2012 Himayatullah 1 Basic Econometrics Course Instructor Prof. Dr. Himayatullah Khan

Prof. Himayatullah 2 Basic Econometrics Introduction: What is Econometrics?

Prof. Himayatullah 3 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 )

Prof. Himayatullah 4 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 )

May 2004 Prof. Himayatullah 5 Introduction What is Econometrics? Definition 4: The social science which applies economics, mathematics and statistical inference to the analysis of economic phenomena ( By Arthur S. Goldberger, 1964 ) Definition 5: The empirical determination of economic laws ( By H. Theil, 1971 )

May 2004 Prof. Himayatullah 6 Introduction What is Econometrics? Definition 6: A conjunction of economic theory and actual measurements, using the theory and technique of statistical inference as a bridge pier ( By T.Haavelmo, 1944 ) And the others

May 2004 Prof. Himayatullah 7 Econometrics Economic Theory Mathematical Economics Economic Statistics Mathematic Statistics

May 2004 Prof. Himayatullah 8 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

May 2004 Prof. Himayatullah 9 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

May 2004 Prof. Himayatullah 10 Econometrics Economic Theory Mathematical Economics Economic Statistics Mathematic Statistics

May 2004 Prof. Himayatullah 11 Introduction Methodology of Econometrics (1) 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”

May 2004 Prof. Himayatullah 12 Introduction Methodology of Econometrics (2) Specification of the mathematical model of the theory Y = ß 1 + ß 2 X ; 0 < ß 2 < 1 Y= consumption expenditure X= income ß 1 and ß 2 are parameters; ß 1 is intercept, and ß 2 is slope coefficients

May 2004 Prof. Himayatullah 13 Introduction Methodology of Econometrics (3) Specification of the econometric model of the theory Y = ß 1 + ß 2 X + u ; 0 < ß 2 < 1; Y = consumption expenditure; X = income; ß 1 and ß 2 are parameters; ß 1 is intercept and ß 2 is slope coefficients; u is disturbance term or error term. It is a random or stochastic variable

May 2004 Prof. Himayatullah 14 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

May 2004 Prof. Himayatullah 15 Introduction Methodology of Econometrics (4) Obtaining Data YearXY

May 2004 Prof. Himayatullah 16 Introduction Methodology of Econometrics (5) Estimating the Econometric Model Y^ = 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

May 2004 Prof. Himayatullah 17 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)

May 2004 Prof.VuThieu 18 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^= (6000) = Income Multiplier M = 1/(1 – MPC) (=3.57). decrease (increase) of $1 in investment will eventually lead to $3.57 decrease (increase) in income

May 2004 Prof. Himayatullah 19 Introduction Methodology of Econometrics (8) Using model for control or policy purposes Y=4000= 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

May 2004 Prof. Himayatullah 20 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

May 2004 Prof. Himayatullah 21 Economic Theory Mathematic ModelEconometric ModelData Collection Estimation Hypothesis Testing Forecasting Application in control or policy studies