Econometrics

Dong Xuan Bach

Data Science program - NEU

2023/2024
 Chapter 1: Introduction to
Econometrics
▶ What is econometrics?
▶ Empirical Economic Analysis
▶ Causality, Ceteris Paribus, and Counterfactual
Overview

▶ Aim of the class: Introduce the theory and application

of econometric methods
▶ Pre-requisites: Probability and statistics, linear algebra
Statistical software: R, Python
▶ Organization:
▶ 15 × 2 hours lectures
▶ 15 hours tutorial
▶ Grading: 10% attendance, 40% mid-term exam, 50%
closed book written final exam
References

▶ Main text book:

[1] Jeffrey M. Wooldridge (2016), Introductory
Econometrics - A Modern Approach, 6th Edition,
Cengage Learning
▶ Additional textbooks:
[2] Douglas C. Montgomery (2012), Introduction to
Linear Regression Analysis, 5th Edition, Wiley.
[3] Christian Kleiber (2008) Applied Econometrics with R,
Springer.
What econometrics is about

▶ Data – Statistics provide many tools to summarize and

analyze data – mean, median, variance, max, min etc.
▶ But what science is about is relationships between
variables ⇐⇒ How social phenomena actually
(empirically) work?
▶ Examples of empirical questions (relationships):
▶ What is the impact of an increase in the minimum wage
on employment levels in a specific industry or region?
▶ Is there a causal relationship between higher levels of
education and higher income levels?
▶ To what extent does technological innovation lead to
changes in employment patterns and job opportunities?
The big challenge: drawing conclusions from
observed relationships

▶ Women earn less than men.

⇒ A sign of discrimination?
▶ Health is negatively correlated with the number of days
spent in hospital.
⇒ Do hospitals kill patients?
How?

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
Arthur S. Goldberger (1964, p.1)

Econometrics, the result of a certain outlook on the role of

economics, 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
Samuelson, Koopmans, and Stone (1954)

⇒ Combines mathematics, statistics and (economic)

theory
 Empirical Economic Analysis
(using data to test a theory or to estimate a relationship)
Step 1: Question of interest

▶ The question might deal with testing an economic theory,

or testing the effects of a government policy, etc.
▶ In some cases, especially those that involve the testing of
economic theories, a formal economic model is
constructed
Illustration 1: Economic model of Crime
In a seminal article, Nobel Prize winner Gary Becker
postulated a utility maximization framework to describe an
individual’s participation in crime.

y = f (x1 , x2 , x3 , x4 , x5 , x6 , x7 ),

where
y = hours spent in criminal activities,
x1 = “wage” for an hour spent in criminal activity,
x2 = hourly wage in legal employment,
x3 = income other than from crime or employment,
x4 = probability of getting caught,
x5 = probability of being convicted if caught,
x6 = expected sentence if convicted, and
x7 = age.
Illustration 2: Job Training and Worker productivity

Consider the following model:

wage = f (edu, exp, training),

where
wage = hourly wage,
edu = years of formal education,
exp = years of workforce experience, and
training = weeks spent in job training.
Step 2: Econometric model

▶ Challenges with economic model: specific form of the

function f , unobserved variables, many other factors, etc.
▶ The ambiguities inherent in the economic model of crime
are resolved by specifying a particular econometric model:

wage = β0 + β1 edu + β2 exp + β3 training + u,

where the term u contains factors such as “innate ability,”

quality of education, family background, etc.
▶ For example, if we are specifically concerned about the
effects of job training, then β3 is the parameter of interest
What really happen?
▶ For the most part, econometric analysis begins by
specifying an econometric model, without consideration
of the details of the model’s creation
▶ We would start with an econometric model and use
economic reasoning and common sense as guides for
choosing the variables
▶ Once an econometric model has been specified, various
hypotheses of interest can be stated in terms of the
unknown parameters
▶ An empirical analysis requires data. After collecting data,
econometric methods are used to estimate the parameters
in the econometric model and to formally test hypotheses
of interest
Causality, Ceteris Paribus, and Counterfactual
Reasoning

▶ In most tests of economic theory, and certainly for

evaluating public policy, the economist’s goal is to infer
that one variable (such as education) has a causal effect
on another variable (such as worker productivity)
▶ The notion of ceteris paribus – which means “other
(relevant) factors being equal" – plays an important role
in causal analysis
▶ The notion of ceteris paribus also can be described
through counterfactual reasoning. The idea is to
imagine an economic unit, such as an individual or a firm,
in two or more different states of the world