Book: Basic Econometrics-D. N. Gujarati and D. C.
Porter
Lecture#01
What Is Econometrics?
In narrow sense Econometrics means Economic Measurement.
In Broader sense
Econometrics may be defined as the social science in which the tools of
economic theory, mathematics and statistical inference are applied to the
analysis of economic phenomena. (Economic Theory by Arthur S. Goldberger)
Methodology of Econometrics?
1. Statement of theory or hypothesis
2. Specification of the mathematical model of the theory
3. Specification of the Statistical or Econometric model
4. Obtaining Data
5. Estimation of the parameters of the Econometric Model
6. Hypothesis testing
7. Forecasting or Prediction
8. Using the model for control or policy purpose
(Example: Is there any a relation between inflation/trade and Economic Growth
of a country?)
1|Page Introduction Econometrics
Book: Basic Econometrics-D. N. Gujarati and D. C. Porter
Types of Econometrics
Econometrics
Theoretical
Classical
Bayesian
Theoretical Econometrics is concerned with the development of
appropriate methods for measuring economic relationships specified by
econometric models. For example one of the methods is Least squares.
Applied
Classical
Bayesian
In applied econometrics, we use the tools of theoretical econometrics to
study some special fields of economics and business, such as production
function, investment function, demand and supply function.
2|Page Introduction Econometrics
Book: Basic Econometrics-D. N. Gujarati and D. C. Porter
Historical Origin of the Term Regression
The term Regression was introduced by Francis Galton in 1886. He found
that the height of children of unusually tall or unusually short parents tends
to move toward the average height of the population. Galton’s law of
universal regression was confirmed by his friend Karl Pearson in 1903,
who collected more than a thousand records of heights of members of
family groups.
Examples of Regression
A monopolist who can fix the price or output but not both, may want to
find out the response of the demand for a product to change in price. Such
an experiment may enable the estimation of the price elasticity i.e. price
responsiveness of the demand for the product and may help determine the
most profitable price.
An Economist may be interested in studying the dependence of personal
consumption expenditure on after-tax of disposable real personal income.
Such an analysis may be helpful in estimating the marginal propensity to
consume (MPC), that is, average change in consumption expenditure for,
say, a kroner of change in real income.
3|Page Introduction Econometrics
Book: Basic Econometrics-D. N. Gujarati and D. C. Porter
Regression versus Correlation:
Correlation coefficient measures the strength of linear association between
two variables but Regression analysis try to estimate or predict the average
value of one variable on the basis of the fixed values of other variables. In
regression analysis there is an asymmetry in the way the dependent and
explanatory variables are treated. The dependent variable is assumed to be
statistical, random or stochastic, that is, to have a probability distribution
and the explanatory variables are assumed to have fixed values. On the
other hand in correlation analysis we treat any two variables symmetrically;
there is no distinction between the dependent and explanatory variables.
Terminology
Dependent Variable Independent Variable
Explained Variable Explanatory Variable
Predictand Predictor
Regressand Regressor
Endogenous Exogenous
Response Stimulus
Outcome Covariate
Controlled Variable Control Variable
4|Page Introduction Econometrics
Book: Basic Econometrics-D. N. Gujarati and D. C. Porter
Types of Data
Time Series Data
Cross Sectional Data
Pooled Data
Time Series Data
Time series is a sequence of data points, measured typically at
successive time instants spaced at uniform time intervals. Time series
data have a natural temporal ordering.
Daily- Weather, Stock Price
Monthly- Unemployment rate
Quarterly- GDP
Yearly- National Budgets
Decennially- Population Census
Cross Sectional Data
Cross-sectional data or cross section is a type of one-dimensional data
set. It refers to data collected by observing many subjects such as
individuals, firms or countries/regions at the same point of time, or
without regard to differences in time.
5|Page Introduction Econometrics
Book: Basic Econometrics-D. N. Gujarati and D. C. Porter
For example, we want to measure the mobile uses for a particular brand
in this campus. We could draw a sample of 100 students randomly from
the population, measure their mobile use, and calculate what percentage
of that sample is used of that brand. For example, 60% of our samples
were used that particular branded mobile. This cross-sectional sample
provides us with a snapshot of that population, at that one point in time.
Note that we do not know based on one cross-sectional sample if the
uses of this brand are increasing or decreasing; we can only describe the
current proportion.
Pooled Data
In Pooled or combined data are the element of both time series and
cross-sectional data.
Types of quantitative variable:
1.Discrete: Some variable can take only integral values, known as discrete
variable. Family member, number of students in a class. Etc
2.Continuous : A variable which can assume any value integral or
fractional within specified limits, is called continuous variable.
Example: Height of a student, length of a fish, weight of an animal etc.
Scale of measurement: In Statistics, measurement has a special meaning. A
measurement is obtained when a variable is measured on experimental unit.
6|Page Introduction Econometrics
Book: Basic Econometrics-D. N. Gujarati and D. C. Porter
Types of scale of measurement:
1. Nominal scale : A qualitative measurements are called nominal, regardless
of whether the categories are designed by names or numbers. In nominal data,
the categories of variables differ from one another in name only. One category
of variable is not necessarily higher or lower or greater or smaller then other
category.
Example: Gender of a student (male, female) , religion, marital status, place of
birth, Holding number
2. Ordinal scale: When there is an ordered relation among the categories, the
variable is said to be an ordinal variable. The categories of the ordinal variable
may have the typical relations as higher, greater, more desired, less difficult
and so on.
Example : Level of knowledge (good, average, poor), Grade Points
(A,B.C.D, E, F), Socioeconomic status( High , middle , low), Degree obtained (
Undergraduate, Graduate, Ph.D)
3. Interval scale: Data generated through the measurement of an interval
variable are called interval data. The level of measurement is called interval
scale when a quantitative variable is measured in natural numerical scale in the
experimental unit but no absolute zero as origin. Zero point may be arbitrarily
defined.
7|Page Introduction Econometrics
Book: Basic Econometrics-D. N. Gujarati and D. C. Porter
Example: Body temperature of a patient, Room temperature of a house.
Calendar time , Intelligence quotient (IQ) etc.
4. Ratio scale: A Level of measurement is called ratio scale when a
quantitative variable is measured numerically on experimental unit with
absolute zero as origin.
Example : Age, income Height , Weight, Family size- A family with six
members is twice as large as of a family with 3 members.
8|Page Introduction Econometrics
