Basic Econometrics

BY
NURA AMANA(MBA)

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CONTACTING ME
 Nura Amana
HARAMBE UNIVERSITY COLLEGE

E-mail:
waameeqnuuraa2008@gmail.com
Mobile: 0915831702

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TEACHING AIDS & REQUIREMENTS OF THE
COURSE
• Texts (Soft Copy will be attached):
Text a) BASSIC ECONOMETRICS 5th Edition
GUJIRAT (2000)
Text b) PRINCIPLE OF ECONOMETRICS 4th
edition
• Materials: Power point slides, the text notes, the
reference books.
 Reading assignments & note preparation
• Passing the assessments
• Attendance: is compulsory (You shouldn’t invite
NG)
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Course Policy
 Late coming is not allowed and no student is allowed to enter after
class has started.
 Duplication of assignments is strictly forbidden; it entails serious
penalty.
 Assignments are required to be submitted before or on the deadline.
 Cheating during exam sessions results in a minimum of “F “grade
while cheating in quizzes and tests is subjected to a zero mark. All
cheating cases will be reported to the department for further
considerations.
 Students should switch off their cell phones while they are in class
and must keep their cell phones switched off during all kinds of
exam sessions.
 students must attend 80% of the class for the course. Failure to
attend 80% of the class will not allow the student to sit for the final
exam.
 Missing a quiz without convincing evidences will earn the students a
grade of zero marks in that specific quiz

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Econometric Packages
 Three econometric packages will be introduced in class
 STATA STATA statistical package.
 It can manage large data sets.
 It offers good facilities for the analysis of cross-section and panel data. In
economics a cross-section data set contains data on collection of economic
agents at a given point in time.
 A panel data set follows the economic agents over a period of time and
repeats the measurement process for each agent in each period.
 EVIEWS EVIEWS is an econometric package
 good facilities for time series analysis.
 SAS or SPSS. These are large general statistical packages. SPSS is
available on the TCD network
 MICROFIT. MICROFIT is a very easy to use econometric package which
is available on the TCD network. It is good for time series analysis. Some
of you may have used it in undergraduate econometrics.

 
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contd
 RATS. RATS like EVIEWS is particularly good for time
series analysis.
 Maple or Mathematical.
 symbolic mathematical manipulation which also can be
used for numerical analysis. They have widespread use in
Finance and Economics. Mathematical is available on
Public Access computer in TCD and you may find it
useful for checking some symbolic mathematical
calculations.
 MATLAB. MATLAB is an interactive system for
numerical computation. From our point of view the basic
variable in MATLAB is a MATRIX and you transcribe
the matrix algebra from your text into MATLAB and it
does the calculations
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 EVALUATION
Assessment will be weighted as follows:
– Paper production (note preparation) 15%

– INDIVIDUAL ASSIGMENT 15%

– Surprising Quizzes 10%

– Critical review 10%

– Group Assignment (optional) 10%

– Final exam 40-50%

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I recognize that COVID -19
is placing anew and
increasing challenge on
physical contact.

Keep covid-19 protocol

NURA AMANA 05/17/22

 CALCULUS

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 Don’t pan!

Slide 1
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 11
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TEAM SPRIT

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NO PROCRASTINATION

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 WHAT IS ECONOMETRICS?
 The term econometrics is derived from two Greek
words. i.e. economy & measure.
literally means “economic measurement”
Use of statistical method to analyze economic data
quantitative measurement and analysis of actual
economic and business phenomena—and so involves:
– economic theory(Economics)
– Statistics inference
– observation/data collection
dealswith measurement of economic relationships between
economic variables (dependent & independent variables).

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WHAT IS ECONOMETRICS?
 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)
 A conjunction of economic theory and actual
measurements, using the theory and technique
of statistical inference as a bridge pier (By
T.Haavelmo, 1944)
 The empirical determination of economic laws (By
H. Theil, 1971)

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 Why a separate discipline?
 Economic theory makes statements that are mostly qualitative in nature,
while econometrics gives empirical content to most economic theory
Ex.1. Consumption depends up on current income (Yt) & previous income (Yt-1) of
an individual other things being constant.
This theory does not give any insight how current income & previous income will
affect consumption by giving numerical values
 Mathematical economics is to express economic theory in mathematical
form without empirical verification of the theory, while econometrics is mainly
interested in the later.
Ex. 2. Ct = α + β1Yt + β2Yt -1- - - - - - - - - (1.1)
Where
Ct.: consumption expenditure
Yt: current income
Yt-1: previous income
Again this mathematical relation does not capture other factors that affect
consumption expenditure. Then mathematical economics explain the exact relation
ship between the dependent variable (Ct) & the independent variables (Yt &Yt-1) by
ignoring other variables that affects consumption expenditure.

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contd
 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
 Though Economic statistics provides numerical data like mean,
median - standard deviation etc. but it does not make reliable the
relationship between the economic variables.
 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
 This is based up on the probability theory, which are developed on
the basis of controlled experiments

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WHAT ARE TIPICAL GOAL OF
ECONOMETRICS
Estimate relation ship between variables
Testing econometric theories
Forecasting future economic activity
Describing economic reality.

–Consider the general and purely theoretical relationship:

Q = f(P, Ps, Yd)
Evaluating and implementing government and
business policy.
NB.Econometricians typically analyze
nonexperimental data
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Econometrics divission
 Theoretical Econometrics
 Applied Econometrics
  Theoretical Econometrics is- concerned with the development of
appropriate methods for measuring economic relationships specified
by econometric models. In this aspect, econometrics leans heavily on
mathematical statistics. For example, method of least squares. It is
the concern of theoretical econometrics to spell out the assumptions
 Applied econometrics- application of the tools of theoretical
econometrics for the analysis of economic phenomena and
forecasting economic behavior. such as the production function,
consumption function, investment function, demand and supply
functions, etc

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 Economic Mathematical
Theory Economics

Econometrics

Economic Mathematic
Statistics Statistics
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DIVISION OF
ECONOMETRICS
Econometrics

Applied
Theoretical

Classical
Bayesian Classical Bayesian

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 METHODOLOGY OF ECONOMETRICS

1. Statement of theory or hypothesis.

2. Specification of the mathematical model of the theory
3. Specification of the statistical, or econometric, model
4. Collecting the data
5. Estimation of the parameters of the econometric model
6. Hypothesis testing
7. Forecasting or prediction
8. Using the model for control or policy purposes.

 To illustrate the preceding steps, let us consider the well-

known Keynesian theory of consumption.

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summary the anatomy of classical econometric modeling.

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Cont’d…….
1. Statement of Theory or Hypothesis
 Keynes states that on average, consumers increase their consumption
as their income increases, but not as much as the increase in their
income (MPC < 1).
2. Specification of the Mathematical Model of Consumption
(single-equation model)
Y = β1 + β2X 0 < β2 < 1 (I.3.1)
Y = consumption expenditure and (dependent variable)
X = income, (independent, or explanatory variable)
β1 = the intercept
β2 = the slope coefficient
The slope coefficient β2 measures the MPC.

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contd
 Specifying the theoretical relationship of variables in
mathematical form. It involves the determination of :
1. The dependent and independent (explanatory)
variables of the model.
2. A priori theoretical expectations about the size and
sign of the parameters of the function.
3. The mathematical form of the model (number of
equations, specific form of the equations, etc.)

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The most common errors of specification

a) Omissions of some important variables

from the function.
b) The omissions of some equations (for
example, in simultaneous equations
model).
c) The mistaken mathematical form of the
functions.

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Cont’d…….
3. Specification of the Econometric Model of Consumption
 The relationships between economic variables are generally inexact.
In addition to income, other variables affect consumption
expenditure.
 For example, size of family, ages of the members in the family, family
religion, etc., are likely to exert some influence on consumption.

 To allow for the inexact relationships between economic variables,

(I.3.1) is modified as follows:

 Y = β1 + β2X + u (I.3.2)

 where u, known as the disturbance, or error, term, is a random

(stochastic) variable that has well-defined probabilistic properties.
The disturbance term u may well represent all those factors that
affect consumption but are not taken into account explicitly.

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Desirable properties of an econometric model
1. Theoretical plausibility. The model should be
compatible with the postulates of economic theory.
2. Explanatory ability. The model should be able to
explain the observations of the actual world.
3. Accuracy of the estimates of the parameters. The
estimates should if possible possess the desirable
properties of unbiasedness, consistency and efficiency.
4.Forecasting ability. The model should produce
satisfactory predictions of future values of he dependent
(endogenous) variables.
5. Simplicity. The model should represent the economic
relationships with maximum simplicity. The fewer the
equations and the simpler their mathematical form, the
better the model is considered, ceteris paribus

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Cont’d…….
 (I.3.2) is an example of a linear regression model, i.e., it
hypothesizes that Y is linearly related to X, but that the relationship
between the two is not exact; it is subject to individual variation. The
econometric model of (I.3.2) can be depicted as shown in Figure I.2.

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Cont’d…….
4. Obtaining Data
 To obtain the numerical values of β1 and β2, we need data.
Look at Table I.1, which relate to the personal consumption
expenditure (PCE) and the gross domestic product (GDP).
The data are in “real” terms.

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Cont’d…….
The data are plotted in Figure I.3

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Cont’d…….
5. Estimation of the Econometric Model
 Regression analysis is the main tool used to obtain the estimates. Using this technique and the data given in Table I.1, we obtain the
following estimates of β1 and β2, namely, −184.08 and 0.7064. Thus, the estimated consumption function is:
Yˆ = −184.08 + 0.7064Xi (I.3.3)
The estimated regression line is shown in Figure I.3. The regression line fits the data quite well. The slope coefficient (i.e., the MPC) was about
0.70, an increase in real income of 1 dollar led, on average, to an increase of about 70 cents in real consumption.
 The stage of estimation includes the following steps.
– Gathering of statistical observations (data) on the variables included in the model
– Examination of the identification conditions of the function in which we are
interested.
– Examination of the aggregation problems involved in the variables of the
function.
– Examination of the degree of correlation between the explanatory variables.
 Choice of the appropriate econometric technique for the estimation of the
function and critical examination of the assumptions of the chosen technique
and of their economic implications for the estimates of the coefficients

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Evaluation of Estimates
 The determination of the reliability of these results. The evaluation
consists of deciding whether the estimates of the parameters are
theoretically meaningful and statistically satisfactory
 i.e. determine the reliability of the results.
 To evaluate the reliability of the estimates we apply /follow/ the
following steps
 i. Economic interpretation of the results - Economic a priori
criterion. ii. Statistical interpretation of the results - statistical
analysis on the basis of R 2 ,t, test, F- test, s.d.
 iii. Test of Econometric criterion

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 criteria
A. Economic a prior criteria: – These are determined by the principles of economic
theory and refer to the sign and the size of the parameters of economic relationships.
In econometric jargon we say that economic theory imposes restrictions on the signs
and values of the parameters of economic relationships.
–Statistical criteria (first-order tests): : – These are determined by statistical theory
and aim at the evaluation of the statistical reliability of the estimates of the
parameters of the model.
– The most widely used statistical criteria are the correlation coefficient and the
standard deviation( or the standard error) of the estimates..
–The most widely used statistical criterions are:
– • The correlation coefficient - R 2 /r 2 /
– • The standard error /deviation/ S.E of the estimate
– • t- ratio or t-test of the estimates
B. Econometric criteria (second-order tests):

–It aims at the detection of the violation or validity of the assumptions of the various
econometric techniques. It helps to establish whether the estimates have the desirable
properties of unbiasedness, consistency etc.

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6. . Hypothesis Testing
 That is to find out whether the estimates obtained in, Eq. (I.3.3) are
in accord with the expectations of the theory that is being tested.
Keynes expected the MPC to be positive but less than 1. In our
example we found the MPC to be about 0.70. But before we accept
this finding as confirmation of Keynesian consumption theory, we
must enquire whether this estimate is sufficiently below unity. In
other words, is 0.70 statistically less than 1? If it is, it may support
Keynes’ theory.
 Such confirmation or refutation of economic theories on the basis of
sample evidence is based on a branch of statistical theory known as
statistical inference (hypothesis testing).

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Cont’d…….
7. Forecasting or Prediction
 Eg. to predict the mean consumption expenditure for 1997. The GDP value for 1997 was 7269.8
billion dollars consumption would be:
Yˆ1997 = −184.0779 + 0.7064 (7269.8) = 4951.3 (I.3.4)
The actual value of the consumption expenditure reported in 1997 was 4913.5 billion dollars. The
estimated model (I.3.3) thus over-predicted the actual consumption expenditure by about 37.82
billion dollars. We could say the forecast error is about 37.8 billion dollars, which is about 0.76
percent of the actual GDP value for 1997.
 Now suppose the government decides to propose a reduction in the income tax. What will be the
effect of such a policy on income and thereby on consumption expenditure and ultimately on
employment?
 Suppose that, as a result of the proposed policy change, investment expenditure increases. What
will be the effect on the economy?
 As macroeconomic theory shows, the change in income following, a dollar’s worth of change in
investment expenditure is given by the income multiplier M, which is defined as:
M = 1/(1 − MPC) (I.3.5)
 The multiplier is about M = 3.33. That is, an increase (decrease) of a dollar in investment will
eventually lead to more than a threefold increase (decrease) in income; note that it takes time for
the multiplier to work.
 The critical value in this computation is MPC. Thus, a quantitative estimate of MPC provides
valuable information for policy purposes. Knowing MPC, one can predict the future course of
income, consumption expenditure, and employment following a change in the government’s fiscal
policies.

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Reasons for a model’s poor forecasting performance
 The values of the explanatory variables used in the forecast may not
be accurate
 The estimates of the coefficients may be poor, due to deficiencies
of the sample data.
 The estimates are ‘good’ for the period of the sample, but
the structural background conditions of the model may
have changed from the period that was used as the basis
for the estimation of the model, and there fore the old
estimates are not ‘good’ for forecasting. The whole
model needs re-estimation before it can be used for
prediction

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Cont’d…….
8. Use of the Model for Control or Policy Purposes
 Suppose we have the estimated consumption function given in (I.3.3). Suppose further
the government believes that consumer expenditure of about 4900 will keep the
unemployment rate at its current level of about 4.2%. What level of income will
guarantee the target amount of consumption expenditure?
 If the regression results given in (I.3.3) seem reasonable, simple arithmetic will show
that: 4900 = −184.0779 + 0.7064X
(I.3.6)

 which gives X = 7197, approximately. That is, an income level of about 7197 (billion)
dollars, given an MPC of about 0.70, will produce an expenditure of about 4900
billion dollars. As these calculations suggest, an estimated model may be used for
control, or policy, purposes. By appropriate fiscal and monetary policy mix, the
government can manipulate the control variable X to produce the desired level of the
target variable Y.

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contd
 Choosing among Competing Models
 When a governmental agency (e.g., the U.S. Department of Commerce)
collects economic data, such as that shown in Table I.1, it does not
necessarily have any economic theory in mind. How then does one know that
the data really support the Keynesian theory of consumption? Is it because the
Keynesian consumption function (i.e., the regression line) shown in Figure I.3
is extremely close to the actual data points? Is it possible that another
consumption model (theory) might equally fit the data as well? For example,
Milton Friedman has developed a model of consumption, called the permanent
income hypothesis. Robert Hall has also developed a model of consumption,
called the life-cycle permanent income hypothesis. Could one or both of these
models also fit the data in Table I.1?
 In short, the question facing a researcher in practice is how to choose among
competing hypotheses or models of a given phenomenon, such as the
consumption–income relationship.
 The eight-step classical econometric methodology discussed above is neutral in the
sense that it can be used to test any of these rival hypotheses. Is it possible to develop
a methodology that is comprehensive enough to include competing hypotheses? This
is an involved and controversial topic

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DATA ,DATUM(singular)
 Raw fact ,usually discrete and gives fact objective about events.
 Its quality affected by;
I Validity—capturing intended concept
Ii Selection bias—mislead to represent population.
Iii Classification bias—non blind assessment of any outcome.
 Harder data ;allow more precise analysis and comparison
 Soft data; capture more of the truth about the world.
 NB Neither hard nor soft data are intrinsically better than the other.
we have to combine the two

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THE NATURE AND SOURCES OF DATA
FOR ECONOMETRIC ANALYSIS

There are 4 types of data which econometricians might use

for analysis:
1. Time series data
2. Cross-sectional data
4. Pooled cross section
3. Panel data, a combination of 1. & 2.

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A.Time serie s Data
 a data related to a sequence of observations over time on an
individual or group of individuals etc. Ex. 1996 E.C. represent by Ct
where t indicates time from 1980 - 1996 E.C.
Examples of time series data
Series Frequency
GNP or unemployment monthly, or quarterly
government budget deficit annually
money supply weekly
value of a stock market index as transactions occur
 set of observations on the values that a variable takes at different
times.
– Typical features of time series: trends and seasonality
– Typical applications: applied macroeconomics and
finance.
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B.Cross-sectional data
 data collected on one or more variables collected at particular period of time
 data on one or more variables collected at a single point in time,
-Example census of population in a given period of time.
- survey of consumer expenditure conducted by Addis Ababa university
- Characterized by clustering
In economics, the analysis of cross-sectional data is closely aligned with the applied
microeconomics fields, such as labor economics, state and local public finance,
industrial organization, urban economics, demography, and health economics.
 Note that due to heterogeneity, cross- sectional data have their own problems.
– Sample of individuals, households, firms, cities, states, countries, or other units
of interest at a given point of time/in a given period
– Cross-sectional observations are more or less independent
– For example, pure random sampling from a population
– Sometimes pure random sampling is violated, e.g. units refuse to respond in
surveys, or if sampling is characterized by clustering
– Cross-sectional data typically encountered in applied microeconomics

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 C.Pooled Cross Sections-
 are repeated surveys of a single (cross-section) sample in different periods of
timei.e record the behavior of the same set of individual microeconomic units
over time.
 Some data sets have both cross-sectional and time series features.
 For example, suppose that two cross-sectional household surveys are taken in
Ethiopia, one in 1985 and one in 1990.
 In 1985, a random sample of households is surveyed for variables such as
income, savings, family size, and so on. In 1990, a new random sample of
households is taken using the same survey questions.
 we can form a pooled cross section by combining the two years. Because
random samples are taken in each year, it would be a fluke if the same
household appeared in the sample during both years.
 To evaluate policy BEFORE AND AFTER.
The importance of pooled cross section data would be:
1. to increase our sample size
2. to see how a key relationship has changed over time
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 D.Panel or Longitudinal data
 These are the results of repeated survey of a single (cross sectional data)
 sample in different periods of time. Ex. If consumption expenditure of a sample of
 population from Bahir Dar city on Teff, Coffee, cloth is taken in 1985, in 1990 & 1996.
 has the dimensions of both time series and cross-sections, e.g. the daily prices of a number of blue
chip stocks over two years.
 t -observation
 T - the total number of observations for time series data, and to
 i -each observation
 N- the total number of observations for cross-sectional data.
 MODEL LAGGED RESPONSE.
 The key feature of panel data that distinguishes it from a pooled cross section is the fact that the
same cross-sectional units (individuals, firms, or counties in the above examples) are followed
over a given time period.

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TYPES OF DATA

 Qualitative data-variables that cannot be quantified

- dummy variables or categorical variable
 Example -male or female, married or unmarried, religion,
etc
-discret(eg nutrition of child) per week
 Qualitative-ordinal(eg education attainment)
-categorical(eg gender 0 or 1
Observation x(it) where x-value of variable in unit i at time t
N #unit T period
Total #of observation N*T
 - are data that can be quantified
 Example. income, prices, money , exchange rates, stock
prices, number of shares outstanding

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SECONDARY DATA
 Gathered and recorded periviosly for other project.
 No access to respondent.
 Advantage;
.Time saving
.Low cost
.Availability
.relevance.
 Disadvantage;
 In accuracy
• Outdated information
 Different use of measurement
 In convenient to compare

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plagarism
 Using some one’s work without giving
credit or without obtaining permission.
 To avoid plagiarism;
 Site some one’s information
 Acknowledge information
 Quoting source
 Don’t paraphrase.

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The Sources of Data
 A governmental agency, an international agency, a private
organization or an individual may collect the data used in empirical
analysis. == > Externally
 Example. Governmental in Ethiopia: - MEDAC, MOF, CSA, NBE
 International agencies: - International Monetary Fund
(IMF), World Bank (WB)
 Internal recording of accounting , marketting, expert employees
  The individual (researcher) himself may collect data through
interviews or using questionnaire.
  In the social sciences the data that one generally obtains is non
experimental in nature; that is not subject to the control of the
researcher. For example, data on GNP, unemployment, stock prices
etc are not directly under the control of the investigator. This often
creates special problems for the researcher in pinning down the exact
cause or causes affecting a particular situation.

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Factors affecting accuracy of data.
 Most social science data are not - experimental in nature i.e. there will be
omission, errors etc.
 ii. Approximation & round off the numbers will have errors of measurement.
 iii. In questioner type of survey non-response and not giving an answer for
all questions may lead to selectivity bias. /rejecting non-response &
excluding those questions which is not answered by the respondent/
 iv. The data obtained using one sample may be varying with the data
obtained in another sample & it is difficult to compare the results of these
two samples.
 v. Economic data are available at aggregated level & errors may be
committed in aggregation.
 vi. Due to confidentiality of some data’s it is impossible to get the data or
may be published in aggregated form.

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forecasting
 Predicting future based on past information based on
trend,seasonality,Autocorrelation,variotion
 Used to;
 Strategic planning
 Budget and cost control
 To develop new product.
 Production and operation.
 A. Qualitative methods; subjective opinion
 Methods of forecasting
 i. grass root by asking respondent.
 ii. market research
 iii. synergy of expert
 V. historical analogy
 Vi Delphi method-panel of expert quiried iteratively until consensus is reached.
 QUANTITATIVE METHODS
 Time series-trend
 Casual relation-cause and effect
 Simulation –incorporate some randomness

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 A Final Note….
“I never guess. It is a capital mistake
to theorize before one has data.
Insensibly one begins to twist facts and theories,
instead of theories to suit facts.”
--Sir Arthur Conan Doyle

Questions?
 uch !
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