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# INTRODUCITON TO ECONOMETRICS CONTENTS 1. Definitions 2. Scope 2.1 Economic theory 2.2 Mathematical economics 2.3 Economic statistics 3.

Goals of econometrics 4. Branches of econometrics 4.1 Theoretical econometrics 4.2 Applied econometrics 5. Methodology of econometrics 5.1 Statement of theory or hypothesis 1.2 Model specification 5.2.1 Mathematical model 5.2.2 Statistical model 5.3 Data collection 5.4 Estimation of parameters 5.5 Checking of goods of fit 5.6 Hypothesis testing 5.7 Forecasting 5.8 Decision making

1. What is Econometrics? Econometrics has been defined as the application of mathematics and statistical methods to economic data and described as the branch of economics that aims to give empirical content to economic relations. More precisely, it is the quantitative analysis of actual economic phenomena based on the concurrent development of theory and observation, related by appropriate methods of inference. Samuelson, P & Nordhaus, W (2004) describes econometrics as allowing economists to sift through mountains of data to extract simple relationships. The first known use of the term "econometrics" (in cognate form) was by Pawe Ciompa in 1910. Ragnar Frisch is credited with coining the term in the sense that it is used today. 2. The scope of Econometrics Econometrics which is the Application of mathematical statistics to economic data covers the areas:a. Economic theory which postulates a qualitative relation b. Mathematical economics that turns economic theory in equations c. Economic statistics which is concerned with collecting, processing and presenting economic data Econometricians estimate precise numerical estimates of these relations 3. Goals of Econometrics Two main purposes of econometrics are to give empirical content to economic theory by formulating economic models in testable form, to estimate those models, and to test them as to acceptance or rejection. Therefore the goals of econometrics are namely:a. Analysis

This is the testing of economic theory applying econometric techniques to obtain reliable estimates of the levels and coefficient of economic relations. b. Policy making This is obtaining policy simulations c. Forecasting the future values of the economic magnitude by formulating policy decisions. This helps policy makers to influence the relevant economic variables. 4. Branches of Econometrics There are two branches of econometrics: theoretical econometrics and applied econometrics. Theoretical econometrics Theoretical econometrics examines the statistical properties of econometric procedures. Such properties include the power of hypothesis tests and efficiency of estimators and of survey-sampling methods. Theoretical econometrics includes the development of appropriate methods for the measurement of economic relationships Applied econometrics Applied econometrics uses theoretical econometrics and real-world data for assessing economic theories, developing econometric models, analyzing economic history, and forecasting. Applied Econometrics involves the application of theoretical econometric tools for analysis of economic phenomena and forecasting economic behaviour. It applies econometric theory to branches within economics, such as unemployment figures, portfolio theory, production, consumption demand and supply functions, e.t.c. Applied Econometrics is concerned with providing a basis for reasoning and learning from samples of economic data. To provide a basis for processing and recovering information from samples of economic data applied econometrics is grounded in probability theory and the principles of estimation and statistical inference. numerical estimates of the coefficient of economic relationship for

5. Methodology of econometrics These are the series of steps followed in the measurement of economic relationships 1. Statement of a theory or hypothesis This usually comes from a mixture of economic theory and previous empirical studies. An example of such a theory might be that the quantity people buy of a particular product might depend more on the past price than on the current price. This becomes the null hypothesis while the opposite of his becomes the alternative hypothesis. This obviously has implications regarding perfect knowledge, information costs, habit formation and irrational behaviour. 2. Model specification. This means determining what variables should be included in the demand model and what mathematical form or forms such a relationship should take. These issues are again determined on the basis of economic theory and prior empirical studies. Various alternative models may be specified at this stage a) Mathematical model Involve formulation the relationship inform of an equation identifying the dependent and independent variables. The models stated as a general function such as Q = f (P) or R = P x Q b) Statistical Model This involves determining the list of variables that is independent which will influence dependent variables. It is concerned with a relationship between variables. To specify the relationship in statistical terms, a residual or random term is use to allow for the influence of any omitted variables Formulated as follows: Qi = a + bPi +i Where:-

Qi is sales Pi is Price a and b are parameters of the model i is the random term. 3. Data collection Statistical methods place a big emphasis on data; therefore the collection of data is crucial in econometrics. This stage can only be performed after the demand model has been specified, otherwise it is not known for which variables we have to collect data. Three aspects are important in data collection i.e. Types of Data, sources data and presentation of the data. 1. Types of Data There are tow main types of data that forms can collect a) Time series data Time series data this refers to data on a entity at different periods of time e.g. sale of firm A in the period 2006 2012 b) Cross section data This refers to data on different entities on a single period of time e.g. Firm A, B, C, D, E, F, in 2012 2. Sources of data a) Records of firms b) Agencies e.g. research firms, banks etc c) Official sources e.g. government departments. 3. Presentation of data a) Tables b) Graphs c) Charts 4. Estimation of parameters.

This means computing the values of the coefficients of the variables in the model to the effects of an independent variable on the dependent variable. These effects can be measured in different ways, for example in terms of the marginal effects and elasticities. The method of ordinary least squares (OLS) regression can be used to estimate these values. 5. Checking goodness of fit. Once a model, or maybe several alternative models, have been estimated, it is necessary to examine how well the models fit the data and to determine which model fits best. If the fit is not good it may be necessary to return to step 2 and re-specify the model before moving on to the next stage. 6. Hypothesis testing. Having determined the best model, we want to test the hypothesis stated in the first step; in the example quoted we want to test whether current price or past price has a greater effect on sales. If the computed value is greater than the critical value, the null hypothesis is rejected; alternative hypothesis accepted and vice versa. 7. Forecasting. This is the ultimate focus of most econometric analysis. In this context we are trying to forecast sales, and may be producing many forecasts in the light of various possible scenarios. The known coefficients are used to predict or estimate the department variable if the independent variables are known. 8. Managerial decision making It should be clear from the above process that, as far as managerial decision making is concerned, the last two stages are the most important. However, it is not possible to test hypotheses or make forecasts reliably without a good understanding of the prior stages. Forecasts help decision makers to judge whether it is possible to take any measures in order to influence the relevant economic variables e.g. if a firm want to increase sales what measures would it take?

References Fumio Hayashi. (2000) Econometrics, Princeton University Press Wooldridge, J (2003). Introductory Econometrics: A Modern Approach. Mason: Thomson South-Western Mills, Terence C., & Patterson K, (2007) Econometric Theory Palgrave Macmillan Mills, Terence C., & Patterson K, (2009) Applied Econometrics. Palgrave Macmillan Samuelson, P. & Nordhaus, W. (2004) Economics.18th ed., McGraw-Hill, New Yolk p. 5 Wilkinson, N. (2005) Managerial Economics- A Problem-Solving Approach. The Edinburgh Building, Cambridge, UK