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Econometrics
Weihong Zeng
2009.2
For the 3
rd
-year undergraduate students
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Lecture 1
Syllabus
Introduction of Econometrics:
Why we study econometrics?
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Introduction
What is Econometrics?
Econometrics 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.
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.
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What is Econometrics?
Statistics
Economics
Econometrics
Mathematics
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Why do we study econometrics?
Rare in economics (and many other areas
without labs!) to have experimental data

Need to use nonexperimental, or
observational data to make inferences

Important to be able to apply economic
theory to real world data

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An empirical analysis uses data to test a
theory or to estimate a relationship

A formal economic model can be tested

Theory may be ambiguous as to the effect
of some policy change can use
econometrics to evaluate the program

Why it is so important?
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Simply establishing a relationship between
variables is rarely sufficient
Want to get the effect to be considered
causal
If weve truly controlled for enough other
variables, then the estimated effect can
often be considered to be causal
Can be difficult to establish causality
The Question of Causality
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Purpose of Econometrics
Structural Analysis
Policy Evaluation
Economical Prediction
Empirical Analysis
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Methodology of Econometrics
1. Statement of theory or hypothesis.
2. Specification of the mathematical model of the theory.
3. Specification of the statistical, or econometric model.
4. Obtaining the data.
5. Estimation of the parameters of the econometric model.
6. Hypothesis testing.
7. Forecasting or prediction.
8. Using the model for control or policy purposes.
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ExampleKynesian theory
of consumption
1. Statement of theory or hypothesis.
Keynes stated: The fundamental psychological law is
that men/women are disposed, as a rule and on
average, to increase their consumption as their
income increases, but not as much as the increase
in their income.
In short, Keynes postulated that the marginal
propensity to consume (MPC), the
rate of change of consumption for a unit change in
income, is greater than zero but less than 1
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2.Specification of the
mathematical model of the theory
A mathematical economist might suggest the
following form of the Keynesian consumption
function:

1 0
1 1 0
< < + = | | | X Y
Consumption
expenditure
Income
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3. Specification of the statistical,
or econometric model.
To allow for the inexact relationships between
economic variables, the econometrician would modify
the deterministic consumption function as follows:






This is called an econometric model.






u X Y + + =
1 0
| |
U, known as disturbance, or error term

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4. Obtaining the data.
year Y X
1982 3081.5 4620.3
1983 3240.6 4803.7
1984 3407.6 5140.1
1985 3566.5 5323.5
1986 3708.7 5487.7
1987 3822.3 5649.5
1988 3972.7 5865.2
1989 4064.6 6062
1990 4132.2 6136.3
1991 4105.8 6079.4
1992 4219.8 6244.4
1993 4343.6 6389.6
1994 4486 6610.7
1995 4595.3 6742.1
1996 4714.1 6928.4
Sourse: Data on Y (Personal Consumption Expenditure) and X (Gross
Domestic Product),1982-1996) all in 1992 billions of dollars
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5. Estimation of the parameters
of the econometric model.
reg y x

Source | SS df MS Number of obs = 15
-------------+------------------------------ F( 1, 13) = 8144.59
Model | 3351406.23 1 3351406.23 Prob > F = 0.0000
Residual | 5349.35306 13 411.488697 R-squared = 0.9984
-------------+------------------------------ Adj R-squared = 0.9983
Total | 3356755.58 14 239768.256 Root MSE = 20.285

------------------------------------------------------------------------------
y | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
x | .706408 .0078275 90.25 0.000 .6894978 .7233182
_cons | -184.0779 46.26183 -3.98 0.002 -284.0205 -84.13525
------------------------------------------------------------------------------


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6. Hypothesis testing.
Such confirmation or refutation of econometric
theories on the basis of sample evidence is
based on a branch of statistical theory know
as statistical inference (hypothesis testing)
As noted earlier, Keynes expected the
MPC to be positive but less than 1. In
our example we found it is about 0.70.
Then, is 0.70 statistically less than 1?
If it is, it may support keyness theory.

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7.Forecasting or prediction.
To illustrate, suppose we want to predict the mean
consumption expenditure for 1997. The GDP value
for 1997 was 7269.8 billion dollars. Putting this
value on the right-hand of the model, we obtain
4951.3 billion dollars.
But the actual value of the consumption expenditure
reported in 1997 was 4913.5 billion dollars. The
estimated model thus overpredicted.
The forecast error is about 37.82 billion dollars.
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Using the model for control or policy
purposes.
This is on the opposite way of
forecasting.
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Example: Returns to
Education
A model of human capital investment
implies getting more education should
lead to higher earnings
In the simplest case, this implies an
equation like
u education Earnings + + =
1 0
| |
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Example: (continued)
The estimate of b1, is the return to
education, but can it be considered causal?
While the error term, u, includes other
factors affecting earnings, want to control for
as much as possible
Some things are still unobserved, which can
be problematic

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Types of Data Sets
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Distribution, Densities and Moments


Random Variable
Discrete r.v.: Binary data; Count data.
Probability Distribution
Continuous r.v.
Cumulative Distribution Function
Probability Density Function




( ) 1
1
=

= i
i
x p
1 ) ( ) (
: :
=
'

} }

dx x F dx x f
) Pr( ) ( x X x F s =
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Normal Distribution
PDF:

CDF:
)
2
1
exp( ) 2 ( ) (
2 2 / 1
x x =

t |
}

=
x
dy y x ) ( ) ( |
] 2 / ) ( exp[
2
1
) (
2 2
o
t o
= x x f
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Monments of Random Variables
Expectation/Population Mean:
Discrete r.v:
Continous r.v.:
Monment:

m
i
i i
x x p X E
1
) ( ) (
}
+

dx x xf X E ) ( ) (
dx x f x X m
k
k
) ( ) (
}
+

The expectation of a random variable is

often referred to as its first moment.
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Calculations

(Mean) Expected value of :


Variance of :


2 2 2
) ( o = X E
) 0 (
'
M =
2 ' ' ' 2
)] 0 ( [ ) 0 ( M M = o
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Homework
Learning the Stata
Review the basic statistics