ECONOMETRICS 2242/2642

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 What is Econometrics?

 Econometrics means “economic

measurement”.
 Econometrics is concerned with the
empirical determination of economic laws.
 Using mathematics and statistical inference.
 Goal – Estimation
 Method – Regression analysis

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 Why a separate discipline?
 Econometrics amalgamates economic theory, mathematical
economics, economic statistics and mathematical
economics.

 It is a separate discipline because:

 Economic theory makes statements & hypothesis that are
qualitative in nature – Econometrics provides numerical estimates.
 Mathematical economics express economic theory in mathematical
form without empirical verification.
 Economic statistics is concerned with collecting, processing and
presenting economic data in the form of charts and tables –
Econometrics use these as raw data to test economic theories.

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 Methodology of Econometrics?

 We look at how econometricians proceed in their

analysis of economic problem
 The traditional econometric methodology proceeds
along the following lines:
 Hypothesis – Statement of theory
 Keynes postulated that the marginal propensity to consume is
greater then zero but less than one – A positive relationship.
 This statement is based on Economic theory.

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 Methodology of Econometrics?

 Specification of the mathematical model of the

theory
 Design the functional r/ship between consumption & income
 Suggest the consumption function

Where Y – Consumption and X – Income, and (known as intercept) and

(known as a slope) are known as parameters of the model.
 The slope coefficient measures the MPC – rate of change
of consumption as income changes.
 (I.3.1) states that consumption is linearly related to income
– consumption function in Economics.
 Y is a Dependent variable while X is an Independent variable

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 Methodology of Econometrics?
 Specification of the econometric model of consumption
 (I.3.1) assumes that there is an exact or deterministic
relationship between consumption & income (in mathematical
terms).
 Relationships between economic variables are generally inexact.
 To allow for inexact r/ships between economic variables,
econometrician modifies the deterministic consumption function
to be
Where is known as the error term (accounts for all other
factors that explains Y but are not taken into account
explicitly).
 (I.3.2) is an econometric model – an example of a linear
regression model
 It hypothesizes that the dependent variable Y is linearly
related to the explanatory variable X but their r/ship is not
exact.
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 Methodology of Econometrics?

 Obtaining Data
 To obtain the numerical values of we need data.
 We will collect consumption and income data for the period we wish to
investigate.
 Estimation of the econometric model
 We estimate parameters of the consumption model.
 The main tool used to estimate parameters is the statistical technique of
regression analysis (to be taught in further chapters).
 Hypothesis testing
 The fitted model (one with the estimated parameters) is assumed to be a
reasonably good approximation of reality.
 Develop a suitable criteria to determine whether the estimates obtained
are in accord with the expectations of the theory being tested (based on
statistical theory known as statistical inference (hypothesis testing).

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 Methodology of Econometrics?

 Forecasting or Prediction
 If the fitted model does not refute the theory under
consideration, then it may be used to predict the future
value(s) of the dependent variable Y based on known value(s)
of the independent variable X.
 Use of model for policy purposes
 Estimated model may be used for control or policy purposes.
 The government can manipulate the control variable X to
produce the desired level of the target variable Y, through
appropriate mix of fiscal and monetary policies.
 E.g. SARB decreasing interest rate to ease borrowing

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 Types of Econometrics

 Theoretical Econometrics
 Concerned with the development of appropriate methods for
measuring economic r/ships specified by econometric models.
 Econometrics here leans heavily on mathematical statistics.
 It spells out the assumptions of a method, its properties,
and what happens to these properties if either of the
assumptions of the method are not fulfilled.
 This course is concerned largely with the development of
econometric methods, their assumptions, their uses and
their limitations.

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Mathematical and statistical prerequisites/background

Although this is an elementary level course, it is assumed that the student is

familiar with the basic concepts of statistical estimation and hypothesis
testing acquired in basis statistics course. However, Appendix A of your
prescribed textbook provides a broad but nontechnical overview of the basic
statistical concepts used in the course. I urge you to go through this as early
as possible in the course. Appendix C gives the summary of basic regression
theory in matrix notation, and you should familiarize yourself with it. These
appendices will not be covered during lectures, but their content will be used
in the course. We will make use of Appendix D together in the course.

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 Econometrics history reading

• This is a suggested reading for knowledge purposes (not content

and not testable)
• Mary S. Morgan, The History of Econometric Ideas, Cambridge
University Press, New York, 1990.

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