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ECON301_Handout_01_1213_02

3 human indeterminacy human behavior is such that

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(3) Human Indeterminacy Human behavior is such that actions taken under identical circumstances will differ in a random way. The disturbance term can be thought of as representing this inherent randomness in human behavior. In other words, People are not predictable in their behavior. There is an element of unpredictability in all human behavior. We might interpret our model as combining a systematic or deterministic component ( t X + ) with a random or stochastic component ( t u ) that represents the unpredictable element in the relationship. Instructor: Dr. Ozan ERUYGUR e-mail: [email protected] Lecture Notes 7
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ECON 301 (01) - Introduction to Econometrics I March , 2012 METU - Department of Economics To sum up, in the social sciences, controlled experiments are usually not possible. For example, an economist cannot hold Turkish national income constant for several years while examining the effect of interest rate on investment. Since the economist cannot neutralize extraneous influences by holding them constant, the best alternative is to take them explicitly into account, by regression Y on X and the extraneous factors (Wonnacott, 1979, p.23) 7. Assumptions of Classical Linear Regression Model (CLRM) The following assumptions are important in CLRM 5 . Assumption 1 (A1): Linear regression model [the regression model is linear in the parameters although it may be nonlinear in variables] o In simple regression model, the value of t Y , for each value of t X is 01 t tt Y Xu ββ = ++ Assumption 2 (A2): X values are fixed in repeated sampling or X values must be independent of the error term: ( ,) 0 Cov X u = . In many practical cases, X t is fixed across samples is not just the simplest assumption; it is also the most realistic assumption 6 . Keeping the value of income X fixed, say, at level 1,100 TL, we draw at random a family and observe its consumption expenditure (Y) as, say, 640 TL. Still keeping at 1,100 TL, we draw at random another family and observe its Y value as 580 TL. In each of these drawings (i.e. repeated sampling), the value of X is fixed at 1,100 TL. 5 Gujarati, D. (2009) Basic Econometrics, 5th Edition, Mc Graw Hill, pp.62-68. 6 Murray, M. P. (2006) Econometrics: A Modern Introduction, Pearson International, pp. 41-42. Instructor: Dr. Ozan ERUYGUR e-mail: [email protected] Lecture Notes 8
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ECON 301 (01) - Introduction to Econometrics I March , 2012 METU - Department of Economics This is the sense in which we are assuming the X’s are fixed in repeated sampling (or, across samples). Assumption 3 (A3): Zero mean value of disturbance t u [ ()0 t Eu = ] which is equivalent to assuming that 01 (| ) tt EY X X ββ = + o In other words, the expected value of the disturbance term for any X should be 0 . Assumption 4 (A4): Homoscedasticity , i.e. constant variance of u t [ 2 () t Var u σ = ]. o Population variance of the disturbance term ( t u ) should be constant for all observations (Homoscedasticity).
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3 Human Indeterminacy Human behavior is such that actions...

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