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Welcome to Econometrics

Introduction

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Why study Econometrics?

An empirical analysis uses data to test a theory or to estimate a relationship

A formal model can be tested

Theory may be ambiguous as to the effect of some policy change – can use econometrics to evaluate the program

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Steps in Empirical Analysis

Careful formulation of the question of interestEconomic Model or Informal Economic Intuition or ReasoningTurn an Economic Model into an Econometric ModelState Hypothesis of InterestDataEstimationTesting of Hypothesis

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Types of Data – Cross Sectional

Cross-sectional data is a random sample

Each observation is a new individual, firm, etc. with information at a point in time

If the data is not a random sample, we have a sample-selection problem

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Types of Data – Cross Sectional

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Types of Data – Cross Sectional

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Types of Data – Time Series

Time series data has a separate observation for each time period – e.g. stock prices

Since not a random sample, different problems to consider

Trends and seasonality will be important

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Types of Data – Time Series

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Types of Data – Pooled Cross-sections and Panel

Can pool random cross sections and treat similar to a normal cross section – known as pooled cross-sections data. Will just need to account for time differences.

Can follow the same random individual observations over time – known as panel data

Types of Data – Pooled Cross-sections

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Types of Data – Panel

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The Question of Causality

Simply establishing a relationship between variables is rarely sufficient

Want to the effect to be considered causal

If we’ve truly controlled for enough other variables, then the estimated ceteris paribus effect can often be considered to be causal

Can be difficult to establish causality

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Example: Returns to Education

A model of human capital investment implies getting more education should lead to higher earnings

In the simplest case, this implies an equation like

ueducationEarnings 10

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Example: (continued)

The estimate of 1, is the return to education, but can it be considered causal?

While the error term, u, includes other factors affecting earnings, want to control for as much as possible

Some things are still unobserved, which can be problematic