Chapter 1
Introduction to Econometrics
Econometrics deals with the measurement of economic relationships. It is an integration of economics,
mathematical economics and statistics with an objective to provide numerical values to the parameters of
economic relationships. The relationships of economic theories are usually expressed in mathematical forms
and combined with empirical economics. The econometrics methods are used to obtain the values of
parameters which are essentially the coefficients of the mathematical form of the economic relationships.
The statistical methods which help in explaining the economic phenomenon are adapted as econometric
methods. The econometric relationships depict the random behaviour of economic relationships which are
generally not considered in economics and mathematical formulations.
It may be pointed out that the econometric methods can be used in other areas like engineering sciences,
biological sciences, medical sciences, geosciences, agricultural sciences etc. In simple words, whenever there
is a need of finding the stochastic relationship in mathematical format, the econometric methods and tools
help. The econometric tools are helpful in explaining the relationships among variables.
Econometric Models:
A model is a simplified representation of a real-world process. It should be representative in the sense that it
should contain the salient features of the phenomena under study. In general, one of the objectives in
modeling is to have a simple model to explain a complex phenomenon. Such an objective may sometimes
lead to oversimplified model and sometimes the assumptions made are unrealistic. In practice, generally, all
the variables which the experimenter thinks are relevant to explain the phenomenon are included in the
model. Rest of the variables are dumped in a basket called “disturbances” where the disturbances are random
variables. This is the main difference between economic modeling and econometric modeling. This is also
the main difference between mathematical modeling and statistical modeling. The mathematical modeling is
exact in nature, whereas the statistical modeling contains a stochastic term also.
An economic model is a set of assumptions that describes the behaviour of an economy, or more generally, a
phenomenon.
Econometrics | Chapter 1 | Introduction to Econometrics | Shalabh, IIT Kanpur
1
, An econometric model consists of
- a set of equations describing the behaviour. These equations are derived from the economic model
and have two parts – observed variables and disturbances.
- a statement about the errors in the observed values of variables.
- a specification of the probability distribution of disturbances.
Aims of econometrics:
The three main aims econometrics are as follows:
1. Formulation and specification of econometric models:
The economic models are formulated in an empirically testable form. Several econometric models can be
derived from an economic model. Such models differ due to different choice of functional form,
specification of the stochastic structure of the variables etc.
2. Estimation and testing of models:
The models are estimated on the basis of the observed set of data and are tested for their suitability. This is
the part of the statistical inference of the modelling. Various estimation procedures are used to know the
numerical values of the unknown parameters of the model. Based on various formulations of statistical
models, a suitable and appropriate model is selected.
3. Use of models:
The obtained models are used for forecasting and policy formulation, which is an essential part in any policy
decision. Such forecasts help the policymakers to judge the goodness of the fitted model and take necessary
measures in order to re-adjust the relevant economic variables.
Econometrics and statistics:
Econometrics differs both from mathematical statistics and economic statistics. In economic statistics, the
empirical data is collected recorded, tabulated and used in describing the pattern in their development over
time. The economic statistics is a descriptive aspect of economics. It does not provide either the explanations
of the development of various variables or measurement of the parameters of the relationships.
Econometrics | Chapter 1 | Introduction to Econometrics | Shalabh, IIT Kanpur
2
Introduction to Econometrics
Econometrics deals with the measurement of economic relationships. It is an integration of economics,
mathematical economics and statistics with an objective to provide numerical values to the parameters of
economic relationships. The relationships of economic theories are usually expressed in mathematical forms
and combined with empirical economics. The econometrics methods are used to obtain the values of
parameters which are essentially the coefficients of the mathematical form of the economic relationships.
The statistical methods which help in explaining the economic phenomenon are adapted as econometric
methods. The econometric relationships depict the random behaviour of economic relationships which are
generally not considered in economics and mathematical formulations.
It may be pointed out that the econometric methods can be used in other areas like engineering sciences,
biological sciences, medical sciences, geosciences, agricultural sciences etc. In simple words, whenever there
is a need of finding the stochastic relationship in mathematical format, the econometric methods and tools
help. The econometric tools are helpful in explaining the relationships among variables.
Econometric Models:
A model is a simplified representation of a real-world process. It should be representative in the sense that it
should contain the salient features of the phenomena under study. In general, one of the objectives in
modeling is to have a simple model to explain a complex phenomenon. Such an objective may sometimes
lead to oversimplified model and sometimes the assumptions made are unrealistic. In practice, generally, all
the variables which the experimenter thinks are relevant to explain the phenomenon are included in the
model. Rest of the variables are dumped in a basket called “disturbances” where the disturbances are random
variables. This is the main difference between economic modeling and econometric modeling. This is also
the main difference between mathematical modeling and statistical modeling. The mathematical modeling is
exact in nature, whereas the statistical modeling contains a stochastic term also.
An economic model is a set of assumptions that describes the behaviour of an economy, or more generally, a
phenomenon.
Econometrics | Chapter 1 | Introduction to Econometrics | Shalabh, IIT Kanpur
1
, An econometric model consists of
- a set of equations describing the behaviour. These equations are derived from the economic model
and have two parts – observed variables and disturbances.
- a statement about the errors in the observed values of variables.
- a specification of the probability distribution of disturbances.
Aims of econometrics:
The three main aims econometrics are as follows:
1. Formulation and specification of econometric models:
The economic models are formulated in an empirically testable form. Several econometric models can be
derived from an economic model. Such models differ due to different choice of functional form,
specification of the stochastic structure of the variables etc.
2. Estimation and testing of models:
The models are estimated on the basis of the observed set of data and are tested for their suitability. This is
the part of the statistical inference of the modelling. Various estimation procedures are used to know the
numerical values of the unknown parameters of the model. Based on various formulations of statistical
models, a suitable and appropriate model is selected.
3. Use of models:
The obtained models are used for forecasting and policy formulation, which is an essential part in any policy
decision. Such forecasts help the policymakers to judge the goodness of the fitted model and take necessary
measures in order to re-adjust the relevant economic variables.
Econometrics and statistics:
Econometrics differs both from mathematical statistics and economic statistics. In economic statistics, the
empirical data is collected recorded, tabulated and used in describing the pattern in their development over
time. The economic statistics is a descriptive aspect of economics. It does not provide either the explanations
of the development of various variables or measurement of the parameters of the relationships.
Econometrics | Chapter 1 | Introduction to Econometrics | Shalabh, IIT Kanpur
2
