Basic Econometrics
Introduction Summary
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Chapter 1 Introduction to Econometrics
1. What is Econometrics?
1.1 Definition
Econometrics is a mixture of economics, mathematics and statistics as illustrated in Figure 1.1.1.
Figure 1.1.1
Economics, or economic theory, makes statements or hypotheses that are mostly qualitative in
nature. Only econometrics gives empirical or numerical content to most economic theory.
The main concern of mathematical economics is to express economic theory in mathematical form
(equations) without regard to measurability or empirical verification of the theory. Econometrics,
as noted previously, is mainly interested in the empirical verification of economic theory.
Economic statistics is mainly concerned with collecting, processing, and presenting economic data
in the form of charts and tables. The data thus collected constitute the raw data for econometric
work. But the economic statistician does not go any further, not being concerned with using the
collected data to test economic theories.
Although mathematical statistics provides many tools to analyze the data, the econometrician
often needs special methods in view of the unique nature of most economic data, namely, that the
data are not generated as the result of a controlled experiment. The econometrician generally
depends on data that cannot be controlled directly.
In econometrics the modeler is often faced with observational as opposed to experimental data.
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That is, in the social sciences, the data that one generally encounters are non-experimental in
nature, that is, not subject to the control of the researcher. This lack of control often creates special
problems for the researcher in pinning down the exact causes affecting a particular situation.
1.2 Categories
General- and narrow-defined econometrics
The former is a general designation of all econometrics methods such as regression analysis,
input-output analysis, time series analysis, semi- and non-parametric analysis and so on.
The latter is just the usual-said classical econometric by using the regression analysis.
Theoretical and applied econometrics
Theoretical econometrics is concerned with the development of appropriate methods for
measuring economic relationships specified by econometric models. It must spell out the
assumptions of this method, its properties, and what happens to these properties when one or more
of the assumptions of the method are not fulfilled.
In applied econometrics we use the tools of theoretical econometrics to study some special field(s)
of economics and business, such as the production function, investment function, demand and
supply functions, portfolio theory, etc.
1.3 Application
The application of econometrics includes four parts: structure analysis, economic forecasting or
predicting, policy comments, verifying and developing economic theory.
Structure analysis
It studies the relations between economic variables and different from the usual-said industrial
structure, consumption structure, invest structure and so on. That is, it studies the influence of the
change of one or some variables on the others or the whole economic system by using the elastic
analysis, multiplier analysis and comparative static analysis.
Economic forecasting
Econometrics can be used to either analyze the historic data or forecasting the future. Econometric
model is developed from the application in economic forecasting.
Case: GHI Financial Services Limited
It is late February 1998, GHI Financial Services limited, a British company, has an offer to buy a
call option on the US dollar expiring on 6 March. The following information is available:
