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© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
What is econometrics?
economic/business data
2) Econometric model
Economic models
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Steps involved in the formulation of
econometric models
Collection of Data
Model Estimation
No Yes
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Choosing among Competing Models
• When a governmental agency collects economic data, it does not necessarily have
any economic theory in mind.
• How then does one know that the data really support the Keynesian theory of
consumption?
• Is it because the Keynesian consumption function (i.e., the regression line) shown in
Figure is extremely close to the actual data points?
• Is it possible that another consumption model (theory) might equally fit the data as
well? For example, Milton Friedman’s the permanent income hypothesis. Robert
Hall’s the life-cycle permanent income hypothesis. Could one or both of these
models also fit the data in Table?
• In short, the question facing a researcher in practice is how to choose among
competing hypotheses or models of a given phenomenon, such as the
consumption–income relationship.
The Nature of Econometrics
and Economic Data
Economic model of crime (Becker (1968))
Derives equation for criminal activity based on utility maximization
Hours spent in
criminal activities
Age
„Wage“ of cri-
minal activities Probability of Expected
Wage for legal
Other Probability of conviction if sentence
employment
income getting caught caught
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The Nature of Econometrics
and Economic Data
Model of job training and worker productivity
What is effect of additional training on worker productivity?
Formal economic theory not really needed to derive equation:
Hourly wage
Years of formal
education Weeks spent
Years of work- in job training
force experience
Other factors may be relevant, but these are the most important (?)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Econometric model of criminal activity
The functional form has to be specified
Variables may have to be approximated by other quantities
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Econometric model of job training and worker productivity
Unobserved deter-
minants of the wage
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Econometric analysis requires data
Cross-sectional data
Panel/Longitudinal data
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Cross-sectional data sets
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Cross-sectional data set on wages and other characteristics
Indicator variables
(1=yes, 0=no)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Cross-sectional data on growth rates and country characteristics
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Time series data
Observations of a variable or several variables over time
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Time series data on minimum wages and related variables
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Pooled cross sections
Two or more cross sections are combined in one data set
Example:
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The Nature of Econometrics
and Economic Data
Pooled cross sections on housing prices Property tax
Size of house
in square feet
Number of bathrooms
Before reform
After reform
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Panel or longitudinal data
The same cross-sectional units are followed over time
Example:
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The Nature of Econometrics
and Economic Data
Two-year panel data on city crime statistics
Number of
police in 1986
Number of
police in 1990
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Causality and the notion of ceteris paribus
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The Nature of Econometrics
and Economic Data
Causal effect of fertilizer on crop yield
„By how much will the production of soybeans increase if one
increases the amount of fertilizer applied to the ground“
Implicit assumption: all other factors that influence crop yield such
as quality of land, rainfall, presence of parasites etc. are held fixed
Experiment:
Choose several one-acre plots of land; randomly assign different
amounts of fertilizer to the different plots; compare yields
Experiment works because amount of fertilizer applied is unrelated
to other factors influencing crop yields
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Measuring the return to education
„If a person is chosen from the population and given another
year of education, by how much will his or her wage increase? “
Implicit assumption: all other factors that influence wages such as
experience, family background, intelligence etc. are held fixed
Experiment:
Choose a group of people; randomly assign different amounts of
eduction to them (infeasable!); compare wage outcomes
Problem without random assignment: amount of education is related
to other factors that influence wages (e.g. intelligence)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Effect of law enforcement on city crime level
„If a city is randomly chosen and given ten additional police officers,
by how much would its crime rate fall? “
Alternatively: „If two cities are the same in all respects, except that
city A has ten more police officers, by how much would the two cities
crime rates differ?“
Experiment:
Randomly assign number of police officers to a large number of cities
In reality, number of police officers will be determined by crime rate
(simultaneous determination of crime and number of police)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Effect of the minimum wage on unemployment
„By how much (if at all) will unemployment increase if the minimum
wage is increased by a certain amount (holding other things fixed)? “
Experiment:
Government randomly chooses minimum wage each year and
observes unemployment outcomes
Experiment will work because level of minimum wage is unrelated
to other factors determining unemployment
In reality, the level of the minimum wage will depend on political
and economic factors that also influence unemployment
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Nature of Econometrics
and Economic Data
Testing predictions of economic theories
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Accuracy of Data
• The quality of the data is often not that good. Some reasons for that are:
• First, as noted, most social science data are non-experimental in nature.
Therefore, there is the possibility of observational errors, either of omission or
commission.
• Second, even in experimentally collected data errors of measurement arise from
approximations and round-offs.
• Third, in questionnaire-type surveys, the problem of nonresponse can be
serious; a researcher is lucky to get a 40% response to a questionnaire.
• Fourth, the sampling methods used in obtaining the data may vary so widely
that it is often difficult to compare the results obtained from the various
samples.
• Fifth, economic data are generally available at a highly aggregate level. For
example, most macro-data (e.g., GNP, inflation, unemployment).
• The researcher should always keep in mind that the results of research are only as
good as the quality of the data.