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LESSON 1:
INTRODUCTION

1.1. CONCEPTS AND CONTENTS

1.2. ECONOMETRICS MODELS

1.3. STEPS OF ECONOMETRIC ANALYSIS

1.4. FIELDS OF APPLICATION

1.5. LIMITS

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OBJECTS:
In this lesson we define the Econometrics and its goals of
finding and quantifying economic relationships using
techniques based on inference and statistics methods. We
will also discuss its relationships with other subjects like
Statistics, Economic Theory and Economic Policy and we
will show that, starting from the economic theory, it is
possible to derive an economic model which describes
what we want to analyze. Then, we figure out the steps to
arrive from an economic model to an econometric model
that we can then use to measure and verifying it
empirically. This will allow the students to be confident
with the fundamental stages of the econometrics research
and with the different fields of application and limits of
the Econometrics.

KEYWORDS:
Econometrics, economic models, econometric models,
elements of an econometric model, stages of the
econometric research, utility and limits of the
econometrics.

REFERENCES:
• Wooldridge, Jeffrey M. Introductory Econometrics: A Modern
Approach, 5th Edition Michigan State University. ISBN-10:
1111531048 ISBN-13: 9781111531041. 2012. Chapter 1.
• William H. Greene, Econometric Analysis, 7/E. Stern School of
Business, New York University. Prentice Hall. 2012. Chapter 1.

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1.1. CONCEPTS AND CONTENTS.

ECONOMETRICS

Measure of the Economy

Econometrics is that field of the Economy that deals with

the quantitative analysis of real economic phenomenon,
following a probabilistic approach.

It aims at finding, quantifying and verifying economic

relationships between variables using mathematic
modelling and techniques based on inferential statistical
methods.

Econometrics is composed by three disciplines:

• Economic Theory
• Mathematics
• Statistics

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 ECONOMETRICS

ECONOMIC
THEORY MATHEMATICS STATISTICS

Techniques for
Information on the Modelling of the summarizing the
theoretical relationships between the information given by the
relationships variables which are data, estimation of
between the relevant for the relationships between the
economic Economic Theory variables, hypothesis
variables... testing over the
relationships between the
economic variables
, ...

ECONOMIC
MODEL MATHEMATICS DESCRIPTIVE AND
MODELLING INFERENTIAL
STATISTICS

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1.2. ECONOMETRIC MODELS

In each econometric study there are two primary subjects:

• The theoretical framework that allows deriving an

economic model which describes the most important
mechanisms for the phenomenon object of the
analysis. Starting from this economic model, an
econometric model can be derived, which allow to
quantify the economic relationships and testing them
empirically.

• The reality which is concretized in a sample of data

that can be cross-sectional (many individuals at the
same point of time) or time series (along the time
dimension).

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1.3. STEPS OF THE EMPIRICAL INVESTIGATION

We can distinguish four steps:

1ª) Specification of the econometric model

2ª) Estimation of the econometric model
3ª) Validation of the econometric model
4ª) Application of the econometric model

1ª step) Specification of the Econometric Model

Suppose that you want to know which are the

determinants of the family consumption and test whether
these factors explain the differences in the consumption
levels of the Catalan families....

Which would be the first step?

Using the Economic Theory...

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 1º step) Choosing an ECONOMIC MODEL

For instance: Keynesian Theory of Consumption

Consumption = f (Income)

2º step) Define the functional form

The most common functional form, for its simplicity, is

the linear functional form (in this course we will study
only linear functional forms or functional form that can be
made linear)

Consumption
C = C0 + cI Income

Fixed Marginal propensity to

consumption consume

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3º step) Specifying the spatial or time dimension

It has to be specified the dimension (spatial or temporal)

that will be used. For instance, we select the Catalan
counties for the last available year.

Ci = C0 + cI i i = 1,2,3,...,42

4º step) Choosing the Econometric Variables

The variables that have to be included in the model have

to be selected and defined. For instance, in the case of the
income, we have to decide whether to use data on the
Gross Domestic Product (GDP), the Gross Available
Family Income,... At the same way it will be chosen the
definition for the Consumption variable. This step is
fundamental when you have to look for the appropriate
statistics information.

5º step) Including the stochastic term

The economic model previously defined as:

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 Ci = C 0 + c I i

assumes a deterministic relationship. This relationship

however is not appropriate. Instead, we will have to
specify a probabilistic relationship. Therefore we will
include a stochastic error term (ui) in the previous
specification, thus obtaining the following form for the
econometric model, which will be the base for the
successive econometric analysis.

Ci = C 0 + c I i + u i

Hence:

C = f (I ) Ci = C0 + cI i + ui

ECONOMIC MODEL ECONOMETRIC MODEL

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 In the econometric model that we specified we can
distinguish the following elements:
Dependent
variable,
endogenous Error term or
variable or Ci = C0 + cI i + ui disturbance term
explained variable

Parameters or Exogenous variable o

independent variable or
Coefficients explicative variable

The direction of causality between the endogeneous

variable and the explicative variables is unidirectional.

An econometric model can be:

• Simple (it has only one explicative variable)
• Multiple (it has more than one explicative variable).

2ª step) Estimation of the econometric model

Once the econometric model has been specified, we will

have to estimate it, i.e. to get estimated values for its
parameters

In terms of our example, we have to find estimation for

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C0 (fixed consumption) and for c (marginal propensity to
consume).

Therefore, we have to perform the following sub-steps:

1º Sub-step) Collecting the data

We need to collect the appropriate statistical information.
We can collect two types of data:

• cross sectional data (data for many individuals at the

same point of time).

• Time series data (data concerning one or more

individuals over time).

2º Sub-step) Estimation of the parameters

Once collected the data (for our example, data on

consumption and income for the 42 Catalan counties for a
specific year), we will apply appropriate econometrics
estimation techniques (these techniques are an extension

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of Statistical methods). The outcome of this step will
allow us to measure and test the relationships suggested by
the economic theory.

Once performed these two steps, we will obtain C$ 0 , c$ .

3ª step) Validation of the econometric model

We will have to test and validate the model from the

economic point of view using statistical inference
methods.

4ª step) Application of the Econometric Model

1.4. FIELDS OF APPLICATION

The principal fields of application of the econometrics are

three:

• Structural Analysis: quantifying the economic

relationships between the variable included in the model
in order to test alternative economic theories, compare
rivals theories, etc....

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 • Economic Forecasting: getting values for the
endogeneous variable out of the sample analyzed.

• Evaluation of the Economic Policies: simulate

alternative policies and make predictions conditioned on
future values of the variables under each of the
alternative hypothesis.

Summary of the steps of the Econometric Investigation:

THEORY FACTS STATISTICAL METHODS

Economic Model Sampled

Information

Processing of Econometrics Methods

Econometric Model
the
Information

Specification

Estimation

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 Validation

Application

Structural Economic Policy

Analysis Forecasting Evaluation

1.5. LIMITS

The Econometric science has a huge potential either in the

economic field or in the business field given that, within
an uncertain world, it gives more elements to judge and
make decisions.
However, the econometric science suffers of some
drawbacks which are important to bear in mind. Among
others:

• Limits relative to the theoretical framework of the

econometric model.

The reality is complex, dynamic, and a lot of factors play a

role at the same time,...The econometric models are a

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simplification of the reality and therefore they have to be
considered as a partial explanation.

• Limits relative to the Data

The experimental sciences work with data generated under
specific conditions, which can be replicate. This is not the
same for the social sciences...

Principal problems: variables are measured with errors, the

data are constantly revised and updated, shortcoming of the
data (short time series, problems in finding data at the desired
sectoral or geographical level,...), not quantifiable information
(qualitative).

Limits relative to the probabilistic character

The Econometric models include stochastic elements and

therefore they can be analyzed only within a probabilistic
environment.

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 ECONOMETRIC I: PROGRAM

• Specification
Lesson 2: Multiple Linear Regression Model I
• Estimation
• Validation

Lesson 3: Multiple Linear Regression Model II

• Application
Lesson 4: Multiple Linear Regression Model III

Lesson 5: Problems with the sample of data • Problems with

the sample

Lesson 6: Specification Errors • Problems with

the
specification

Lesson 7: Qualitative Exogenous Variables • Including

qualitatives
variables

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