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# Introduction To Econometrics

By Kaoru Yamaguchi

What is Econometrics

## An Application of Statistics to Economics

The social science in which the tools of economic
theory, mathematics, and statistical inference are
applied to the analysis of economic phenomena (Arthur
S. Goldberger)
The result of a certain outlook on the role of
economics, consists of the application of mathematical
statistics to economic data to lend empirical support to
the models constructed by mathematical economics and
to obtain numerical results (P.A.Samuelson)

## Why study econometrics

How do we apply Econometrics to
Energy Economics

## Essentials For a Practitioner

Essentials of Methodology
Review of Basic Statistical Concepts
Essentials of Linear Regression Model

Essentials of Methodology
Statement of theory or hypothesis
Specification of the mathematical model
Specification of the statistical or econometric
model
Collection of data
Estimation of the parameters of the chosen
econometric model
Tests of the hypothesis derived from the model
Forecasting

Economic Theory

Econometric Model

Estimation

Specification testing
and diagnostic
checking

NO

Is the model
YES
Hypotheses tests

## Forecast and policy simulation

1. Economic Data
2. Energy Demand Data
3. Energy Supply Data

Quantity

## Statement of theory or hypothesis

90
80
70
60
50
40
30
20
10
0
10
Demand
Supply

Examples:

20

30
Price

40

Demand decreases
as price increases
Supply increases as
price increases
Energy demand
increases as GDP
increases

## Specification of the mathematical

model
1. Linear Model:
Q=b0 + b1 * P
2. Non-Linear (Log-Linear) Model:
Q=b0 * P^b1
Log(Q)=Log(b0) + b1*Log(P)

Specification of Statistical or
Econometric Model
1. Linear Model:
Q=b0 + b1 * P + u
2. Non-Linear (Log-Linear) Model:
Q=b0 * P^b1 * u
Log(Q)=Log(b0) + b1*Log(P) + u

Collection of Data
Time Series

Cross-Sectional

Pooled Data

## Combination of time series and cross-sectional

data
Panel data: Same samples surveyed over time

Estimation of Parameters
1. Linear Model:
Q=B0 + B1 * P
2. Non-Linear (Log-Linear) Model:
Q=B0 * P^B1
Log(Q)=Log(B0) + B1*Log(P)

## Tests of the Theory or Hypothesis

Coefficient of the Price:
B1 < 0 ?

Q u an tity

Forecasting
90
80
70
60
50
40
30
20
10
0

10
Demand
Supply

20

30
Price

40

## Basic Statistical Concepts

Probability distribution function
Normal distribution and t-distribution
Estimator and the property of BLUE

## PDF: Probability Distribution

Function
Example: Binominal Probability Distribution: p(y)=n!/(y!(n-y)!)*0.5^n
0.5

n=2

0.25
0.2
Probability

Probability

0.4

n=10

0.3
0.2
0.1

0.15
0.1
0.05

0
0

1
Event

Event

10

Normal Distribution
X
Normal distribution is a model for a
continuous random variable whose value
depends on a number of factors.
Mean value Xi/n=
Sample Variance Xi)2/(n-1)=

## Standard Normal Distribution

X

The t-Distribution

## t-distribution is used to test the

significance of coefficients
(b1-B1)/se(b1) tn-2
Normal Distribution

## Standard Error (Deviation)

= Variance
Degree of Freedom d.f.:
The number of independent observations
available to compute a quantity

t20
t5

Desirable Property of
Estimator
The sample mean is the most frequently
used measure of the population mean
because of the following property.
Linearity
Unbiasedness
Efficiency
Best linear unbiased estimater (BLUE)

Linearity
An estimator is a linear estimator if it
is a linear function of the sample
observation.
EX. Sample mean=
(X1+X2+.+Xn)/n

Unbiasedness

UnBiased:E(X)=

Biased: E(X)<>

Efficiency
Efficient:E(X)=

Inefficient: E(X)=

## Best Linear Unbiased Estimator

(BLUE)
If the estimator is linear, is unbiased,
and has a minimum variance (most
efficient)

## The Linear Regression Model

The meaning of regression

## Regression analysis is concerned with the study

of the relationship between one variable called
explained, or dependent variable and one or
more other variable called independent, or
explanatory variable.

Yi = B0 + B1 * Xi + ui
Regression Coefficients
Dependent variable

## Random Error (Residual)

Independent variable

## Objective of Regression Analysis

To estimate the mean value of the dependent
variable, given the values of independent variabls.
To test hypotheses.
To predict or forecast the mean value of the
dependent variable, given the values of
independent variables.
Notes: Estimated relationship does not imply
causation.

## OBJECTIVE: Estimate PRF based on SRF

Whole Population
(Yi, Xi)

Sample Population

PRF: Population
Yi = B0 + B1* Xi + ui
Regression Function
SRF: Sample
Yi = b0 + b1* Xi + ei
Regression Function

## Meaning of Linear Regression

Linearity in the variable
Y=B1+B2X2
Y=B1+B2/X

## Linearity in the parameters

Y=B1+B22X

Estimation of Parameters
The Method of Ordinary Least
Square (OLS)

## Ordinary Least Square

Yi = b0 + b1* Xi + ei

80
Quantity

Estimate parameters to
minimize Residual
ei2)

e4
e3

60

e2

40

e1

20
0
10

20

30

Price

40

## Classical Linear Regression

Model
Regression model based on the
assumptions;

## The independent, or explanatory variables are

not correlated
The variance of each ui is constant
var(ui)=

## There is no correlation between two error

terms.

Regression in Practice
Violation of Assumptions
Multicollinearity

## If explanatory variables are correlated

Heteroscedasticity