INTRODUCTION

SEEQ2023
BASIC ECONOMETRIC
 Why study Econometrics?
Research in finance and economics becoming very
quantitative Using information from economic/finance/
business theory and from economic/finance/business data
e.g.
• testing stock market efficiency
• predictability of stock market; can you make a million?
• determination of wages; is your time at university worth it?
• labour supply elasticities; will the new child care measures
give the incentive to return to work?
• How do quantity/prices respond to taxes?
 Methodology of Econometric
• Statement of theory or hypothesis.
• Specification of the mathematical model of the theory.
• Specification of the statistical, or econometric model.
• Obtaining the data.
• Estimation of the parameters of the econometric
model.
• Hypothesis testing.
• Forecasting or prediction
• Using the model for control or policy purposes
 Statement of Theory of Hypothesis

• Keyness postulated – marginal propensity to

consume (MPC) , rate of change of cons for a unit
change in income, is greater than zero but less than
1.
 Specification of the mathematical model of
the theory
• Keyness postulated positive relationship (C & Yd), but not
specify precise form of functional relationship.
• Mathematical form:

• Where Y = cons expenditure (C) and X = income (Yd).

• and known as parameter of the model – intercept and
slope coefficient.
• Slope coefficient – measure the MPC.
• Left side – dependent variable
• Right side – independent or explanatory variable(s)
Specification of the mathematical model of
the theory
Y

X
 Specification of the statistical, or econometric model

• Mathematical model assumed – exact or deterministik

relatioship between C and Yd.
• Reality – relationship generally inexact.
• If we used the real data, not expect all observations to lie
exactly on the straight line.
• To allow inexact relationship, econometrican modify the
model:

• Where known as disturbance, or error term variable.

• Error term represent all those factors that affect C but are not
taken into account explicitly.
• Equation – example econometric model.
Specification of the statistical, or econometric model




 
 



X
 Obtaining the data

• To estimate econometric model (obtain values and ) –

we needed data.
• Eg: U.S economy data for personal cons expenditure (PCE) and
gross domestic product (GDP) for the period 1981-1996. Both
measured in billion of 1992 dollar.
 Estimation of the parameters of the
econometric model
• The numerical estimates of the parameters give empirical
content to the cons function.
• Note – statistical technique of regression analysis – main tool
used to obtain the estimates.
• We obtain following estimates: = -184.08 and = 0.7064
• Estimates cons function is:

• The hat on Y indicates that is an estimates.

• MPC = 0.7, for the sampel period an increase in real income 1
dollar will led (average) increase about 70 percent in real cons
expenditure.
 Hypothesis Testing

• Assume the fitted model is good approximation of reality –

have to develop suitable criteria to find whether estimated
obtained are in accord with the expectations of the theory
that is being tested.
• Our example , MPC = 0.7.
• Before accept this finding, must test is 0.70 statistically less
than 1?
• If yes, may support Keynes theory.
• Confirmation of economic theory on the basis of sample –
based on branch statistical theory known as statistical
inference (hypothesis testing).
 Forecasting and Prediction

• Use the model to predict the future value of dependent

variable Y on the basis of known or expected future value of
explanatory variable X.
• Supposed to predict the mean cons expenditure for 1997. The
GDP value 1997 = 7269.8 billion:

• or about 4951 billion dollar.

• If actual cons expenditure value 1997 = 4913.5 billion.
• Means the forecast error is about 37.82 or 0.76 per cent of
actual value GDP 1997.
• Try to find out if such an error s “small” or “large”.
 Control or Policy Purposes
• Supposed government believe cons expenditure about 4900
billion will keep unemployment rate about 4.2% (at current
level) in early 2000.
• What level of income (GDP) will guarantee the target amount
of cons expenditure ?
• From regression result, simple arithemetic show that:

• which give X = 7197 (approx).

• Calculation suggest an estimated model may be used for
control, policy purposes.
• The government can manipulate the control variable X to
produce desired level target variable Y.