ECO 8101: ECONOMETRICS

Session 1
Dr. Janaka Fernando
(pjsampath@sjp.ac.lk /0714191996)

Senior Lecturer
Department of Business Economics
Faculty of Management Studies and Commerce
University of Sri Jayewardenepura 1
 Lecture Outline

 Introduction to Econometrics
 The Role of Econometrics
 Methodology of Econometrics
 Types of Data in Economic Analysis
 Measurement Scales of Variables
 Regression Analysis
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What is Econometrics?
• Econometrics literally means “economic measurement”
• It is the quantitative measurement and analysis of actual economic
and business phenomena and so involves:
• Economic theory
• Statistics
• Mathematics
• Observation/data collection
• Studying econometrics fills the gap between being “a student of
economics” and being “a practicing economist.”
What you can do if you know econometrics?

• You can predict the sales of a product (or it may be

macroeconomic variables such as exchange rate)
• You can estimate the effect on the sales of a product if your
competitor lowers its price by rupees 10 per unit.
• You can assess the effectiveness of your advertisement campaign
• You can assess whether you should send your subordinates for a
particular training program

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• Three major uses of econometrics:
• Describing economic and financial realities
• Testing hypotheses about economic theory
• Forecasting future economic activities

• So econometrics is all about questions: the researcher (YOU!) first

asks questions and then uses econometrics to answer them
  Example
• Consider the general and purely theoretical relationship:
Q = f(P, Ps, Yd)

• Econometrics allows this general and purely theoretical relationship to

become explicit:

Q = 27.7 – 0.11P + 0.03Ps + 0.23Yd

 Definitions
“Econometrics is concerned with the empirical determination of economic laws”
(H. Theil, Principles of Econometrics, John Wiley & Sons, New York, 1971)

“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, Econometric Theory, John
Wiley & Sons, New York, 1964)

“Econometrics may be defined as the quantitative analysis of actual economic

phenomena based on the concurrent development of theory and observation,
related by appropriate methods of inference” (P. A. Samuelson, T. C. Koopmans,
and J. R. N. Stone, “Report of the Evaluative Committee for Econometrica,”
Econometrica, vol. 22, no. 2, April 1954). 7
 The Role of Economic Theory

 The Role of Mathematical Economics

 The Role of Economic Statistics

 The Role of Econometrics

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Unemployment rate among most of the age
categories increased during 2019 compared to the
previous year. Youth (15-24 years) unemployment
rate, which continued to be at higher levels,
recorded 21.5 per cent during 2019, which was a
marginal increase from 21.4 per cent recorded
during the previous year.

In addition, it is noteworthy that the youth category

accounted for the highest share, of 49 per cent, of
the total unemployed population during the
reference period.

More than one fifth of the youth labour force being

unemployed indicates the urgent need of
capitalising the unutilised capacity in the youth on
economic growth and development of the country
by properly directing them to fill gaps in the 9labour
market
 The Role of Econometrics

• Using information:
1. Information from economic or financial theory
2. Information from economic data

• Econometrics helps us to combine economic theory and

economic data to make economic decisions.
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 Methodology of Econometrics

1. Creating a statement of theory or hypothesis

2. Collecting data
3. Specifying the mathematical model of theory
4. Specifying the statistical, or econometric, model of theory
5. Estimating the parameters of the chosen econometric model
6. Checking for model adequacy: Model specification testing
7. Testing the hypothesis derived from the model
8. Using the model for forecasting or prediction
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 Example
• An economist wants to determine whether the monthly salary of a bank
manager is different for male and female counterparts in the Sri Lankan
banking system.
• It is assumed that there are 600 bank managers in the banking system
where the average monthly salary of a bank manager is LKR 89624.07.
• The economist surveyed 100 respondents randomly and the sample
consists of 50 male managers and 50 female managers.
• The sample data revealed that the average salary of a bank manager is
89580.50. In addition, average salary of a female manager (LKR
76188.85) was less than the average salary of a male manager (LKR
97788.23).
Department of Business Economics 09/20/2022 12
 1) Creating a statement of theory or hypothesis

Hypothesis: Is there a gender discrimination in the banking

system in Sri Lanka?

Department of Business Economics 09/20/2022 13

 2) Collecting data

 Experimental versus nonexperimental data

 Micro versus macro data
 Flow versus stock data
 Quantitative versus qualitative data

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3) Specifying the mathematical model of theory:

Salary   0  1Gender

4) Specifying the econometric model of theory:

Salary i   0  1Genderi  ui
Where “” represents the random error term (all the other factors
affect the salary other than variables explicitly included in the
model. In this case, all the variables that affect salary other than
gender) 15
5) Estimating the parameters of the chosen model

Source SS df MS Number of obs = 100

F( 1, 98) = 14.99
Model 1.0991e+10 1 1.0991e+10 Prob > F = 0.0002
Residual 7.1858e+10 98 733243513 R-squared = 0.1327
Adj R-squared = 0.1238
Total 8.2849e+10 99 836861449 Root MSE = 27078

salary Coef. Std. Err. t P>|t| [95% Conf. Interval]

gender 21599.28 5578.744 3.87 0.000 10528.44 32670.12

_cons 76188.95 4392.708 17.34 0.000 67471.76 84906.13

Salary  76188.95  21599.28Gender

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 6) Checking for model adequacy or specification testin g

• Is it possible to analyze the salary differences simply focusing on

gender?
• What are the other key factors that explain the salary differences?
• Let’s consider two more variables;
Education
Experience
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 Salary vs. Experience
200000

180000

160000
Monthly salary in Rupees
140000

120000

100000

80000

60000

40000

20000

0
0 5 10 15 20 25 30 35 40
Years
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 Salary vs. Education
200000

180000

Monthly Salary in Rupees 160000

140000

120000

100000

80000

60000

40000

20000

0
10 11 12 13 14 15 16 17 18 19 20
Years
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 New Model

𝑆𝑎𝑙𝑎𝑟𝑦 𝑖 = 𝛽0 + 𝛽1 𝐸𝑑𝑢 𝑖 +𝛽 2 𝐸𝑥𝑝 𝑖 +𝛽 3 𝐺𝑒𝑛𝑑𝑒𝑟 𝑖 +𝑈 𝑖

Department of Business Economics 09/20/2022 20

Regression Output
Source SS df MS Number of obs = 100
F(3, 96) = 73.99
Model 5.7868e+10 3 1.9289e+10 Prob > F = 0.0000
Residual 2.5026e+10 96 260686574 R-squared = 0.6981
Adj R-squared = 0.6887
Total 8.2894e+10 99 837314348 Root MSE = 16146

salary Coef. Std. Err. t P>|t| [95% Conf. Interval]

education 2128.141 1010.465 2.11 0.038 122.3847 4133.898

experience 4120.47 314.6956 13.09 0.000 3495.805 4745.136
gender 1706.534 3673.907 0.46 0.643 -5586.114 8999.182
_cons -6278.22 15956.14 -0.39 0.695 -37950.91 25394.47

The estimated model is;

……………………………………….
Department of Business Economics 09/20/2022 21
7) Testing the hypothesis

Do you see a gender discrimination in the banking sector in Sri Lanka?

1. Ho: = 0 (Hypothesis)
2. P value =0.643 (Test statistics)
3. P value > 0.1 (Decision Criteria)
4. We fail to reject the null hypotheses. No gender discrimination in
the banking sector in Sri Lanka (Conclusion)

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8) Using the model for forecasting or prediction

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Types of Data and Variables in Economic Analysis

 Time Series Data

 Cross-Sectional Data
 Pooled Data
 Panel /Longitudinal or Micro Panel Data

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 Random Variable

• A variable whose value is unknown until it is observed. The value of a

random variable results from an experiment.
• The term random variable implies the existence of some known or
unknown probability distribution defined over the set of all possible
values of that variable.
• In contrast, an arbitrary variable does not have a probability
distribution associated with its values.
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 Continuous Random Variable

• A continuous random variable can take any real value (not just whole
numbers) in at least one interval on the real line.
• Examples:
• Gross national product (GNP)
• Money supply
• Interest rates
• Price of eggs
• Household income
• Expenditure on clothing 26
 Discrete Random Variable

• A discrete random variable can take only a finite number of

values, that can be counted.
• Examples:
- Number of students in a class
- Number of buildings in a city
- Number of universities in a country
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 Dummy Variable

• A discrete random variable where the value of the variable is restricted

to two possible values (usually 0 and 1) is called a dummy variable
(also, binary or indicator variable).
• Dummy variables account for qualitative differences:
• Gender (0=male, 1=female)
• Race (0=white, 1=nonwhite)
• Citizenship (0=U.S., 1=not U.S.)
• Income class (0=poor, 1=rich) 28
 Deterministic Variables

• In deterministic phenomena, on the other hand, we deal with

relationships of type that are specific or non stochastic in nature.
• Newton’s Law of gravity:
F
Where F=force, m1 and m2 are the masses of two particles, r is
the distance, and k is the constant of proportionality.
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Measurement Scales of Variables

 Ratio Scale
 Interval Scale
 Ordinal Scale
 Nominal Scale

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 31

https://byjus.com/maths/scales-of-measurement/
1. How old are you?
2. Select the relevant age category from the following list.
• Less than 15
• 15~30
• 30~50
• 50~60
• 60 or above
3. Select the applicable answer;
• Teenage
• Youth
• Middle age
• Elder
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Types of Econometrics

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 Regression Analysis

 What is regression analysis?

 Simple and multiple regression analysis

 Regression versus causation

 Regression versus correlation 34

 Terminologies
Dependent Variable
Explanatory Variable(s)
 
Explained Variable Independent Variable(s)
 
Predictand Predictor(s)
 
Regressand Regressor(s)
 
Response Stimulus or control variable(s)
 
Exogenous(es)
Endogenous
3
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The End of Session 01

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