CHAPTER ONE

INTRODUCTION
1.1 What is Econometrics?
1.2 Models, Economic Models &
Econometric Models
1.3 The Econometric Approach
1.4 Types of Data for Econometric
Analysis
1.5 Causality & Ceteris Paribus
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 1.1 What Is Econometrics?
WHAT IS ECONOMETRICS?
economic measurement
application of statistical methods to
economics.
application of mathematical & statistical
techniques to data in order to collect
evidence on questions of interest to
economics.
combines economic theory, mathematical
economics, economic statistics &
mathematical statistics. 2
 1.1 What Is Econometrics?
Economic Mathematical
theory economics
provides theory or expresses economic
imposes a logical theory using
structure on the mathematical form
question

Econometrics
data presentation
and description Estimation and
testing techniques
Economic Mathematical
statistics statistics 3
 1.1 What Is Econometrics?
GOALS/USES OF ECONOMETRICS
1. Estimation of economic parameters or
relationships needed for policy- or
decision-making;
2. Testing (and perhaps refining) economic
theory;
3. Forecasting/prediction of future values
of economic magnitudes; and
4. Evaluation of policies/programs.
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1.2 Models, Economic Models & Econometric
Models
Simplified representations of the real
world phenomena.
Models on relationships between/among
economic variables.
Economic models combined with assump-
tions about the random nature of the data

ECONOMETRIC
MODELS

ECONOMIC MODELS

MODELS 5
 1.3 The Econometric Approach
1. Economic Theory/Model
2. Mathematical Model
3. Econometric Model (economic theory in an
empirically testable form)
+ Some a priori
information
4. Data
5. Estimation of the Model
6. Tests of Hypothesis (verifying any claim
suggested by the economic model)
7. Interpreting Results and Using the
Model for the Particular Purpose 6
 1.3 The Econometric Approach
1. Statement of theory or hypothesis:
e.g.: people increase consumption as
income increases, but not by as much
as the increase in their income.
2. Specification of mathematical model:
C = α + βY; 0 < β < 1.
where: C = Consumption,
Y = Income,
β = slope = ΔC/ΔY,
α = intercept
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 1.3 The Econometric Approach
3. Specification of the econometric model:
C = α + βY + ɛ; 0 < β(= MPC) < 1.
α = intercept = autonomous consumption
ɛ = error/stochastic/disturbance term.
It captures several factors:
omitted variables,
measurement error in the dependent
variable and/or wrong functional form.
randomness of human behavior …
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 1.3 The Econometric Approach
4. Obtain data….
5. Estimate parameters of the model:
How? Various (3 broad) methods!
For now, suppose Cˆ i  184.08  0.8Yi
6. Hypothesis testing:
Is 0.8 statistically significantly > 0? < 1?
7. Interpret the results & use the model for
policy or forecasting:
1 Br  in Y  an 80 cent  in average C.
If Y = 0, then average C = 184.08.
Pick a value of control variable (Y) to get
a desired value of target variable (C). 9
 1.4 Types of Data for Econometric Analysis
 Time series data: a set of observations on
the values that a variable takes at different
times. e.g. money supply, unemployment
rate, … over years.
 Cross-sectional data: data on one/more
variables collected at a point in time.
 Pooled data: cross-sectional observations
collected over time, but the units don’t
have to be the same.
 Longitudinal/panel data: a special type of
pooled data in which the same cross-
sectional unit (say, a family or a firm) is
surveyed over time. 10
 1.4 Causality & Ceteris Paribus
The goal of most of economic tests is to
infer that a variable has a causal effect on
another.
Finding an association between variables
might be suggestive, but is rarely sufficient.
The notion of ceteris paribus plays an
important role in causal analysis.
Because of the non-experimental nature of
most data in the social sciences, uncovering
causal relationships is very challenging.
But, when carefully applied, econometric
methods can simulate a ceteris paribus
experiment.
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