1. Explain the definition and scope of econometrics?

Definition and Scope of economtrics

 Econometrics is the use of statistical and mathematical models to develop theories or test
existing hypotheses in economics and to forecast future trends from historical data. It subjects
real-world data to statistical trials and then compares the results against the theory being
tested.
 Depending on whether you are interested in testing an existing theory or in using existing data
to develop a new hypothesis, econometrics can be subdivided into two major categories:
theoretical and applied. Those who routinely engage in this practice are commonly known as
econometricians.
 Econometrics is the use of statistical methods to develop theories or test existing hypotheses in
economics or finance.
 Econometrics relies on techniques such as regression models and null hypothesis testing.
 Econometrics can also be used to try to forecast future economic or financial trends.
 As with other statistical tools, econometricians should be careful not to infer a causal
relationship from statistical correlation.
 Some economists have criticized the field of econometrics for prioritizing statistical models over
economic reasoning.
 Econometric methods are statistical methods specifically adapted to the peculiarities of
economic phenomena
 These methods deal with the random component of economic relationships which is ignored by
mathematics, statistical methods and economic theory.
 Econometrics and Mathematical economics states economic theory in terms of mathematical
symbols.
 lthere is no essential difference between economic theory nor mathematical economics
 Neither allows for random elements which might affect the relationship and make it stochastic
nor do they provide numerical values for the coefficients of the relationships.
 Econometrics and Mathematica; Example
 Economic theory postulates that the demand for commodity depends on its price, on the prices
of commodities, on consumers’ income and on tastes:
2. What is the difference between Economic model and econometrics model?
Major differences between the economic model and econometric model are:-
 It shows the economic relationship between different economic variables. It measures the
values of parameters in economic relationships.
 The economic model is the theoretical construct that represents the complex economic process
or association between economic variables while as An econometric model is the combination
of mathematical, statistical, and economic concepts that represents the mathematical estimate
of the variables or parameters there in the identified model
 Economic models are qualitative but by nature, they are based on mathematical models as they
ignore residual variables where as Econometric models are extensively statistical or future
forecast oriented and thus based on statistical models.
 Economic models attempt to exhibit the logical relationship between different variables
considered in the modelwhile Econometric models focus on calculating the numerical values and
direction of variables considered in the model.
 The economic model is directly linked with the mathematical model as in mathematical
economics all the economic models are applied to express them in quantitative form while
Econometric models are also directly linked with the mathematical model but it is used for
further empirical forecasting and extension of an economic model or mathematical model.
 The outcome of the economic model is almost certain and exact. It means all the economic
models are developed with a set of fixed assumptions/conditions so the outcome is also almost
fixed where as The econometric model includes the residual variables/uncertainty so their
outcome is not fixed and unknown, unlike the economic model. So the outcome of econometric
models may be certain but not exact.
 Economic models are deterministic models. Deterministic models do not include the error term
where as All the econometric models are stochastic and econometrics assumes all the economic
models as stochastic by including the error terms.
 Economic models forecast the future values of economic variables regardless of their
uncertainty or degree of probability where as Econometric models forecast the future values of
economic magnitudes with a certain degree of probability.
 Economic models do not have anything to do with the significance testing of the variables and
parameters while Econometric models require significant testing of their parameters.
 Economic model is no uncertainty in the values of variables in the model at any point in time in
the case of an economic model while Econometric model are linear as well as non-linear
relations in the econometric model so there is a possibility of uncertainty n the value of
variables in any particular instant of time.
 Economic models allow for random elements which might affect the exact relationship and
tender it in stochastic character. Econometric models take randomness as an essential
element of the model. So all the economic models in econometric models as probabilistic
models.
 Economic models are less powerful to predict the future while Econometric models are more
powerful to predict the future.
3. What is relationship between Econometrics and Econometrics theory
 Econometrics theory makes statements or hypotheses that are mostly qualitative in
nature
 Econometrics uses economic theory, mathematics, and statistical inference to quantify
economic phenomena.
 In other words, it turns theoretical economic models into useful tools for economic
policymaking.
 The objective of econometrics is to convert qualitative statements (such as “the relationship
between two or more variables is positive”) into quantitative statements.
 Econometricians—practitioners of econometrics—transform models developed by economic
theorists into versions that can be estimated. As Stock and Watson put it, “econometric
methods are used in many branches of economics, including finance, labor economics,
macroeconomics, microeconomics, and economic policy.” Economic policy decisions are rarely
made without econometric analysis to assess their impact.
4. What are the main goals of Econometrics?
GOALS OF ECONOMETRICS
 A. Analysis: Testing Economic Theory
 In the earlier stages of the development of economic theory economists formulated the
basic principles of the functioning of the economic system using verbal exposition and
applying a deductive procedure. The earlier economic theories started from a set of
observations concerning the behaviour of individuals as consumers or producers.
 Some basic assumptions were set regarding the motivation of individual economic units.
Thus in demand theory it was assumed that the consumer aims at the maximization of his
satisfaction (utility) from the expenditure of his income, given the prices of the
commodities.
 Similarly, producers were assumed to be motivated by maximization of their profits. From
these assumptions the economists by pure logical reasoning derived some general
conclusions (laws) concerning the working processes of the economic system. Economic
theories thus developed in abstract level were not tested against economic reality. In other
words, no attempt was made to examine whether the theories explained adequately the
actual economic behaviour of individuals.
 Econometrics aims primarily at the verification of economic theories. In this case, we say
that the purpose of the research is analysis, i.e., obtaining empirical evidence to test the
explanatory power of economic theories, to decide how well they explain the observed
behaviour of the economic units. Today any theory regardless of its elegance in exposition
or its sound logical consistency cannot be established and generally accepted without some
empirical testing. Therefore, Econometrics is the science of estimation and testing.
B. Policy making: Obtaining Numerical Estimates of the Coefficients of Economic
 Relationships for Policy Simulations In many cases, we apply the various econometric
techniques in order to obtain reliable estimates of the individual coefficients of the
economic relationships from which we may evaluate elasticities or other parameters of
economic theory (multipliers, technical coefficients of production, marginal costs, marginal
revenues, etc.).
 The knowledge of the numerical value of these coefficients is very important for the
decisions of firms as well as for the formulation of the economic policy of the government. It
helps to compare the effects of alternative policy decisions
C. Forecasting the Future Values of Economic Magnitudes
  In formulating policy decisions it is essential to forecast the value of the economic
magnitudes. Such forecasts will enable the policy-maker to judge whether it is necessary to
take any measures in order to influence the relevant economic variables.
 For example, suppose that the government wants to decide its employment policy. It is
necessary to know what is the current situation of employment as well as what the level of
unemployment will be say, in 5 years' time, if no measure whatsoever is taken by the
government.
 With econometric techniques we may obtain such an estimate of the level of
unemployment. If this level is too low, the government will take appropriate measures to
avoid its occurrence. If the forecast value of employment is higher than the expected labour
force, the government must take different measures in order to avoid inflation.
 Forecasting is becoming increasingly important both for the regulation of developed
economies as well as for the planning of the economic development of developing
countries.
5. Explain briefly the methodology of Econometrics
 The methodology of econometrics is the study of the range of differing approaches to
undertaking econometric analysis.
 Econometrics may use standard statistical models to study economic questions, but most
often they are with observational data, rather than in controlled experiments.
 In this, the design of observational studies in econometrics is similar to the design of studies
in other observational disciplines, such as astronomy, epidemiology, sociology and political
science. Analysis of data from an observational study is guided by the study protocol,
although exploratory data analysis may by useful for generating new hypotheses.
 Economics often analyzes systems of equations and inequalities, such as supply and demand
hypothesized to be in equilibrium. Consequently, the field of econometrics has developed
methods for identification and estimation of simultaneous-equation models.
 These methods are analogous to methods used in other areas of science, such as the field
of system identification in systems analysis and control theory. Such methods may allow
researchers to estimate models and investigate their empirical consequences, without
directly manipulating the system.
 One of the fundamental statistical methods used by econometricians is regression analysis.
 Regression methods are important in econometrics because economists typically cannot use
controlled experiments.
 Econometricians often seek illuminating natural experiments in the absence of evidence
from controlled experiments. Observational data may be subject to omitted-variable bias
and a list of other problems that must be addressed using causal analysis of simultaneous-
equation models.