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Methodology of Econometrics

S K KotheAssistant Professor

Department of Economics

University of Mumbai

kothesk@gmail.com

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Methodology of Econometrics

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Statement of theory or hypothesis:yKeynes stated: Consumption increases as

income increases, but not as much as the

increase in income. It means that Themarginal propensity to consume (MPC) for aunit change in income is grater than zero

but less than unit

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Specification of the mathematical

model of the theory

yY = 1+ 2X ; 0 < 2< 1

y

Y= consumption expenditureyX= incomey 1 and 2 are parameters; 1 is intercept, and 2 is slope

coefficients

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Specification of the econometric model

of the theory

yY = 1+ 2X + u ; 0 < 2< 1;

y

Y = consumption expenditure;yX = income;y 1 and 2 are parameters; 1is intercept and 2 is slope

coefficients; u is disturbance term or error term. It is arandom or stochastic variable

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Obtaining Data

y

Y= Personal consumption expenditureyX= Gross Domestic Product all in Billion

US Dollars

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Obtaining Data

Year X Y

1980

19811982

1983

1984

1985

1986

1987

1988

1989

1990

1991

2447.1

2476.92503.7

2619.4

2746.1

2865.8

2969.1

3052.2

3162.4

3223.3

3260.4

3240.8

3776.3

3843.13760.3

3906.6

4148.5

4279.8

4404.5

4539.9

4718.6

4838.0

4877.5

4821.0

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Estimating the Econometric Modely Y^ = - 231.8 + 0.7194 X (1.3.3)

y MPC was about 0.72 and it means that for the

sample period when real income increases 1USD, led (on average) real consumptionexpenditure increases of about 72 cents

y Note: A hat symbol (^) above one variable willsignify an estimator of the relevant population

value

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Hypothesis Testingy Are the estimates accord with the

expectations of the theory that is being

tested? Is MPC < 1 statistically? If so, itmay support Keynes theory.

yConfirmation or refutation of

economic theories based on sampleevidence is object of StatisticalInference (hypothesis testing)

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Forecasting or Prediction With given future value(s) of X, what is the future

value(s) ofY?

GDP=$6000Bill in 1994, what is the forecastconsumption expenditure?

Y^= - 231.8+0.7196(6000) = 4084.6

Income Multiplier M = 1/(1 MPC) (=3.57). decrease

(increase) of $1 in investment will eventually lead to$3.57 decrease (increase) in income

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Using model for control or policy

purposesy Y=4000= -231.8+0.7194 X Xb 5882

y MPC = 0.72, an income of $5882 Bill will produce an

expenditure of $4000 Bill. B y fiscal and monetarypolicy, Government can manipulate the control

variableXto get the desired level of target variableY

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Economic Theory

Mathematic Model Econometric Model Data Collection

Estimation

Hypothesis Testing

Forecasting

Applicationin control or

policystudies

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ThankYou