Module 01 - Introduction and Simple Linear Regression Model.docx

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Module One – Introduction and Simple Linear Regression Model 1.0 Introduction to Econometrics 1.1 What is Econometrics Econometrics = Art consisting several statistical techniques to empirically validate various theories in finance, economics and social sciences using relevant data Analyse data for purposes of: o Modelling relationship b/w variables o Testing relationship b/w variables o Assessing quality of the model o Forecasting variable of interest Examples o Demand curve slopes downward o Does exchange rate follow a random walk? o How significant is the proportion of fraudulent tax returns submitted by self-employed business? Other Examples o State government ponders question of how much violent crime will be reduced if an additional million dollars is spent putting more uniformed police on the street? o Bill Shorten questions how many additional QLD voters will vote for labour party candidates in next election if he spends an additional million dollars in advertising in QLD marginal seats o Owner of local Pizza Hut franchise decides how much advertising space to purchase in the local newspaper, and thus must estimate the relationship b/w advertising & sales o Real estate developer must predict how much the population & income will increase to the south of Springfield, QLD over the next few years, and whether it will be profitable to begin construction of new Shopping & cinema malls o Financial planner must decide how much of his client’s savings will go into a stock fund and how much into the money market. This requires him to make predictions of the level of economic activity, the rate of inflation and interest rates over his client’s planning horizon o Department of Transport in Melbourne must decide how an increase in fares for public transport (trams, trains and buses) will affect the number of travellers who switch to car or bike, and the effect of this switch on revenue going to public transport 1.2 The Econometric Model An econometric model consists of a systematic or deterministic part and a random error For example, an econometric model for demand of beer: Q Beer d = f ( p Beer , p Wine , p Spirits , Income ) + ε If the functional form is linear f ( p Beer , p Wine , p Spirits , Income ) = β 1 + β 2 p Beer + β 3 p Wine + β 4 p Spirits + β 5 Income Then Q Beer d = β 1 + β 2 p Beer + β 3 p Wine + β 4 p Spirits + β 5 Income + ε Then using above formula we can test o Does the price of beer influence it’s consumption negatively? H 0 = β 2 = 0 vs. H A = β 2 < 0 o Are beer and wine substitutes? H 0 = β 3 = 0 vs. H A = β 3 > 0 1.3 Data Collection and statistical Inference Data Types o Time Series Form Data collected over discrete intervals of time E.g. annual price of wheat in Australia from 1880 – 2012
E.g. daily price of gold from 1980-2012 o Cross Section Form Data collected over sample units in a particular time period E.g. Income by states in Australia during 2012 E.g. high school graduation rates by state in 2012 o Panel Data Form (combination) Data

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