1. What is Econometrics?

ECON 103, Lecture 1: Introduction What is ECONOMETRICS?

Application of statistical methods for analyzing and predicting

Maria Casanova economic phenomena:

TESTING economic theories

casanova@econ.ucla.edu
QUANTIFYING relationships among economic variables
Office: 9359 Bunche Hall
EVALUATING government and business economic policies
Office hours: Fridays 1:30 to 3:00pm
FORECASTING micro (and macro) economic variables

Maria Casanova Lecture 1 Maria Casanova Lecture 1

1. What is Econometrics? 1. What is Econometrics?

EXAMPLES:

What is the quantitative effect of reducing class size on

Economic theory suggests important relationships, often with
student achievement?
policy implications.
How does another year of education change earnings?

What is the price elasticity of cigarettes?

Economic theory virtually never suggests quantitative magnitudes
What is the effect on output growth of a 1% decrease in
of causal effects.
interest rate by the Fed?

What is the effect on housing prices of environmental

improvements?

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1. What is Econometrics? 2. Measuring Causal Effects

We use Econometrics for empirical analysis in every branch of Many econometric questions involve causal relationships among
applied economics: variables.

Ideal way to measure causal effect is in a randomized controlled

labor economics experiment:
industrial economics
A control group receives no treatment.
macroeconomics
A treatment group receives the treatment.
marketing
Treatment is assigned randomly.
economic development

financial economics Most of the course deals with difficulties in estimating causal
effects from observational data.

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2. Measuring Causal Effects 3. Steps of Empirical Analysis

In this course you will learn: The 6 steps of empirical analysis are:

methods for estimating causal effects using observational data 1 Formulate the question of interest (using economic theory)

tools that can be used for other purposes, e.g. forecasting 2 Obtain data
using time series data
3 Specify econometric model
how to evaluate other people’s regression analyses
4 Estimate econometric model
The course focuses on applications 5 Conduct statistical inference

Solving the problem sets you will give you hands-on experience 6 Make predictions
with regression analysis

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3. Steps of Empirical Analysis 3. Steps of Empirical Analysis
Step 1: Formulate question of interest
Step 2: Obtain data (I)
Matt has just started his first job. He earns $1,000 per month.
How much out of the $1,000 is he going to consume? Types of economic data according to source:
Experimental
A simple Keynesian model (economic theory) tells us that all
This type of data are rarely available.
additional income has to be consumed or saved.
Obtained under controlled experiment.
Example: randomized employment program.
If Y = consumption and X = income, Problems: costly, ethical questions.
Non-experimental
Y = f (X )
Most economic data are of this type.
This type of data are collected from subjects.
Marginal propensity to consume Example: survey data.
∆Y Problems: non-response, measurement error.
0< <1
∆X
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3. Steps of Empirical Analysis 3. Steps of Empirical Analysis

Step 2: Obtain data (III)
Step 2: Obtain data (II) Figure: Plot of income (X) and consumption (Y) for N=500 individuals

Types of economic data according to structure: 5500

5000

Cross-sectional data: data on different entities (individuals, 4500

firms, families, classes, etc.) taken at a given point in time. 4000

3500

Pooled cross-sectional data: group of cross-sectional data sets. 3000

Example: the Current Population Survey (CPS) in the U.S. 2500

2000
Panel or longitudinal data: data on different entities, where
1500
each entity is observed at two or more time periods.
1000

Time-series data: data for a single entity (person, firm, 500

country, stock) at multiple periods of time. 0

0 500 1000 1500 2000 2500

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3. Steps of Empirical Analysis 3. Steps of Empirical Analysis
Step 3: Specify econometric model (I) Step 3: Specify econometric model (II)
Figure: Plot of income (X) and consumption (Y) for N=500 individuals Figure: Plot of income (X) and consumption (Y) for N=500 individuals

5500
5500

5000
5000

4500
4500

4000
4000

3500
3500

3000
3000

2500
2500

2000
2000

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1000

500
500

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3. Steps of Empirical Analysis 3. Steps of Empirical Analysis

Step 3: Specify econometric model (IV)

Assume that relationship between Y and X is linear. Then, Step 3: Specify econometric model (V)

Y = β0 + β1 X In the data, the relationship between Y and X is not exact.

graph
where
Y = dependent variable The econometric model includes an unobservable error term or
X = explanatory variable disturbance:

β0 = constant or intercept graph

Y = β0 + β1 X + ε
β1 = slope graph

β0 and β1 are the unknown parameters

ε contains unobserved factors that affect Y
In the linear model, β1 is the marginal propensity to consume

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3. Steps of Empirical Analysis 3. Steps of Empirical Analysis

Step 3: Specify econometric model (VI)

Step 4: Estimate econometric model
Previous example is bivariate (or two-variable) linear regression
To estimate the model means to obtain values for the
model.
unknown parameters of the model.
An example of a multivariate linear regression model be: During the course you will learn different methods for
estimating the model parameters.
Y = β0 + β1 X1 + β2 X2 + ε
A predominant methodology for obtaining estimates is called
where
regression analysis of least squares.
Y = consumption
Estimates are typically denoted by a hat. βˆ0 and βˆ1 are the
X1 = income estimated parameters of our consumption model.
X2 = number of children

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3. Steps of Empirical Analysis 3. Steps of Empirical Analysis

Step 5: Conduct statistical inference

Statistical inference refers to the confirmation or refutation of
economic theories based on sample evidence.
This includes hypothesis testing and confidence interval
construction.
In our example
Step 6: Make predictions
Suppose we have estimated the econometric model in previous
slides and have found β̂0 = 2000, β̂1 = 0.72.
We can use these estimates to predict Matt’s consumption:

Y = β0 + β1 X1 + ε Y = 2, 000 + 0.72X = 2, 000 + 0.72 × 1, 000 = 2, 720

Matt will consumer $720 from his wage.

We may want to test if 0 < β1 < 1
Suppose that β̂1 = 0.72. Is 0.72 statistically less than 1? Matt’s total consumption will be equal to $2,720
How small should β̂0 be for you to conclude that β0 = 0

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4. Final remarks

Economic theory deals typically with deterministic

relationships, while econometrics deals with stochastic
(random) variables that have some probability distribution.
We do not observe the entire population, only a specific
sample.
If we estimate the same model from two different samples, we
will most likely obtain different estimates for β0 and β1
In economics we are concerned with causal effects.
Establishing that one variable is associated with another
variable does not mean that one variable causes the other.
When we examine the causal effect of one variable on another
variable, we do so holding all other variables unchanged
-ceteris paribus.

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