CHAPTER 1: INTRODUCTION1.1 WHAT IS ECONOMETRICS?Literally interpreted,econometricsmeans “economic measurement.” So econometrics deals withthe measurement of economic relationships. Econometrics may be defined as the social science inwhich the tools of economic theory, mathematics, and statistical inference are applied to theanalysis of economic phenomena. Econometrics may also be considered as the integration ofeconomics, mathematics and statistics for the purpose of providing numerical values for theparameters of economic relationships (e.g., elasticity, propensities, marginal values) and verifyingeconomic theories.The most important characteristics of economic relationships is that they contain a randomelement, which, however ignored by economic theory and mathematical economics whichpostulate exact relationships between the varies economic magnitudes. Econometrics hasdeveloped methods for dealing with random component of economic relationships.1.2 WHY A SEPARATE DISCIPLINE?As the preceding definitions suggest, econometrics is an amalgam of economic theory,mathematical economics, economic statistics, and mathematical statistics but it is completelydistinct from each one of these branches of science for the following reasons.Economic theory makes statements that are mostly qualitative in nature, whileeconometrics gives empirical content to most economic theoryThe main concern of Mathematical economics is to express economic theory inmathematical form without empirical verification of the theory, while econometrics ismainly interested in the laterEconomic Statistics is mainly concerned with collecting, processing and presentingeconomic data in the form of charts and tables. It does not being concerned with using thecollected data to test economic theories. While econometrics do.Mathematical statistics provides many of tools for economic studies, but econometricssupplies the later with many special methods of quantitative analysis based on economicdataGoals of econometricsThere are three main goals of econometrics:(1)Analysis, i.e. testing of econometric theory(2) Policy making, i.e. supplying numerical estimates of the coefficients of economicrelationships, which may be then used for decision making(3)Forecasting, i.e. using the numerical estimates of the coefficients in order to forecast thefuture values of the economic magnitudes. Of course, these goals are not mutuallyexclusive. Successful econometric applications should include some combinations of allthree aims.1.3 METHODOLOGY OF ECONOMETRICS1

In any econometric research one may distinguish four stages.Stage A: Specification of the modelThe first, and most important, step the econometrician has to take in attempting the study of anyrelationship between variables is to express these relationship in mathematical form, that is tospecify the model, with which the economic phenomenon will be explored empirically. This iscalled the specification of the model or formulation of the maintained hypothesis. It involves thedetermination of:(1) The dependent and the explanatory variables which will be included in the model(2) A priori theoretical expectation about the sign and size of the parameters of thefunction(3) The mathematical form of the model (number of equations, linear or non-linear formof these equations, etc)The specification of the econometric model will be based on econometric theory and on any

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