eed 401: econometrics
DESCRIPTION
EED 401: ECONOMETRICS. COURSE OUTLINE Meaning and purpose of econometrics Methodology of econometric research Correlation analysis and single equation models; simple linear & multiple linear regression models Functional forms of the regression model - PowerPoint PPT PresentationTRANSCRIPT
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EED 401: ECONOMETRICS• COURSE OUTLINEMeaning and purpose of econometricsMethodology of econometric researchCorrelation analysis and single equation models;
simple linear & multiple linear regression models
Functional forms of the regression modelSpecial models in regression analysis; dummy
variables, RTO.
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COURSE OUTLINE CONT’D
Problems of single equation models; autocorrelation, heteroscedasticity, multicolinearity, errors in variables
Simultaneous equation models and estimationQualitative choice modelsTime series analysis
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SOME REFRENCES• A. KOUTSOYIANNIS (2003). THEORY OF
ECONOMETRICS. 2ND EDITION. PELGRAVE
• JEFFREY M. WOOLDRIDGE. INTRODUCTORY ECONOMICS- A MODERN APPROACH
• DAMODAR N. GUJIRATI. BASIC ECONOMETRICS. FOURTH EDITION.
• ETC, ETC.
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WHAT IS ECONOMETRICS?
• The word ‘econometrics’ is derived from two Greek words, oikovoμia (economy), and μetpov (measure)
• Definition: the social science in which the tools of economic theory, mathematics and statistical inference are applied to the analysis of economic phenomena (Arthur Goldburger, 1964).
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WHAT IS ECONOMETRICS? CONT’D
• Thus, econometrics is an amalgam of economics, mathematics and statistics
• The uniqueness of econometrics lies in the inclusion of a random element in models
ILLUSTRATION (economic model of crime)• Based on economic reasoning (theory) time
spent on criminal activity by an individual will depend on, hourly ‘criminal wage’ ( ),
1x
1x
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WHAT IS ECONOMETRICS? CONT’D
• Hourly wage in legal employment,• Income other than from crime or employment,• Probability of getting caught, • Probability of being convicted if caught,• Expected sentence if convicted,• Age,
2x3x
4x5x
6x7x
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WHAT IS ECONOMETRICS? CONT’D
• The above depicts an exact relationship ie the time spent on crime is completely dependent on 7 factors
• This is stated mathematically as:
• Or ),,,,,,( 7654321 xxxxxxxfy
776655443322110 xbxbxbxbxbxbxbby
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WHAT IS ECONOMETRICS? CONT’D
• This still leaves us with a deterministic relationship
• But there are other factors that influence crime apart from the 7. eg. health, vengeance, religion, etc.
• Econometrics introduces a random factor (stochastic term) which takes care of these ‘other’ factors
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Econometric representation of the crime model
),,,,,,,( 7654321 uxxxxxxxfy
uxbxbxbxbxbxbxbby 776655443322110
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Econometric representation of the crime model CONT’D.
• U is the random factor encapsulating all other random factors that affect time spent on crime
• PROCEDURE FOR TESTING ECONOMIC THEORY
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Reading assignment
• Establish the superiority of econometrics to mathematical economics and statistics
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Branches of econometrics
• Two main branches: -Theoretical econometrics –dev’t. of appropriate
methods for the measurement of economic relationships
-Applied econometrics: application of econometrics to specific fields of economic theory ( demand, supply, investment, production) for the analysis of economic phenomena and forecasting economic behaviour
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Purpose of econometrics
• Policy-making: Provide numerical values for the parameters of economic relationships (elasticities, propensities, marginal values) for decision making
• Analysis: Empirical verification of economic laws/theories
• Forecasting: determining future values of economic magnitudes based on numerical estimates
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METHODOLOGY OF ECONOMETRIC RESEARCH
Generally, econometric research involves 4 stages:
1. Formulation of the maintained hypothesis: ie. The specification of the model
2.Testing of maintained hypothesis: estimation of the model by appropriate econometric method
3. Evaluation of estimates: decide on the basis of certain criteria whether the estimates are satisfactory & reliable.
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METHODOLOGY OF ECONOMETRIC RESEARCH CONT’D.
4. Testing the forecasting validity of the model 1&3 are the most important for any
econometric research. Require strong knowledge in the functioning of economic systems
2&4 are technical & require a deep understanding of econometrics
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Formulation of the maintained hypothesis
• It involves determining1.Dependent and explanatory variables2.The a priori theoretical expectations about
the signs & the size of the parameters of the function to form the basis for the evaluation of the model
3.The mathematical form of the model: single vs. simultaneous equation; linear vs. nonlinear functional forms
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Reasons for incorrect specification of economic models
1. Looseness/ imperfection of statements in economic theories
2. Limitation of our knowledge about factors which are operative in a particular situation
3. Problems associated with large data requirements of large models. Errors of specification- omission of variables, equations, & wrong mathematical form of functions
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2. Estimation of the model
The estimation process involves the ff. Stages:1. Gathering data-: cross-sectional, time series &
panel data2. Examination of the identification condition of the
function3. Examination of the aggregation problems of the
function (aggregation over individuals, commodities, time,& space)
4. Examination of the degree of correlation among the explanatory variables
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5. Choice of the appropriate econometric technique:-
i. Single equation techniques:- Classical Least Squares (CLS) OR ordinary Least Squares(OLS) method, Indirect Least Squares (ILS) or reduced-form technique, 2SLS, Limited information maximum likelihood method,etc.
ii. Simultaneous equation techniques:- 3SLS, FIML
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3. Evaluation of estimates
Are the parameters theoretically meaningful and statistically satisfactory?
We use 3 criteria for the evaluation;1.Economic ‘a priori’ criteria: are the
parameters of the correct signs and the right size?
2.Statistical criteria: first-order tests- usually by using the correlation coefficient & the standard deviation (error)
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3. Econometric criteria: second-order test (test of the statistical tests). This may involve tests of consistency, efficiency, unbiasedness, assumptions, identification, etc.
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4. Evaluation of the Forecasting Power of the Model
• Forecasting is one of the major objectives of econometrics.
• Given data on personal consumption (Y) and GDP (X) from 1982-1996 in billions of dollars the estimated consumption function is given by:
• We can forecast the mean consumption expenditure for 1997 given GDP=7269.8 billion dollars
as
0.7064X -184.08Y i
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• Actual consumption for 1997 was 4913.3 billion dollars
• Forecast error is 37.81 billion dollars• Question is: is the error large or small?
dollarsbillion 4951.309
9.8)0.7064(726 -184.0779Y1997
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Properties of econometric models
• Econometric models are judged based on• Theoretical plausibility• Explanatory ability• Accuracy of the estimates of the parameters• Predictive power• simplicity
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GOD BLESS YOU!