Probability of Multiple Events 33 Diserow Probability Distributions: The Binomial Dastriburion 34 The Poisson Distribution 35) Continuous Probability Distribstions; The Normal Distribution Statistical Inference: Estimation 41 Sampling 42 ie Distribution of the Mean 43° Estimation Using the Normal Distrib 44° Confidence Tntervals for the Mean Using the ¢ Distribution Statistical Inference: Testing Hypotheses SA Teating Hypotheses 52 Testing Hypotheses about the Population Mean and Proportion 3° Testing Hypotheses far Dillerencey between Two § Proportions SA ChisSquare Test of Goodness of Fit and Independence Analysis of Variance Nonparametric Testing ‘STATISTICS EXAMINATION CHAPTER 6 ‘Simple Regression Analysis 6.1 The Two-Varlable Linear Modet 62 The Ordinary Least-Squares Method ‘Copyright 2002 The McGraw-Hill Companies, Inc, Click Here for Terms of Use, 1 1 1 67 67 a 69 87 87 87 9 92 124 128 128 128CHAPTER 7 CHAPTER & CHAPTER 9 CHAPTER 10 CHAPTER 11 CHAPTER 12 CONTENTS 43 Tests of Significance of Parameter Estimates GA Test of Goodness of Fit and Correlation 65 Propertics of Ordinary Least-Squares Estimators Multiple Regression Analysis 7 The Three-Variable Linear Model ‘72 Tests of Significance of Parameter Estimates 7.3 The Coctficient of Multiple Determination 74 Test of the Overall Significance of the Regression 7S Partial-Correlation Coefficients 766 Matrix Notation Further Techniques and Applications in Regression Analysis 1 Functional Form 82 Dummy Variables 3.3 Distributed Lag Models Forecasting BS Binary Choice Models $846 Interpretation of Binary Choice Models Problems in Regression Analyst 91 Multicolineas 2 Heteroscedastici 93 Autocorrélation 94 Errors in Variables Simultaneous-Equations Methods 10.1 Simultancous-Equations Models Ww tasnuticauon 10.3 Estimation: Indirect Least Squaes Wa Estimation; Two-Stage Least squares Time-Series Methods ut 2 “3 14 Testing for Unit Rant ILS Cointegration and Error Correction 11.6 Causality Computer Applications in Econometrics 12.4 Data Formats 122. Microsoft Excel 130 ne 133 154 1st 158 1ST 158 158 181 181 182 182 133 184 185 266 266 267vi CONTENTS 12.3 Eviews 124 5A5, ECONOMETRICS EXAMINATION Appendix: 1 Binomial Distribution ‘Appendix: 2 Poisson Distribution “Appendix 3 Standard Normal Distribution Appendix 4 Table of Random Numbers pendix § Student's ¢ Distribution ‘Appendix 6 ‘Chi-Square Distribution ‘Appendix 7 F Distribution Appendix 8 Durbin Watson Statistic ‘Appendis: 9 Wikeoxon Appendix 10 Kolmogorov-Smirnov Critical Values ‘Appcadis 1 ADF Critical Values ‘Appendix 12 Data Souroes on the Web INDEX 268 18Introduction 1A THE NATURE OF STATISTICS ‘Statics refers to the collection, presentation, analysis, and utilization of numerical data to make inferences and reach decisions in the face of uncertainty in economics, business, and other social and. physical sciences. ‘Salisties is subdivided into descriptive and inferential, Deseriptive statistics is concemed with summarizing and describing: a body of data, Mnjerential seattsvies is the process of reaching general- izations about the whole (called the populatian) by examining a potion (called the sample). In order for this to be valid, the sample must be representative of the population and the probability of error also. must be specified ‘Deschiptive statsties is discussed in detail in Chap. 2. This is followed by (the more crucial statistical inference: Chap. 3 deals with probability. Chap. 4-with estimation, and Chap. 5 with hypoth sis testing EXAMPLE 1. Suppose that we fave data on the incomes of [000 US. families. This body of data cam be Summarized By foding the average family income and the spread of these family incomes above and below the iiverage The data also can be described by constricting a table, chart, or graph of the number or proportion of families fm each income clase. This i descriptive statictace. If those [00 Famili are representative of all US. families, we ean then estimate and test hypotheses about the average family ancome an the United States at a whos Since these conclusions are subject to error, we also would have to indicate the probability of error, This 1 saristeal Inference 1.2. STATISTICS AND ECONOMETRICS -Economiciricy refers to the application of economic theory, mathematics. and statistical techniques for the purpose of testing hypwoubwescs ancl id foreeasting eennomic phenomena. Feane- imetrics has become stvongly ilenified with regression analysis. This rolatcs a dependent variable to one ior more independent or explanutory variables Sines relationships arenag aecnomi: variahles are generally inexact, a disturkance or error term (with well-defined probabilistic properties) must be incluted (500 Prob 1 8) ‘Chapters 6 und 7 deal with regression analysis: Chap. 8 extends the hasic regression model; Chap. 9 deals with methods of testing and correcting for violations in the assumptions of the basic regression model and Chaps 10 and 11 4 two specific areas of econometrics, specifically simultancous- equations and time-series methods. Thus Chaps. | to 5 deal with the statistice required for sconometricr (Chaps. 6t0-11). Chapter 12 is concerned with using the computer to aid in the cileulations involved in tho previous chapters ‘Copyright 2002 The McGraw-Hill Companies, Inc, Click Here for Terms of Use,2 INTRODUCTION lomar. t EXAMPLE 2. Consumption thoory tells ws that, in general, peop: inexease their eonsumpéion expensiture C as thete dicporable (after-tax) necome ¥, increater, bul aot by at mach ag the dneveace in thairdisporalie income. This ean be stated i explicit incur equation fost 38 cathe wa ‘where by and dare unknown constants called parameters, The parameter hy is the slope coulicient representing the frarginal propensity to constume (MPC) Since even people with icatical disposable ineowe are Likely to have somemhat different consumption expenditures, the theoretically exact and deterministic relationship represented by Eq, (11) must be madifed to inchude a randam disturbance or error term, 1, making tt stochastic: c ba heee uw 13 THE METHODOLOGY OF ECONOMETRICS Econometric research, in general, involves the following throe stages: |. Specification of the model or maintained hypothesis in explicit stochastic equation form, together with Uwe a primi theoretical expectations about de sign and size of Ure pranuncters of the function, 2 Collection of data on the variables of the model and estimation ofthe enefficients of the function ‘with appropriate econometric techniques (presented in Chaps. @ to 8). 3. Evaluation of the estirsated coefficients of the Funetion om the basis of economic, statistical, and eeanamettic criteria, EXAMPLE 8. The frat stage in coummctic sorcarch wu cannumption theuny ie alate the than i exp stochastic equation form, as in Eq. (1), with the expectation that fy > 0 (ae, at Ty = 0, C>Oas people dssave fandjor harrow) and 0. = ET secand sfage involves che collstion of data on consumption sxpondicure and Sispacable income an estimation of F.(1 1). The died rage in econometric research involves (1) hing ose if theesticnated vale of be O aed by 1: Ohdeterminine a “satisfactory” peapartion af the variation ia Cs explained by changes in Vand i hy andy ae “statistically significant at acceptable level [se Prob. 1.15) and See, 5.2 and (3) testing to see the assumptions of the basi regression model ae satistied oF. if not, how to correct for violations, If the estimated relationship does mot pass these tests, the hypothesized relationship mnsst be modified and reestimated until a satisfactory estimated consumption relationship is ahseved. Solved Problems ‘THE NATURE OF STATISTICS 1.4 What is the purpose and function of (a) The ficld of study of statistics? (by Descriptive sta fisties? (03 Inferential statistics? (@) Statistics is the body of procedures and teriques sed to calle, presen, and analyze data on wish totinedcesions Inte ice ofuncermny or incomplctsiformation. Sac ana Isused voy in practically every profeson. The economist weit to test the eicency of akernative prodution techniques the buitesaperoh ay nae ft test the pot eng or package that mses aes the sociolosist to analy the res of a drug habitation program; the instil peychologit to tczorina borkart ruepouit to plant etre sree the pola etn 1 foes Woting pale the physi tows the efciveness of new drug; the chemist to produce cheoper frien and so (0) Design stasis suhasicd «bik of dat with nt eek W fai tha cas tne whole data. abo telorsfo the prosetation of boy of dala he rm of tabs, chars graphs another Forme of graphic dpCHAP. 1) INTRODUCTION 3 12 13 La (©) Infeccotial statistics dhoth estimation and hypothesis testing) refers to the drawing of generalizations about the properties of the whole (called a prpufarion} trom the epeific or a eample drawn from the population. Inferential statistics thus involves inductive reasoning. (This is to be eoatrasted with rletuetive reasoning, which asesibes properties to the spestie starting with the whe) (a) Ate descriptive or inferential statistics mone important today? (B) What is the importance of a representative sample in statistical inference? (c) Why is probability theory required? (a) Statics started as a purely descriptive scence, but it grew émto a powerful too! of decision making as its inferential branch was seveloped. Modern statistical analysis vefers peicnaily 4 inferential o¢ inductive statistics, However, declucive and insuctive statistics are complementary, We must stusly hhow to generate carnplae from poptlationc before we can beara to gooeraline from expe to popati (Uy Gis oidee for statistical aatnnve tir be val iL aimst be based om a siaiple that Fully safety the characterstis and properties of the population feom which is drawn. A sepeesentative sample is soriced by random rampling, whershy ach sloment of the population hae an aqual chance of baing Included! in the sample (see See. 4.1). (0) She the puossbiliy uf eis enink i staintialinfercem, elinaten ye teks oa pupa prone y characteristic are given together with the chance or probabikty of being wrong. Thus probability thoory i an essential slomont in statistoal infarc How can the manager of a firm producing lightbulbs summarize and describe to a board meeting the results of testing the Hife of a sample of 100 Tightbwihs produced by the fin? Providing the (raw) data on the le ofeach in the saeple of 100 Kightbulbs prod oc by’ the firm would be very inconvenient and ime-consursing or tne tard members to evaluate. Instead, the manager might summarize the data by indicating that the average life ofthe bulbs tested is 360h and that 95% of the bulbs tested tea Uetest 320 nd A001, Byung Ui Une nana io ridin te wicoen fini sativs (ee average if and the spread i te average lif) that characterize the life ofthe 100 bulls tested. ‘The manager taka might want to describe the data with a table or chart indicating the murber or proportion of bulbs tested that lasted within cach IO-Nclasification, Such a tabular oF araphic representation of the data is abso seny usefil for gaining a quick oversiew of the data stimmaririna and deseabing the data inthe ways indicated, the manages is engaging in deseriptive statistics. It should be noted that descriptive statistics can be used to summarize and describe any how of data, whether it sa sample (as above) ora population when all the elements of the population arc known and its characterstics can Be calculated) (a) Why may the manager in Prob, 1.3 want to engage in statistical inference? (6) What would this involve and require? a} Quality control requires that the manager have a Fairly good idea about the average life and the spread ‘in the life of the lightbulbs produced by the firm. However, testing all rhe lightbulbs produced would destroy the entire output of the firm. Even when isting does not destroy ths produc, testing the entire output is usually probibitively expensive and famecconsurring. The usual procedure i ta take asample ff the output and infer the properties and characteratice of the entire ousput (population) from the conesponding charsetenstiss of a sample drawn [rom the population, (6) Statistical inference requires frst of ll that the sample be repsesentative of the population being sampled. If the frm produces lightbulbs in diferent plants, with more than one workshift, and ‘with raw materials from different suppliers, these must be represented in the sample in the propertion in which they contribute to the tolal output of the firm, From the average life and spread in the if of the bulbs in the sample, the fim manager might estimate, with 98% probability of being correct and 1% probability of being wrong, the average Ife oC all the lightbulhs produced hy the frm to be berween S20and 400 {oee Sec. 4.3). Instead, the manager may use the sample information ta test, with 95%. feovtabaity of being corvest and £0% plokublity of bung Weomg, that the average life of the population of all the bulbs produced by the firm is greaier than 320h (see See. 5.2) In estimating or testing the average fora population from sample information, the manager engaping im ctateical inferenceINTRODUCTION lomar. t STATISTICS AND ECONOMETRICS. 1s 7 What is meant by (a) Econometrics? (b) Regression analysis? {c) Disturbance or error term? () Simultaneous-equations models? («) Exonomeiries is the integration of economic theary, mathematics, and statisical techniques for the ‘parpov: of teting hypothotor about aconamic phenomena, extimaling eveliconts af economic relation ‘tips, nd forecasting oe prodieting funure values of economic Variables or phenomena. Econometrics is suhtivided into theoretical and applied econometrics Thvweetical accaowmieenis neters to the methaels for measurement of economic relationships in general. Applied econameteics examines the problems encountered and the findings in particular elds af economics, such as demand theory, peaduction, investment, consumption, and other fells of applied eeonomie rewearch, In any case, econometrics is partly art and portly a ssience, because oRen the intuition and good judgment of the ssonometrician plays a crosial role (6) Regression analysis studios the causal relationship between one economic variable to be explained (the Aepenlent variable) und one ar mare independent or explanutary variables, When there is only one ‘iwdependent of explanatory variable, We have simple regression. la the wore usual case of tase that ‘one independent or explanatory variable, we have mullple regression. (©) A frandom) disturbance or error must be included in the exact relationships postulated by economis theory and mathematical esonamnis in order ts make them stochastic (ic, in onder 1 reflect the fact that in the real world, ccanomic reathonships among econoraic variables are inexael and somewhat ertatic). (df) Simultaneous equations models refer to relationships among economic variables expressed with mone than one equation and such that the ssonomic ¥artables in the various equations imeract, —Simuta- ncous-oquations rodclsare the most coraplex aspect of economnetsics and are discussed in Chap. 10. (a) What are the unctions of coonometnes? (0) What aspects ol ecomomets (and other social sciences) make it basically different (rom most physical sciences? (4) Beonometies has basically theee closely interelated functions. The first sto west coonomie theories or hnypothesee. For example, is sansuraption directly relied tn income? Ts the quantity demanded of a commodity inversely related to its price? The second function of econometrics is to provide numeral estimates of the coefficients of economic relationships. These are csscntial in decision making. For ‘xample,a government polieyemaker needs to have an aocurate estimate ofthe svefisient of the relation- ship between consumption and income in order to determine the stimulating (i. the multiplier) effect fof proposed tax reduction. A manager needs to know i a price reduction increases or reduces the total sales rexenues of the firm and, if so, by how mach, The thd function of econometrics is the foresasting of events. Is, 109, i Mesessary a. orver for polkeymakers to faRe apprOprae cArrecteNe action ifthe ratz of unemployment or inflation is predicted 10 rise an the future. () There are two basse differences between econometrics (and other socialsciences) on one handl, and most physical sciences feuck as physic) oa the other. One is that (as pointed out eather relationsheps among economic vanabies are ensxact ars somewhat erratic. Ihe sesond 1s that most economis [Phenomena coeur sontemporancensy, s that Iahoratery experiments eannot be conducted, These differences require special methods efanalyss (sich as the incisslon ata disturbance or error sre with the cxaet relationships postulated by economic theory! and multivariate analysis (each ae multiple regression analysis), Ths Istts issltss the affect of sash indspondent or explanatory variable on the dependent variable in the face ef contemporancous change in all explanatory variables, In what way and for what purpose are (a) economic theory, (S) mathematics, and (¢) statistical analysis combined to form the field of study of econometrics? |w)Peonometes presupposes the existence ofa body of economic theorkes or hypotheses requlring texting. [the variables suggested ly econarnic theory do nat pravade a satisfactory explanation, the researcher nny copra it alternative rsialions anid Vaniables suggested by paved Lats oe carols theories, In this may, economeiti research can lead to the acceptance. ection, and reformulation of sconomie theoriesCHAP. 1) INTRODUCTION = 18 (6) Mathematics is used to express the verbal statements of economic thearies in mathematical form, expresiing an exact or daterminiatic fanciional relationship between the dependent and one oF more independent or explanatory variables, (0) Statistical analysis applies appeopiate Hla oes to etic the ncaa aud uomenpesiaee tal clation ships among economic variables by utling relevant economic data and evaluating the results, Wht justifies he inlusion af disturbance or ceeur (erty in regrension analysis? ‘The inclusion of a frandom) disturbance or estor teem (with wellatined probabilistic properties) is required in regression analysis for three important reasons, Firs, sings the purpose of theory isto generalize and simplify, ceonomie relationships usually inlude only the most important farces at work, This means that nuimeraus other variables with slight ane repr effects are not ineluded. The error term can be viewed a representing the act elect ofthis large number of small and irregular forees at work. Second, the Imctusion of the error ferm ean be JUsihed -oTder to take mer onsiceration the Net eect oF possAbkesrTaT: im measuting the dependent variable, ar variable being explained. Finally, sinee human behavior usally Gifers im random way under idcnlical circumstances dhe disturbs or ceror term eam be uoed wo expluse this inherently random human behavior, ‘This ersor term thus allows for inéiritual rarsiomn deviations from ths enact and deterministic relationships postlated by economic theory ng mathematical economics, Consumer demand theory states tat the quantity demanded of'a commodity Dy isa function of, or depends an. ils price Py. consumer's income and the price of otber (related) commodities, say, commodity Zi, Fz). Assuming that consumers" rast remain constant during the period. of analysis, tate the preceding theory in (a) spociic or explicit incar form or equation and (6) in stochastic form. (c} Which are the costtcients to be estimated? What are they called? @ Dy=By4b\Pr by) + bP sn oo Dra hy thiPrth¥ ther te a (e) The cooticents to be estimated are by by, and by, They ar called paranster THE METHODOLOGY OF ECONOMETRICS. 110 With refercnee to the consumer demand theory in Prob. 1.9, indicate (a) what the frst step is in econometric research and (4) what the a priori theoretical expectations are of the sign and possible size of the parameters of the demand funetion given by Eq. (1-4) (a) The first step in econometric analy is to express the theory of consumer demand in stochastic ‘equation form, as in Eq. (14), and indicate the a priori theoretical espestations about the sign and possibly the size ofthe parameters of the Function. (6) Consumer demand theory postulates that in Eq. (1.4), < 0 (indicating that price and quantity ase inversely elated, by = 0 ifthe commodity is a normal pood (incieating thax consumers purchase more of the commodity at bigher incomes), by =i X and Z are substitutes, and by <4 X and Z are complements Indicate the sccond stage in econometric research (a) in general and (4) with reference to the demand function specified by Eq. (1.4, (a) The second stage in econometric research involves the caleetion of data on the dependent variable and ‘on each of the independent or explanatory variables of the model and utilising these: data for the ctipivieal eitimatlon of the pacaineters of the wiodel. The i URUslly davse with multiple regression analysis (diseussed in Chap. 7) (oy tis wrdee to stints the desman fection given by By. (1), data must be solleeted ou (Up the «quantity demanded of commodity ¥ bby consumers, (2) the prive of ¥Y, (3) consumer's incomes. and. (8) the price of commodity 7 per unit of time (ie, par day, month, oF yeas) and aver a number12 INTRODUCTION lomar. t of days. months, or years. Bata on Py. Vand Py are then regressed against data on Diy and estimates of parameters by by bane By obtained, How doos the iype of data required to estimate the demand function specifiod by Fa, (1.4) difler fear the type of ata eat wail Be teqired ta estimate the consumption function for a gecsp af families at ane pons in rie In onder to estimate the demand function given by Eq, (1.4), numencal values of the vanables are required over a period of time. Fer example, ifwe want to estimate the demand finetion for coffee, we need she numerical value ofthe quantity of coffee demanded, say, per yeas, over a numberof years say, ram 1960 ter 1980, Similarly, we need data om the average peice of colle, canstmers income, and the ries, of say, tea (a: aubatitute for coffec} per gear from 1960 to 1980, sta that give nimerical wales for the warinbles of 8 function from pertod to period are walled tinw-serics data. However 1 estimate the consumption funtion for 4 group of Families at one point in tec. we ced crorssectional data (L., numerical valucs foe the consumption expenditures and dispacable incomes of each Family in the group at particular point in time, say, mn 192 What is meant by (a) Lne third stage am econometnc analysts! (b) A pnori theoretical en teria? (c) Statistical criteria? (al Feonometric criteria? (e) The forecasting ability of the moet? he evahvalion of the estimated matel on the sis of ty of the model (6) Thee print economic criteria fer to the sign and sas af the parometers of the model paatulated by csonomie thoory. Ifthe estimated cooflcicats do wot conform to those postulated, the mods! must be revised or rgected (©) The statistical crteria eefer ta (1) the proportion of variation inthe dependcat variable “explained” bby changes inthe independent or explanatory wariables and (2) verifention that the dispersion or spread of eich estimated evellicicot around the true parameter is suficiently microw Lo give us "eon ‘dence in the estimates The ecowomeerc criteria reler to test that the assumptions of the basic regression model, and particu: larly these about the disturbance or 0 (WT W a normal good), and wf; > O ( Za substitute for A, 28 postulated by demand theory, () The statistical criteria are satisfied only if a “high” proportion of the variation in Dy. ovce time is “explained by changes in Py, Vand P, and ifthe dispersion of etmated 4, an By aro the {rue parameters are “slficiently narzoww.” There is no generally atcepled answer as to what sa “high” ‘proportion ofthe variation in Dy “explained” by Fy, P.and Py. However, beause of eommon trends in imesseries data, we would expect more than $0 0 70% of the varlation In the dependent varlabie 10 bbe explained by the independent or explanatory variables for the model to be judged satisactory. ‘Silty, in eee fit sich estnasted cacnnt to La Staisacally signi” wre Wahl eae the Alspersion of cach estimaicd cosflcient about the true paramcier measured by is standard devi as Seo, 21) to be panoraly lee than half the ertimatad salve of the eoalficiontCHAP. 1) INTRODUCTION 7 Las (0) The econometric criteria are used to determine i the assumptions of the ceanometric methods used are catiled inthe ecimation of the demand fnetion of Eq. (11) Only i thew aerumptione are ratified ill the estimated coefficients have the desirable properties of unbiasedness, consistency, fficeney, and sa forth (s98 See. 64 Qe way to test the forcxasting ability of the demand model given by Eq. (1.4) isto use the estimated Faction to predict the value of Diy For a periad mat included in the cample and checking that this predict! value s "sufficiently close tothe actual observed value of Dy foe that perise 15 stages Of econometric research 4 Mathematical riod 1 oonomettic (stochastic) model Stage 2: Collection of approprints data 4 Entimation of the parameter of the model ‘Stage 4: Evaluation of the model om the basis af sconemie, atistical, and seonometric critecia I C74 Accent theory Reject theory Revise thenry if compatible if incompatible if incompatible with data wits data wwith data L Prediction Confrontation of revised theory vont new dana Supplementary Problems THE NATURE OF STATISTICS ut (a) To hich field of study is statistical analysis important? (6 What are the most important Functions of Sescripeive statistics? (¢} What is che most important function of inferential statistics? Ars. (a) Toccanomics, business, and other social and physical sciences (By Summarizing and describing | body of data. (0) Drawing inferences abst ths characteristics of 4 population from the comesponding characteristics of a sample drawn from the popallation. (a [s statistical inference associated with deductive or inductive reasoning? (8) What are the conditions required in order fr statistical inference to be wali ‘Ans. (a) Unduetive seasoning (b) A representative sample and probabiity theory STATISTICS AND ECONOMETRICS [Express in che form oP an explicit Incr equation the statement that she Level of investment sponding F bx inversely related 10 rate of interest R dn J y+ byR with by postulated to be negative usINTRODUCTION lomar. t 1.4 What is the answer to Prob, 18 an example of? dng. Aneconomne theory exproted io {enact or deerennitis) evatheratia! form 1.2m Express Bq. (1. in stochastic form, ss. Tet 4b Ro U6 1.21 Why isa stochastic form required in econometric analysis? sing. Becavse the rbationshis among economic variables are inexact and somewhat erratic as opposed to the exact and deterministic relationships postulated by economic theory und matherutical economics THE METHODOLOGY OF ECONOMETRICS 1.2% What are wager (a) ome, (4) two, and (4) thies in oomometaie research? Ans. (a) Spesiication ofthe theory in stochastic equation form and ification of the exposted signs and posse since of estimated paramtrs (8) Collertinn of dats on the warnbles ofthe movil ana timation Othe coofcients ofthe Function. (ch Eeonoeni, statistical, and cconometic evaluation ofthe estsmated rameters 1.28 What isthe frst stage of esonometic analysis for the investment theory in Prob. 118? Ans. Stating the theory iv the Form of Ea. (2.6) and pricing by ~ 0 1.24 What is the sosond stage in esonometric analysis forthe investment theory in Prob. 1.18 Ans, Colfsstie of time-series data on / and and estmation of Ea. (8) 1.26 What is the third stage of ssonometic analysis for the investment theory in Prob, 18? dus, Determination thatthe estimated coeficient of 8, ~ 0, that an “adsquate” proportion of the variation in Fover ome 6 explatned” by changes in R, that 6) is“satistically significant at eastornary levels” and that the econornetsic assumptions of the madel ate satistiedDescriptive Statistics 2 FREQUENCY DISTRIBUTIONS frequency distribution, This breaks upp s the number of abservations in each class. The number of sfisiribution is obtained by dividing the number The sum of the felative frequencies equals |. A histogram isa bar graph of a frequency distribution, where classes are measured along the horizontal axis and frequencies along the vertical axis. A frequency polygom isa line raph of a froquency distribution resulting from joining the frequeney of each class plotted at the class midpoint, A. cumecative frequemey distribuste cach class, the total number of observations in all classes up to and including that class. W. this gives a dlstribution curve, or ogive tis often useful 1o organize or arr the data into: groups ar classes anal sh classes is usually between Sand 15. A relative frequenc plott EXAMPLE 4. A student rescived the following grads (measured from 0 to 10).on the 10 quizses he took during 3 semester: 6,7, 6,8, 5, 7,6, 9, 10, and 6, These grades can be arranged into frequency distributions asin Table 3 | and shown graphically as in Fig. 2-1 Table 21 Freqsensy Distributions of Grades Grades ‘Absolute Frequency Relative Frequency t 1 ‘ oa 2 2 U l L el o eo io Lo Fig. 24 9 ‘Copyright 2002 The McGraw-Hill Companies, Inc, Click Here for Tenms of Use,10 DESCRIPTIVE STATISTICS [oHar, 2 EXAMPLE 2. The cans in a sample of 0.cans of fruit contain net weights of frit ranging fram 19:3 to 20.90%. a5 piven in Table 22, If we want to group there data into & claster, wo git eforr éntoreak of O.Fox [(2L0-192)/6=03ed. The weights given in Table 2. can be arranged into the frequency distributions gven in Table 9 ¥and chown praphically in Fig. 9-9 ‘Vale 2.2 Net Weaghe i= Ounces of Feat 7 199 m2 199 m0 26 1 m4 1D 20d 201 9S MY M3 2S 199 WO He 19 198 ‘Table 2.3. Frequency Disertnutlon of Wels rr 192194 195197 19200 Dotan ma me mo7209 Panel A toga ae: Reve epee gain ® é «| a. a z ‘ a ea Panel ive anal; Prequeney peiyzoa " i 3 ‘weghie a ciate Fig 22cua, DESCRIPTIVE STATISTICS u 2.2 MEASURES OF CENTRAL TENDENCY, Central tendency refers to the location of a distribution. The most important measures of central tendency are (1) the mean, (2) the median, and (3) the made. We will be measuring these for Populations (i... the collection of all the elements that we ars describing) and for samples drawn from populations, as well a Tor srouped and ungrouped data 1. The artiimietic mean of average, of a population is represented by ys (the Greek letter muy and. fora sample, by F (read “X bar"). For ugrouped data, ys and Y are calculated by the following, formulas: St am THEE (res) ¥ * where OX refers to the cum of all the obsarvations, while Nand m refer to the number of observations in the population and sample, respectively. For groped data, ye and Y are caleulated by oe and H (22a,0) +e where 7 roe to the sum of the Trequeney of exeh elass mes the chs mapornt 2. The median for uogrouped data is the-valuc of the middle item when all the tems are arranged in either ascending oF descending order in terms. of values: N4I Median = the ( im item in the data array 4) where’ refers to the number of items in the population (n for a sample). The median for _groupedt dava is given by the formula nfl—F Median = L425 Se (4) Whore J =lower limit of the median class (i¢., the elass that contains the middle item of the distribution = the number of abservations in the data set F = sum of the frequencies up to but not including the median class Jue = frequency of the median elas ¢= width of the elass interval 3. The mode is the value that occurs most frequently in the data set. For grouped data, we obtain (25) Where J. = lower hmit of the modal class (2. the class with the greatest Irequency) dy = frequency of the modal class minus the frequency of the previous class dy = frequency of the modal class minus the frequency of the following class = width of the eas rv ‘The mean is the mort commonly used measure of central tendency. The mean, however, is affected by extreme values im the data set, while the median and the mode are mot. Other meusures of central tendency are the weighted moan, the genmerric- moan, and the harmonic mean (soe Peobs. 2.7 to 29),2 DESCRIPTIVE STATISTICS lemar. 2 EXAMPLE 3. The mean grade for the population en the 10 quizess given in Example 1, sing the Formula for nmogrouped data, ie LX _LO+TH64 8454746494106 _ 70 we 10 @ ‘To find the median forthe ungrouped data, ve fist arrange the 10 grades in ascending ovder: 5, 6,6, 6,6, 7.7.8, 1, Then-we find the grade of the (¥ + 1)/20r (10-+ 11/2 = $.Sth itr, Thus the median is the average ofthe Sth ‘nd 6th item in the array. ar (6-+ 72 =63. The made for the ungrouped data is 6 (he value that occurs most Frequently in the data set} sins EXAMPLE 4, We can estimate rhe mean for the grouped data given in Table 2.3 with the aid of Table 2.4 Ste 2 at [ns calcuration cous ne simpined coming, (8 Hrobs 2.0 Y= M08 0% Table 24 Caleulatlon of the Sample Mean forthe Data: in Table 2.3 Chass Frequency Weight, on | Midpoiae * pe 1294 193 193 195.197 196 3a ret) 19 8 vn 20..-203 m2 4 sas, m4 208 as 3 ee 20.1209 208 2 416 wid Te = 98402676 = oar Mod = 198+ Unbere £ = 19.8 = lower limit of the median class tic. the 198-2040 class which contains the 10th and 1th obscevations) f= 20 number of observations or terns r sum of frequensies up to bet not inchading the median class fre = 8= frequency of the median class 603 — width of class intersal Similarly Modest n= 8s¥o ssa 9tec As noted in Prob. 2.4, the mean, snadian, and mode for grouped data are estimates used when only the grouped data ble-ar to reduce calculations with a large wngrowped data extcua, DESCRIPTIVE STATISTICS B 23 MEASURES OF DISPERSION Dispersion refers to the variability or spread in the data. The most important measures of disper- sion are (1) the aveeage deviation, (2) the variance, and (3) the standard deviation, We will mea sure these for populations and samples, as well as for grouped and unerouped data. |. Auerage devaateon. The average devianion (AD), also called the mean atieolute deveatton (MATD}, is given by ‘for populations (26a) nat for samples (ey where the two: vertical bars indicate the absolute value. or the walues oenitting the sign, with the other symbok having dhe same meaning as in See. 2.3. For grouped data ap LAX =o for populations (27a) sot ap-E2™=T pe ampts em where f refers to the frequency of each class and to the class middpoints, Variance. The population variance o? (the Greck letter sigina squared) and the sample variance # for ungrouped data are given by > Step) rw-xy 5 oe ond gf ES (28a) For grouped data eB od eo (290. 3, Standard deviasion, The population standard deviation ¢ and sample standard deviation s are the positive square root of their recpective variances, For ungrouped data a poy [ou = ul? uy - FF ae a Eni gg y= YEAS (2a. The most widely used measure of (absolutey dispersion is the standard deviation, Other measures (besides the variance und average deviation) are he range, Uhe Orrerguarcle range, and the guarate deviation (see Probs, 2.11 and 2.12). 4. The conffcient of variation (8°) measures relative dispersion: and (2.100) For grouped data or populations (2.120) and v=4 for samples (2.12) EXAMPLE 8. The average deviation, variance, standard deviation, and coefisint of variation For the ungrouped ata givon io Kxample 1 can be found with the aid of Table 2.5 (je = 7; eae Example 3k“ DESCRIPTIVE STATISTICS lomar. 2 "Palle 2:5 Custos he Dut bn Examgie 1 Grade | Yawn [Nal Wen? 6 |7 T 7 7 7 |? o ° ° 6 |? “1 1 1 s |r \ 1 1 5 7 2 4 1/7 ° 6 6 |? 1 1 9 |? 2 4 w |? 3 3 ’ 6 |? “1 1 1 Elteal=0 | DW am EXAMPLE 6. The average deviation, variance, standard deviation, and eoeficient of variation for the frequency distribution of weights (grouped data) piven in Table 2,3 can be found with the aid of Table 26 (1° — 2008 a; see Brample O31802 225 9 star quid [ELL OY POS _ Vous = 0.84202 # 0.3982 02 ae 0.0196, or 1.56! Yo War oz * [Note that in the formula for ? and ¢,a— I rather than m is used inthe denominator ieee Prob, 2.16 forthe reason} [Pr the fiers fv oor a Biv tis ssl thers may he esi that wl sey scars for a large body of data (soe Probs. 2.17 to 2.19 for their derivation and application} Table 246 Calculations om the Data in Table 24 a a we | edna | ER] efi} eam ae} Towa | rn we ie some | 0 4 |e | ome] on as ones manana | ans + | am | nae | one as De ava | 0 2 | aw | oz] on La si Eysss> Lae Foecuar, DESCRIPTIVE STATISTICS 1s 24 SHAPE OF FREQUENCY DISTRIBUTIONS: The shape ofa distribution refers to. (1) its symmetry oF lack of it (skewness) and (2) its peak: edness (kurtosis) 1. Skewness. A distribution has zero skewness if it is symmetrical about its mean. For a symmetrical (unimodal) distribution, the mean, median, and mode are equal, A distribution is positively skewed if the right tail is longer. Then, mean > median > mode. distribution is neastvely skewed if the left tail is longer. Then, mede > median > mean (see Fig. 2-3). Mean Mode Mean ae on Pu A Syma Pama Rose shew na ent avd fg 23 Skewness can bo measured by the Pearson coeficien of skenness: sx = %A= met) for populations 23a) and se Em bop samples (2b) Monn and variance ary the first and second moments ofa distribution, respectively, Skowmeas an also be measured by the third moment [the numerator of Eq. (2.14a.b)] divided by the cube of the standard deviation: sea ZL or popattons (2 and SELEY compte eum For symmetric distributions, Sk = 0. 2 Kurtosts, A peaked curve is called leprolerric, as opposed to a flat one (plarykurric), relative te fone that is mesokurtic sce Fig. 2-4). Kurtosis can be measured by the fouth emament [the numerator of Eg. (2.154.01] divided by the standard deviation raised to the fourth power. The kurtosis for a mesokurtic curve is 3. Lepeokutic Meese