Chapter 1: Introduction

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Chapter 1 Introduction
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• 1. Econometrics

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Econometrics

• Econometrics - Apply statistical methods to
  economic data
• Econometric approach
• Develop working model from an economic theory
• Estimate model with real world data.
• Real world data is not perfect

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• 2. Keynesian Consumption Function

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Keynesian Consumption Function

• Theory people increase consumption as income
  increases, but not by as much as the increase in
  their income.
• Marginal Propensity to Consume (MPC) is the
  change in consumption divided by change in income.

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Keynesian Consumption Function

• C a bY
• C Consumption
• a Intercept
• Y Income
• b slope (how much C changes for a given change
  in Y)
• Not an econometric model
• Assumes a deterministic relationship

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Econometric Model

• C a bY e
• e error term
• Error term captures several factors
• omitted variables
• measurement error in the dependent variable
• randomness of human behavior

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Expected Results

• a gt 0
• 0 lt b lt 1
• b represents the MPC

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Model Estimation

• How estimate model? - Fit a line through the
  data.
• Suppose get C 1000 .8Y
• a 1000
• b .8

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Least Squares

• Estimate on basis of least squares
• the line of best fit minimizes the sum of the
  squared deviations of the points on the graph
  from the points on the straight line.
• Minimize S (CAi - CPi)2
• CAi Actual Consumption for obs i
• CPi Predicted Consumption for obs I

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Interpretation

• Sample income levels
• Y 0, Consumption 1000
• Y 1000, Consumption 1800
• If Y increases by 1 dollar, then C increases on
  average by .8 dollars.
• These estimates are consistent with theory since
  agt0 and 0ltblt1
• Suppose b was .9?
• b lt 1, but is it due to the sample?

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• 3. Econometric Studies

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Econometric Studies

• Price and Quantity
• Demand and elasticities of demand
• ln Q a b lnP e
• Phillips Curve
• Relationship between change in money wages and
  unemployment
• Dw f (Du)

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Econometric Studies

• Production Function
• Relationship between inputs and outputs.
• Y f (K,L)
• Cobb Douglas Y AKaLb
• Wage equation
• ln W a0 a1EDUC a2EXP a3GENDER a4RACE

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Econometric Studies

• Finance
• Price/Earnings a b Debt/Equity

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• 4. Terminology

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General Terminology

• Y dependent variable
• X independent or explanatory
• subscript i refers to ith observation
• t for time series data at time t
• Cross-sectional data collected at 1 point in
  time
• Time series data collected over a period of time
  

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General Terminology

• Pooled data mixture of cross-sectional and time
  series data
• Panel data follow a microeconomic unit over time
• Quantitative data continuous data
• Qualitative data categorical data