outline:

 Definition and Scope of Econometrics

 Economic models and Econometric models

 Goals of econometrics

 Methodology of Econometrics

 Desirable properties of an econometric model

1 November 30, 2021

Introduction

Economic theories suggest the relationship of various economic

variables. As investigator(economist) we may interested in: if one

variable changes in a certain magnitude, by how much will another

variable change?; can we forecast or predict the corresponding value

of another variable given that of the know value of one variable(s)?

So as to understand the real world.

This questions can be answered by econometrics.

Definition & Scope of Econometrics

Economy

Econo-metrics
Measure

Thus, econometrics means economic measurement. Measuring the

unknown values of theoretically defined parameters.

Econometrics is the science which integrates economic theory,

economic statistics, and mathematical economics to investigate

the empirical support of the general schematic law established by

economic theory.

It is a special type of economic analysis and research in which the

general economic theories, formulated in mathematical terms, is

combined with empirical measurements of economic

phenomena.
Econometrics is about how we can use economic, business or

social science theory, data and tools from statistics, to answer

“how much” type questions.

It is the application of statistical and mathematical techniques to

the analysis of empirical data with the purpose of verifying or

refuting theories.

Measurement is the crucial aspect of econometrics. But, the

scope of econometrics is beyond measurement.

Economic

theory

Econometrics

Mathematics

Statistics
Econometrics vs. mathematical economics

Economic theory state the relationship of variables by using

verbal expression.

But, mathematical economics states economic theory in terms of

mathematical symbols. There is no essential difference between

mathematical economics and economic theory.

Both express economic relationships in an exact or deterministic

form.
On the contrary, econometrics state the relationship of economic

variables by assuming random disturbance term.

Econometrics method design to consider random relationships

among economic variables.

Furthermore, unlike both mathematical economics and

economic theory, econometric methods provide numerical values

of the coefficients of economic relationships.

Econometrics vs. statistics

 Econometrics depart from statistics(economic and mathematical

statistics).

 Economic statistics collect empirical data, records them,

tabulates them or charts them.

 Its descriptive aspect of research and try to detect some

relationship between various economic magnitudes.

 It does not provide numerical coefficients of economic

relationships as econometrics does.

 Mathematical (or inferential) statistics concern on measurement

which are developed on the basis of controlled experiments.

 However, inferential statistics must be adapted/adjust to real

economic problem.
Economic models vs. econometric models

i. Economic Model

Its an organized set of relationships that describes the functioning of

an economic entity under a set of simplifying assumptions.

Economic model consists of three structural elements:

1. A set of variables

2. A list of fundamental relationships

3. A number of coefficients
Economic model postulates exact (deterministic)

relationships among variables and do not consider

disturbance term.

ii. Econometric model:

 Consists of behavioral equation derived from economic models

and specification of probability distribution of errors.

 contains a disturbance term.

Example the economic theory postulate that economic

growth is depend on overall fiscal policy volatility (GEVA),

urbanization ratio (URA), gross capital formation (GCFA), foreign

direct investment (FDIA), financial development (FDA), inflation

rate (IFA), trade openness (TOA), and human capital (HCA).

Accordingly the economic and econometrics model can be specified

as follow:
Economic model

GDPA it = α0 + α1GEVAit + α2URAit + α3GCFAit + α4FDIAit +

α5IFAit + α6FDAit + α7TOAit + α8HCAit ---------------------------- (1)

Econometrics Model

GDPA it = α0 + α1GEVAit + α2URAit + α3GCFAit + α4FDIAit +

α5IFAit + α6FDAit + α7TOAit + α8HCAit + ℇi---------------------- (2)

Main goals of Econometrics

1. Analysis - testing the implication of a theory. verifying how well

economic theories explain the observed behavior of economic

units.

2. Policy making - Obtaining numerical estimates of the

coefficients of economic relationships for policy simulations.

3. Forecasting- using the numerical estimates of the coefficients in

order to forecast the future values of economic magnitudes .

Methodology Of Econometrics

Econometric research is focused on measurement of the parameters

of economic relationships and predication of the values of economic

variables.

Generally econometric research follow the following step:

1. Specification the model

2. Estimation of the model

4. Evaluation of the estimates

5. Evaluation of he forecasting power of the estimated model

1. Specification of the model

This is the stage of expressing the relationships between economic

variables in mathematical form.

Basically in this step the ff activities have been done:

1. Identification of dependent and independent variables

2. priori theoretical expectations about the size and sign of the

parameters of the function.

3. the mathematical form of the model

The specification of the econometric model based on economic

theory and other information and the investigator require the know

how of them.

It’s the weakest point of most econometrics research.

The econometrics model may incorrectly specified due to:

1. The imperfections, looseness of statements in economic theories.

2. limitation of our knowledge about factor in particular case.

3. Data related problem.

The most common errors of specification are:

 Omissions of some important variables from the function.

 The omissions of some equations (for example, in simultaneous
equations model).
 The mistaken mathematical form of the functions.
2. Estimation of the model

Estimation of the model requires knowledge of the various

econometric methods, their assumptions and the economic

implications for the estimates of the parameters.

This stage includes the following activities.

 Gathering of the data

 Examination of the identification conditions of the function

 Examination of the aggregations problems

 Examination of the degree of correlation

 Choice of appropriate economic techniques(OLS, MLM, Logit,

and Probit).

3. Evaluation of the estimates

In this step we are going to check whether parameters are

theoretically meaningful and statistically satisfactory or not.

In this step the econometrician is expected to evaluate the

reliability of result.
To end this three criteria are used:

1. Economic a priori criteria: evaluate by economic theory and refer

to the size and sign of the parameters.

2. Statistical criteria (first-order tests): determined by statistical

theory and aim at the evaluation of the statistical reliability of the

estimates of the parameters of the model. by using standard error

test, t-test, F-test, and R2 –test.

3. Econometric criteria (second-order tests): in this test the

econometrician is expected to check the fulfillment of the

assumption of the employed econometrics techniques/detection of

the violation of the assumptions.

4. Evaluation of the forecasting power of the model:

In this stage the sensitivity of the result to the change like sample

size a and econometrics techniques is checked. If the result is

insensitive to the change in sample size and econometrics

techniques we can accept the result of the study and used to forcast

the future value of the concerned variable.

Desirable properties of an econometric model

The ‘goodness’ of an econometric model is judged customarily

according to the following desirable properties:

1. Theoretical plausibility: econometric model should

compatible with economic theory.

2. Explanatory ability: econometrics model should explain the

real world.
3. Accuracy of the estimates of the parameters: the estimated

coefficients should the best approximate of the true parameters.

4. Forecasting ability: The model should forecast the future values

of the dependent variable.

5. Simplicity: econometrics model should specify the relationship

of variables with a maximum simplicity.