3/23/2023

Econometrics for
management
MGMT 3071
INSTRUCTOR: MAMARU S.(MA)
AMU 1
 Outlines
I. What is Econometrics? What its
methodology?
II. Basic definitions: sample, population,
random variable
III. Data: cross-section, time series, panel
data
IV. Variables: quantitative and qualitative
V. Measures of centralization, dispersion,
and others
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 CHAPTER ONE
1. INTRODUCTION
1.1 Definition & Scope of Econometrics
What is Econometrics?
The term econometrics is derived from two Greek
words. i.e. economy & measure. Therefore,
econometrics-literally, “Economic measurement” - is
the quantitative measurement and analysis of actual
economic and business phenomena.
Econometrics deals with measurement of economic
relationships between economic variables (dependent
& independent variables).
“Econometrics is the positive interaction between data
& ideas about the way the economy works.”
3/23/2023 3
 Cont’d….
There is no universal definition of econometrics. Different
scholars defined econometrics on different way.
Gujarati (2003): Econometrics simply means “economic
measurement”. The word “metric” indicates measurement
and hence it is a branch of economics concerned with
measuring the empirical estimation of economic
relationships among economic variables.
Maddala (1992): Econometrics is the application of
statistical and mathematical methods to the analysis of
economic data, with a purpose of giving empirical content
to economic theories and verifying them or refuting them.
Verbeek (2008): Econometrics is the interaction of
economic theory, observed data and statistical methods.
These interactions make econometrics interesting,
challenging and difficult. But “econometrics is much easier
3/23/2023 4
without data”.
 Cont’d….
Woodridge (2004): Econometrics is based upon the
development of statistical methods for estimating
economic relationships, testing economic theories, and
evaluating and implementing government and business
policy.
Generally; Econometrics can be defined as “the
quantitative analysis of actual economic phenomena
based on the concurrent development of theory &
observation, related by appropriate methods of
inference (using statistics)”(P. Samuelson). OR
“the application of statistical & mathematical methods
to analyze economic data, with a purpose of giving
empirical content to economic theories and verifying or
refuting them”
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 1.1.1 Econometrics & Other Disciplines of
Economics
❑Why Econometrics is a Separate Discipline?
➢Econometrics is a composed of:
✓Economics (Economic Theory)+ Mathematics
(formulating theory)+ Statistics (Empirical
estimation of economic theory to test its
practicability)(A.S. Goldberger, 1964). However, the
distinction has to be made between econometrics,
economic theory, economic statistics and
mathematical economics.
✓One of the most distinctive natures of
Econometrics is that it contains the random term
which is not reflected in mathematical economics
& economic theory.
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 Economic Theory Vs Econometrics
➢Economic theory makes statements or hypotheses that are
mostly qualitative in nature.
➢Economic theory is mainly concerned with quantitative
relationships among economic variables (demand, supply,
production function, cost function, utility function).
These relations are presented in terms of smooth curves or
precise equations or statements/ hypotheses that are
mostly of qualitative nature.
➢However, econometrics is aiming at testing theoretical
propositions embodied in these relations and estimating
parameters.
➢Eg Consumption depends up on current income (Yt) &
previous income (Yt-1) of an individual other things being
constant. This theory does not give any insight how
current income & previous income will affect consumption
by giving numerical values.
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 Econometrics vs. Mathematical economics
➢It explains the economic theory in the equation or
mathematical forms/symbols. Econometrics differs from
mathematical economics in that,
I. Econometrics assumes random relationships among
economic variables or it does not assume exact or
deterministic/stochastic/ relationship. (𝑪 = 𝜶 + 𝜷𝒀 + 𝝁)
II. It take into account random disturbances which relate
deviations from exact behavioral patterns suggested by
economic theory and mathematical economics.
◦ E.G we can explain the above theoretical relationship in
mathematical form; 𝑪𝒕 = 𝜶 + 𝜷𝟏 𝒚𝒕 + 𝜷𝟐 𝒚𝒕−𝟏 … . 𝟏
◦ Then, mathematical economics explain the exact relation
ship between the dependent variable (Ct) & the
independent variables (Yt &Yt-1) by ignoring other variables
that affects consumption expenditure. 3/23/2023
8
 Econometrics vs. Economic statistics
➢Economic statistics is concerned with descriptive
aspect of economic theory (by collecting, processing
and presenting economic data in the form of table and
chart) including the development and refining of data
such as national income accounts and index numbers.
➢It provides numerical data like mean, median -
standard deviation etc. but it does not make reliable
the relationship between the economic variables & it
does not provide measurement of the parameters of
economic relationships
➢While econometrics utilizes these data to estimate
the quantitative economic relationships and test
hypotheses about them.
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 Econometrics vs. Mathematical statistics:-
➢This is based up on the probability theory, which are
developed on the basis of controlled experiments. This
statistical method can be applied in economic
relationships because such experiment can not be
designed for economic phenomena.
➢This probability theory applied for very few cases in
economics such as Agricultural or industrial
experimentations.
➢NB. In all of the above methods they completely ignore
the other factors that will affect the economic relationship
but econometrics by developing a method for dealing
with the random term that will affect the economic
relation ships differentiate itself from the remaining.
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 Cont’d..
Economic Theory: Mathematical economics
Provides theory or impose expresses economic theory
a logical structure on the using mathematical form.
question.

Econometrics

Economic statistics Mathematical statistics

data presentation and Estimation and testing
description techniques
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 1.1.2 Goals of Econometrics
1. Structural Analysis:-for testing economic theory
and hypothesis.
▪ Economic theories thus developed in an abstract level
were not tested against economic reality.
Econometrics aims primarily at the verification of
economic theories.
2. Policy –Making: Estimation of the coefficients of
Economic relationship.
▪ The knowledge of the numerical value of individual
coefficients of the variable is very important for the
decisions of firms as well as for the formulation of the
economic policy of the government.
▪ It helps to compare the effects of alternative policy
decisions.
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 1.1.2 Goals of Econometrics
3. Forecasting: Forecasting the future values of
economic magnitudes.
• In formulating policy decisions it is essential to be
able to forecast the value of the economic magnitudes.
•Such forecasts will enable the policy-maker to judge
whether it is necessary to take any measures in order
to influence the relevant economic variables. E.g
inflation rate, unemployment rate, GDP growth rate of
a nation.
4. Developing statistical methods for the
estimation of economic relationships,
5. Collecting and analyzing no experimental or
observational data.
6. Describing economic reality
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 1.1.3 Methodology of Econometrics
➢Methodology represents the way how econometricians
analyze an economic problem (which can be expressed in
a mathematical equation).
✓Example: what caused inflation in Ethiopia in 2009?
Y = f(X1, X2, X3, . . .)
➢Econometric research or inquiry is concerned with the
measurement of the parameters of economic relationships
and with the predication of the values of economic
variables.
➢It starting with the postulated theoretical
relationships(cause and effect) among economic variables.
➢Traditional econometric methodology suggests how to
proceed with Econometric Modeling.
➢See in below graph.
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 Stages of Econometrics modeling
Economic theory

Mathematical model of theory

Econometric model of theory

Collecting Data

Estimation of econometric model

Hypothesis testing /Evaluation of estimates

Application: Forecasting or predicting

3/23/2023 Using the model for controlling or policy making 15
 How Econometric model differs from
Mathematical Model???
✓In general, the mathematical equations are written
for the whole population,
✓but in econometric analysis, we almost always deal
with sample data.
✓Thus, econometric models often include a
stochastic component to account for deviation of
sample data from the population characteristics,
✓So, it accounts for possible measurement errors or
incorrect specification of the model

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 Cont’d…
➢Assume Y is a dependent variable (endogenous
variable) & X is an independent variable (Exogenous);
➢Mathematical model:
✓using sample data, econometrics explains the
relationship between Y & X as;

✓Where βs represent parameters

✓Generally, in Econometric models includes a
stochastic component that satisfies;

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 1.2 Basic definitions: sample,
population, random variable
❑Statistics is defined as the science which deals with
the method of collecting, classifying, presenting,
comparing, and interpreting numerical data .
Statistics can be classified in to two major categories;
1. Descriptive Statistics: Is a statistical methods
involving the collection, presentation, and
characterization of a set of data in order to describe
the various features of the set of data.
2. Inferential statistics: Is the process of reaching
generalizations about the whole (called the
population) by examining a portion (called the
sample).
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 1.2 Basic definitions: sample,
population, random variable
❑A survey is any activity that collects information in
an organized and methodical manner about
characteristics of interest.
❑Population - is the collection of all possible
observations of a specified characteristic of interest.
❑Sample – is the portion or part of the population of
interest.
❑Element – entity on which data are collected.
❑Census or complete enumeration: - a study that
includes every member of the target population, but
it is too costly & time consuming.

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 1.2 Basic definitions: sample,
population, random variable
❑Parameter – is the population characteristics of
interest.
❑Statistic – is the characteristics of sample.
❑Variable- is a characteristic that assumes different
values for different elements.
❑Sampling is the process of selecting small number
of items or parts of a larger population to make
conclusions about the population.
❑ Population Elements – refers to an individual
number of the population.
❑Target population – is the specific complete group
relevant to the study or research project.
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 1.2 Basic definitions: sample,
population, random variable
❑Population Parameters – are variables in a
population or measured characteristics of the
population.
❑The survey population is the population that is
actually covered by the survey.
❑A random variable is a variable whose value is
unknown until it is observed or a variable whose
value is determined by the outcome of a chance
experiment.
❑A census collects information from all units of the
population,
❑A sample survey collects information from only a
fraction (typically a very small fraction) of units of
the population.
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 1.2 Basic definitions: sample,
population, random variable
Example
Survey of Household Income and Expenditures
Target population: Entire resident population of
Arba Minch December 30, 2018.
Survey population: Population of Arba Minch on
December 30, 2018, excluding people living in
institutions or with no fixed address. In this
example, the only frame available is for peoples
living with institution and have fixed asset, so
those with no fixed addresses are excluded from
the survey population.
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 1.3 Data: Types of data
❑What are data (singular; Datum)
➢Data are distinct information about a given
subject or object (individuals, households,
firms, cities, states, countries… )
➢Based on the time data collected, data can be
classified in to four categories'.
1. Cross-Sectional Data
2. Time series data
3. Pooled data
4. Panel data
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 Cross-Sectional Data
➢A cross-sectional dataset is a sample of a given
subject/entities (individual, firms, industries, regions,
countries) at a given point in time.
➢Data collected on one or more variables collected at
particular period of time.
➢E.g Data for 2nd year Economics students in 2007 E.c.
✓Cumulative GPA (Y)
✓age in years (X1)
✓Their score in Microeconomics (X2)
✓Distance from/to their dormitory (X3)
✓Their sex (X4)
✓Total amount of money sent from family (X5),
✓Etc . . . .
3/23/2023 24
 Cont’d…
Data for 2nd year Economics students (academic year 2007)
Name CGPA X1 X2 X3 X4 X5
(Y) (1=Male)
Abdu 3.90 17 89 11 1 770
Azeb 3.80 18 80 13 0 567
Aster 2.50 16 80 11 0 543
Awol 2.75 17 48 11 1 234
Mebratu 3.00 20 70 14 1 456
Meaza 3.66 22 76 17 0 432
Zerihun 2.75 25 78 15 1 456
Zemen 2.00 19 67 15 1 788
. .
. .
N
3/23/2023 3.76 23 92 19 1 432 25
 Time Series Data
➢A time series dataset consists of observations on
variables over several periods of time (days, weeks,
months, years).
➢Are data that give information about numerical values
of variables from period to period.
➢A data related to a sequence of observations over time
on an individual or group of individuals
➢A key feature of time series data is that, typically,
observations are correlated across time.
➢We do not have a random sample.
➢Correlation introduces very important issues in the
estimation and testing of econometric models using
time series data.
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 Time series data
Data for 2nd year Economics student (Abdu in year 2007)
Year CGPA Number Micro Distance Health Income
(Y) of result (1=Sick)
courses
2006 3.90 7 89 11 1 770

2007 3.80 6 80 13 0 567

2008 3.66 6 80 11 0 543

2009 3.77 5 48 11 1 234

27
 Pooled (Combined) cross sections
◦ Pooled cross-sectional data is useful data to
analyze the evolution over time of the cross-
sectional distribution of variables
✓individual wages, household income, firms’
investments)
◦ It is the combination of time series & cross-sectional
data. It inclined to more of time series than cross
sectional.
◦ Suppose that we have a sequence of cross sections
of the same variables and from the same
population at years 2000, 2001, 2002 … and 2005.
◦ E.g. data regarding export of d/t countries (cross
section) over a period of ten years (time series). For
each year we have 40 cross-sectional observations
and for each state we have two time series
observations on prices and output of eggs, a total
of 80 pooled (or combined) observations.
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 Pooled cross sections

Note: Y1 = eggs produced in 1990

(millions). Y2 = eggs produced in 1991
3/23/2023
(millions). X1 = price per dozen (cents) in 29
1990. X2 = price per dozen (cents) in 1991
 Panel Data or Longitudinal Data
➢These are the results of repeated survey of a single
(cross sectional data) sample in different periods of
time.
➢When we have a group of individuals (or households,
firms, countries, …) who are observed at several points
in time.
➢That is, we have time series data for each individual in
the sample.
➢The key feature of panel data is that the same
individuals are followed over a given period of time.
➢It is a special type of pooled data in which the same
cross-sectional unit is surveyed over time.
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 Cont’d…
Data for 2nd year Economics students (from year 2007-2008)
Name Year CGPA (Y) X1 X2 X3 X4 (1=Male) X5
Abdu 2007 3.90 17 89 11 1 770
Abdu 2008 3.80 18 90 13 1 567
Azeb 2007 2.00 19 67 15 0 788
Azeb 2008 2.50 16 68 11 0 543
Awol 2007 2.75 17 48 11 1 234
Awol 2008 3.00 20 70 14 1 456
Meaza 2007 3.66 22 76 17 0 432
Meaza 2008 3.75 25 78 15 0 456
. .
. .
N 3.76 23 92 19 1 432

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1.4 Variables: quantitative and qualitative
Based on quantifiable, variables can be classified in to
qualitative and quantitative variable.
I. Qualitative (Dummy) variable
➢A variable with qualitative data
➢It cannot be easily counted, measured or easily
expressed using numbers and interpretation-based.
➢It describes qualities or characteristics
➢It is a non measurable information that we obtain or
gather for a given variable.
➢It is an indicator variable that is non measurable or non
quantify in nature.
➢Indicator variable, binary variable, categorical and
dichotomous variable are use interchangeable.
➢It is collected using questionnaires and interviews.
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 Example of qualitative variables
I. Gender may play a role in determining salary levels.
II. Different ethnic groups may follow different
consumption patterns.
III. Educational levels can affect earnings from
Employment.
Other examples of qualitative variables are :
 Marriage status (Single, Married, Separated, divorced)
 Employment status (Employed, Unemployed).
 Union membership
 Owning a house
 Voting in elections (No, Yes and Undecided).
 Political party membership (Republican, democrat,
other)
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 II. Quantitative Variables
➢A variable with quantitative data.
➢Are numerical in nature and can be measured.
➢Are ratio scale variables that can be divided, subtracted
and ordered for comparison. E.g Income, price, output,
➢Are interval scale variables that subtraction between
any two values of the variable and ordering of values of
variable. E.g Temperature & credit score.
➢Quantitative variables can be classified into two.
I. Discrete type - values are obtained by counting, and the
possible values are (0, 1, 2, 3, 4, 5, 6, 7, 8 …) which cannot be
in fraction.
II. Continuous type – determined by measurement and its
value include decimal values. Such as, distance between two
towns, weight of a person, height …etc
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1.5 Measures of centralization and dispersion,

Numerical measures

Measures of
Measure of central dispersion
tendency ❖ Coefficient of
❖ Mean range
❖ Median ❖ standard
❖ Mode deviation
❖ Variance
3/23/2023 35
 1.5.1 Measure of central tendency
➢Statistics provides its tools to reduce each group of
values into a single summary figure representing each
group. These representative values are called averages
(the measures of central tendency).
➢In other words, they are measures, which condense a
huge widely set of numerical data into a single value.
➢Its value always lies between the minimum and
maximum values, or it has a tendency to be somewhere
at the center. In general, the measures of central
tendency is divided in to two:
I. Mathematical Measures of Central Tendency
(Arithmetic mean)
II. Positional(Place of value) Measures of Central
Tendency (Median, Mode) 3/23/2023 36
 ARITHMETIC MEAN (AM)
 The arithmetic mean is the sum of the values in a
group divided by the number of items in that group.

 Let x1, x2… xn be n values of a variable x, then their

arithmetic mean is defined by:

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 MODE
 A value, which occurs most frequently in a
series of observations, is called Mode. So, by
looking the observations mode can be identified.
It is the value, which has the greatest frequency
density in its immediate neighborhood.
 Importance:
 Mode can be used as a central location for
qualitative as well as quantitative data, like the
median.
 Mode can be used when one or more of the
classes are open-ended.
3/23/2023 38
 Computation of Mode for Ungrouped and
Grouped Data
 For ungrouped data: Mode = that value in the data set,
which occurs most often.

 For grouped data: Discrete Series: Mode = the value of

the variable corresponding to the maximum frequency.

 Example: Find the value of mode for the following data.

3/23/2023 39
 Cont’d…

3/23/2023 40
 MEDIAN
 The median is that value of the variable, which
divides the group in to two equal parts;
 one part comprising all the values greater.
 the other all the values less than median.
 Or median can be defined as the middle value of a
set of data values when they are arranged in
ascending or descending order.
 First, rearrange the values in the order of magnitude.
Then apply the following formula.
3/23/2023 41
 Computation of Median for Ungrouped Data

Example: Find the median of the following data.

i. a) 27, 33, 42, 25, 23, 25, 33, 28, 27, 16, 18, 12
b) 8, 5, 2, 6, 15, 10, 25 3/23/2023 42
 Cont’d…

3/23/2023 43
 Computation of Median for grouped Data
 For continuous grouped data, the exact median
can not be obtained unless the original raw data is
retained. The class which contain the median is
the class whose cumulative frequency equals or
exceeds half of the total number of observations.
Where, L= Lower limit of median class (the
class in which the middle observation in
the distribution lies
pcf = Preceding cumulative frequency to
the median class
f = Frequency of the median class
i = the class interval of the median class.
 Computation of Median for grouped Data
 Example: The age classification of 940 workers in industrial
establishment is given in table below. Find the median age of
the workers. Age Number of workers CF
18-22 120 120
22-26 125 245
26-30 280 525
30-34 260 785
34-38 155 940

 Solution: Median class= (940/2)th observation = 470th

Hence, median lies in the class 26-30
 Therefore, median =
 1.5.2 MEAURES OF DISPERSION
 The various measures of central value give us one
single figure that represents the entire data.
 But the average alone cannot adequately describe a
set of observations, unless all the observations are the
same.
 It is necessary to describe the variability or dispersion
of the observations.
 In two or more distributions the central value may be
the same but still there can be wide disparities in the
formation of distribution.
 Measures of dispersion help us in studying this
important characteristic of a distribution.
 Some important definitions of dispersion are given
below:
1. Dispersion is the measure of the variation of the items.

2. The degree to which numerical data tend to spread about an

average value is called the variation of dispersion of the data.

3. Dispersion or spread is the degree of the scatter or variation of

the variable about a central value.

4. "The measurement of the scatterings of the mass of figures in

a series about an average is called measure of variation or
dispersion.
 Types of Measures of Dispersion
 Various measures of dispersions are in use.
 The most commonly used measures of dispersions
are:
Range and relative range/ coefficient of
range
Standard deviation and
Variance.
 The Range (R)
 The range is the largest score minus the smallest score.

 It is a quick and dirty measure of variability, although when a

test is given back to students they very often wish to know the
range of scores.

 Because the range is greatly affected by extreme scores, it

may give a distorted picture of the scores.

 The following two distributions have the same range, 13, yet
appear to differ greatly in the amount of variability.
 Con….

 For this reason, among others, the range is not the

most important measure of variability.

 R=L-S
S=smallest observation
L=largest observation
 Relative range/co-efficient of range
 Co-efficient of Range = L – S
 L+S
 Example: Find the value of range and it’s co-efficient for
the following data. 7, 9, 6, 8, 11, 10, 4
Solution:
L=11, S = 4.
Range = L – S = 11- 4 = 7
Co-efficient of Range = L – S = 11- 4 = 7/15 = 0.4667
L + S 11 +4
 Variance and Standard Deviation
 The standard deviation is similar to the mean deviation in
that here too the deviations are measured from the mean.

 At the same time, the standard deviation is preferred to the

mean deviation or the quartile deviation or the range because
it has desirable mathematical properties.

 Before defining the concept of the standard deviation, we

introduce another concept viz. variance.
 Population Variance
 The formulas for the population variance and the sample
variance are slightly different.

 The population variance is considered first. (Recall that a

population is the totality of all observations being studied.)

 The population variance is found by

 If we divide the variation by the number of values in the

population, we get something called the population variance.

 This variance is the "average squared deviation from the mean".

Con…
 Con….
 Example:

 The second column shows the deviations from the mean.

 The third or the last column shows the squared deviations, the sum
of which is 70.
 Population Standard Deviation
 Taking our earlier example of individual observations, we take the
square root of the variance

 In applied Statistics, the standard deviation is more frequently used

than the variance.
 Sample Variance
 We just changed the symbols for the sample mean; that is:

 Unfortunately, the conversion from the population variance to the

sample variance is not as direct.

 It requires a change in the denominator. Instead of substituting n

(number in the sample) for N (number in the population), the
denominator is n -1

 Thus the formula for the sample variance is:

Example: The weekly wages for a sample of part-time
employees at Adola Town are: $12, $20, $16, $18, and $19.
What is the sample variance?

Solution: The sample variance is computed by using formula

 Sample Standard Deviation
 The sample standard deviation is used as an estimator of the
population standard deviation.

 As noted previously, the population standard deviation is the

square root of the population variance.

 Likewise, the sample standard deviation is the square root of the

sample variance.

 The sample standard deviation is most easily determined by:

 The coefficient of variation
 In some instances, analysis entails comparing two or more data
sets that have different means or units of measurement. The
coefficient of variation(CV) serves as a relative measure of
dispersion and adjusts for differences in the magnitudes of the
means.
 It is calculated by dividing a data sets standard deviation by its
mean, CV is a unitless measure that allows for direct
comparisons of mean-adjusted dispersion across different data
sets.
 The Coefficient of variation (CV)
Sample CV = sample standard deviation(s)/ sample mean
Population CV = population standard deviation / population
mean