Introduction: What is Econometrics? Basic Econometrics Introduction: What is Econometrics?

Introduction What is Econometrics? Definition 1: Economic Measurement Definition 2: Application of the mathematical statistics to economic data in order to lend empirical support to the economic mathematical models and obtain numerical results (Gerhard Tintner, 1968)

Introduction What is Econometrics? Definition 3: The quantitative analysis of actual economic phenomena based on concurrent development of theory and observation, related by appropriate methods of inference (P.A.Samuelson, T.C.Koopmans and J.R.N.Stone, 1954)

Econometrics Economic Theory Mathematical Economics Economic Statistics Mathematic Statistics

Introduction Why a separate discipline? Economic theory makes statements that are mostly qualitative in nature, while econometrics gives empirical content to most economic theory Mathematical economics is to express economic theory in mathematical form without empirical verification of the theory, while econometrics is mainly interested in the later

Introduction Why a separate discipline? Economic Statistics is mainly concerned with collecting, processing and presenting economic data. It does not being concerned with using the collected data to test economic theories Mathematical statistics provides many of tools for economic studies, but econometrics supplies the later with many special methods of quantitative analysis based on economic data

Econometrics Economic Theory Mathematical Economics Economic Statistics Mathematic Statistics

Introduction Methodology of Econometrics Statement of theory or hypothesis: Keynes stated: ”Consumption increases as income increases, but not as much as the increase in income”. It means that “The marginal propensity to consume (MPC) for a unit change in income is grater than zero but less than unit”

Introduction Methodology of Econometrics (2) Specification of the mathematical model of the theory Y = ß1+ ß2X ; 0 < ß2< 1 Y= consumption expenditure X= income ß1 and ß2 are parameters; ß1 is intercept, and ß2 is slope coefficients

Introduction Methodology of Econometrics (3) Specification of the econometric model of the theory Y = ß1+ ß2X + u ; 0 < ß2< 1; Y = consumption expenditure; X = income; ß1 and ß2 are parameters; ß1is intercept and ß2 is slope coefficients; u is disturbance term or error term. It is a random or stochastic variable

Introduction Methodology of Econometrics (4) Obtaining Data (See Table 1.1, page 6) Y= Personal consumption expenditure X= Gross Domestic Product all in Billion US Dollars

Introduction Methodology of Econometrics (4) Obtaining Data Year X Y 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 2447.1 2476.9 2503.7 2619.4 2746.1 2865.8 2969.1 3052.2 3162.4 3223.3 3260.4 3240.8 3776.3 3843.1 3760.3 3906.6 4148.5 4279.8 4404.5 4539.9 4718.6 4838.0 4877.5 4821.0

Introduction Methodology of Econometrics (5) Estimating the Econometric Model Y^ = - 231.8 + 0.7194 X (1.3.3) MPC was about 0.72 and it means that for the sample period when real income increases 1 USD, led (on average) real consumption expenditure increases of about 72 cents Note: A hat symbol (^) above one variable will signify an estimator of the relevant population value

Introduction Methodology of Econometrics (6) Hypothesis Testing Are the estimates accord with the expectations of the theory that is being tested? Is MPC < 1 statistically? If so, it may support Keynes’ theory. Confirmation or refutation of economic theories based on sample evidence is object of Statistical Inference (hypothesis testing)

Introduction Methodology of Econometrics (7) Forecasting or Prediction With given future value(s) of X, what is the future value(s) of Y? GDP=$6000Bill in 1994, what is the forecast consumption expenditure? Y^= - 231.8+0.7196(6000) = 4084.6 Income Multiplier M = 1/(1 – MPC) (=3.57). decrease (increase) of $1 in investment will eventually lead to $3.57 decrease (increase) in income

Introduction Methodology of Econometrics (8) Using model for control or policy purposes Y=4000= -231.8+0.7194 X  X  5882 MPC = 0.72, an income of $5882 Bill will produce an expenditure of $4000 Bill. By fiscal and monetary policy, Government can manipulate the control variable X to get the desired level of target variable Y

Introduction Methodology of Econometrics Figure 1.4: Anatomy of economic modelling 1) Economic Theory 2) Mathematical Model of Theory 3) Econometric Model of Theory 4) Data 5) Estimation of Econometric Model 6) Hypothesis Testing 7) Forecasting or Prediction 8) Using the Model for control or policy purposes

Economic Theory Mathematic Model Econometric Model Data Collection Estimation Hypothesis Testing Application in control or policy studies Forecasting