Lecture 1

Introductory Econometrics

September 1, 2015
 Introductory Econometrics Course
• Lecturer: Podvysotska Tamara Olexandrivna
• tpodvysotskaya@gmail.com
• Schedule
• Lectures – Tuesdays:
• 10:00-11:20 a.m. – room 6-2
• Practice Sessions – Tuesdays:
• 11:30a.m -12:50 p.m – Group #1/#2, room 6-
306
 Introductory Econometrics Course
• Course Requirements:
• 12 lectures
• 6 practice sessions (seminars)
• 4 home assignments (account for 30 points)
• Midterm Exam (account for 20 points)
• Written Final Exam (account for 50 points)
• Minimum required to pass the course:
• At least 30 points in the exam + 20 points
• Recommended literature:
• Лук’яненко І.Г., Краснікова Л.І. Економетрика. Теорія та практика.
К.: Знання, 1998 — 493с.
• Damodar N. Gujarati : Basic Econometrics. McGrawHill Bool Company,
1995. - 838 р.
• Wooldridge J.M. Introductory Econometrics: A Modern Approach.
Thomson South-Western, 2002. – 863 p.
• Колеников. С. Прикладной эконометрический анализ в
статистическом пакете Stata. – РЭШ,2000. -111с.
 Course Content
Lectures:
• Lecture 1: Introduction, repetition of statistical background
• Lectures 2-6: Linear regression models
• Lectures 7-10: Violation of standard assumptions
• Lecture 11. Introduction to qualitative dependent variables
• Lecture 12. Revision

Practice Sessions:
• Will serve to clarify and apply concepts presented on
lectures
• To solve the exercises we will use statistical package STATA
 What is econometrics?
• To beginning students, it may seem as if econometrics is an
overly complex obstacle to an otherwise useful education. (...)
• To professionals in the field, econometric is a fascinating set of
techniques that allows the measurement and analysis of
economic phenomena and the prediction of future economic
trends.

A.H. Studenmund (Using Econometrics: A Practical Guide)

 What is Econometrics?
• Econometrics is the quantitative measurement
and analysis of actual economic and business
phenomena
• It attempts to quantify economic reality and
bridge the gap between the abstract world of
economic theory and the real world of human
activity
It has three major uses:
• 1. describing economic reality
• 2. testing hypotheses about economic theory
• 3. forecasting future economic activity
 Example
Consumer demand for a particular commodity can be
thought of as a relationship between
– quantity demanded (Q)
– commodity’s price (P)
– price of substitute good (Ps)
– disposable income (Y)
• Theoretical functional relationship:
Q = f (P; Ps;Y)
• Econometrics allows us to specify:
• Q = 31.50 – 0.73P + 0.11Ps + 0.23Y
 Random Variables
A random variable X is a variable whose numerical value
is determined by chance. It is a quantification of the
outcome of a random phenomenon.
Discrete random variable: has a countable number of possible values
Example:
– the number of times that a coin will be flipped before a heads is obtained
– the number of newborn girls among 100 newborn babies is a discrete random
variable that can take a value 0,1,2,3,4,5,………,100

Continuous random variable: can take on any value in an interval

Example:
– time until the first goal is shot in a football match between FC Barcelona and Real
Madrid
– The distance which the projectile of a fired gun would fly. It would take the values
from interval (a,b)
 Discrete Random Variables
Probability distribution of a variable X that can
take values x1, x2, x3, …. :
• P(X = x1) = p1
• P(X = x2) = p2
• P(X = x3) = p3
Cumulative distribution function (CDF) :
F X ( x)  P( X  x)   P( X  x )
i 1, xi  x
i
 Continuous Random Variables
• Probability density function f X (x) (PDF)
describes the relative likelihood for the
random variable X to occur at a given point x
• Cumulative distribution function (CDF) :
x
F X ( x)  P( X  x)   fx(t )dt

 Expected Value and Variance:
• Expected value (mean):
• Discrete variable Continuous Variable


E[ X ]   xi P( X  xi ) E[ X ]   xf X ( x)dx
i 1 

• Variance:
Var[ X ]  E[ X  E[ X ] ]  E[ X ]  ( E[ X ])
2 2 2

• Standard Deviation:
•  X  Var[X ]
Covariance, Correlation, Independence
• Covariance:
Cov( X , Y )  E[( X  E[ X ])(Y  E[Y ])]  E[ XY ]  E[ X ]E[Y ]
• Correlation:
Cov( X , Y )
corr ( X , Y ) 
 XY
• Independence:
• X and Y are independent if the conditional probability
distribution of X given the observed value of Y is the
same as if the value of Y had not been observed.
• If X and Y are independent , then E[XY]=E[X]E[Y] and
Cov(X,Y)=0
 Sample Moments
• Counterparts of theoretical moments of the
distribution of X, computed based on
• observations X 1 ,....., X n ,drawn from this distribution
• Sample mean: 1 n
X n   Xi
n i 1
• Sample variance:
n
1
sn2  
n  1 i 1
( X i  X n ) 2

• Sample covariance:
1 n
Covn ( X , Y )  
n  1 i 1
( X i  X n )(Yi  Yn )
 Computational Rules
E (aX  b)  aE ( X )  b
Var (aX  b)  a Var ( X )
2

Var ( X  Y )  Var ( X )  Var (Y )  2Cov( X , Y )

Cov(aX , bY )  Cov(bY , aX )  abCov( X , Y )
Cov( X  Y , Z )  Cov( X , Y )  Cov( Z , Y )
Cov( X , X )  Var[ X ]
 Normal (Gaussian) Distribution
• Notation: X ~ N (  ,  )
( x ) 2

• PDF: f X ( X )  1 e 2 2

2
• . [X ]  
E
• .Var[ X ]   2
 Standardized Random Variable
• Standardization is used for better comparison of
different variables
• Define Z to be the standardized variable of X:
X  E[ X ]
Z
X
• No matter what are the expected value and variance
of X, it always holds that:
• E[ Z ]  0 and Var[Z ] 1   Z
• Standard normal distribution:
X 
X ~ N ( , )  Z  ~ N (0,1)

 Chi Squared Distribution
• Chi-squared distribution with k degrees of
freedom: k 2

• Let Zi ~ N (0,1) for i and independent, then

k
X   Z i2  X ~  k2
i 1
 t and F distributions
• Student’s t-distribution with n-degrees of
freedom: tn
• Fisher-Snedecor F-distribution with m and n
degrees of freedom: Fm,n
• Let Z ~ N (0,1), X ~  m2 and Y ~  n2 ,
independent, then
Z X /m
• ~ tn and ~ Fm ,n
Y /n Y /n
• Note that T ~ tn  T 2 ~ F1,n
• Note also that as n grows, t distribution
approaches N(0,1)
Examples
• Let X1,…….X2 be independent values drawn from
• N ( , )
• Then
S n2
(n  1) ~  n21
2
• and
• Xn  
~ t n 1
• Sn / n

• Why do we care? => Construction of

confidence intervals, hypothesis testing
 Some terminology
• Population: the entire group of items that interests us
• Sample: the part of population that we actually observe
• Statistical inference: use of the sample to draw conclusion
about the characteristics of the population from which the
sample came
• Correct statistical inference can be performed only on a
random sample – a sample that reflects the true distribution
of population
• Biased sample – any sample that differs systematically from
the population that it is intended to represent
• Selection bias – occurs when the selection of the sample
systematically excludes or under represents certain groups
• Self-selection bias – occurs when we examine data for a
group of people who have chosen to be in that group
 Some more terminology
• Parameter: a true characteristic of the distribution of the
variable, whose value is unknown, but can be estimated
• Example: population mean E[X]
• Estimator: a sample statistic that is used to estimate the value
of parameter
• Example: sample mean X n
• Note that the estimator is the random variable
• Estimate: the specific value of the estimator that is obtained
• Sampling distribution: probability distribution that describes
the population of all possible values of the estimator
• An estimator is unbiased if the mean of its sampling
distribution is equal to the value of the population parameter
• An estimator is consistent if it converges to the value of the
true parameter as the sample size increases
• An estimator is efficient if the variance of its sampling
distribution is the smallest possible
 Properties of an Estimator- Example
• Let Xi be observations sampled from a
distribution with mean  and variance  2
1 n
• Let us consider the sample mean X n   xi
 n i 1
as an estimator of
• It can be shown that:
• 1. E[ X n ]  
• 2. X n   as n increases
• 3. X n has the smallest variance of all possible
estimators of 
• Hence X n is as unbiased, consistent and
efficent estimator of 
 Summary
• Today we revised some concepts from statistics
that we will use throughout our econometrics
classes
• It was a very brief overview, serving only for
information what students are expected to
know already
• The focus was on distributions and their
moments, on sampling and estimation
terminology
To be continued…
• On the exercise session we will practice some
of the concepts mentioned today
• Work with normal distribution (tables)
• Construction of confidence interval
• On the next lecture we will start with regression
analysis and introduce the Ordinary Least Squares
(OLS) estimator