Economics X
What is econometrics?
Metric means: measurement and
Econometric means: economic measurement.
“Economics may be defined as social science in which tools of economic theory, mathematics and statistical infereEconomics Xnces are applied to the analysis of economic phenomenon.”
- Arthur S.
“Econometrics is the result of a certain outlook on the role of economics; it consists of application of mathematical, statistics to economics data, to lend empirical support to the models constructed by mathematical economics and to obtain numerical results.”
- Samuelson, Koopmints and stone.
It was Ragnar Firsch who gave a clear idea of this scope and method of econometrics in the opening editorial of ‘econometrica’ in 1933.
Nature of Econometrics
Since econometrics deals with measurement of economic variables, it relies heavily upon mathematics, statistics besides economic theory. Thus, the nature of econometrics resembles that of any other mathematical science.
- Econometrics is analytical. While economic theory describes the various economic relationships, econometric help in the analytical understanding of those theories.
It establishes models that express the economic relationships in mathematical and statistical mode that helps further analysis and inference.
- Econometrics is not theoretical, it is mathematical and statistical. Since econometrics expresses economic relationships in mathematical and statistical form, it is the purely mathematical in nature.
- It lends itself to empirical research:
The general principles of economics describe relationships which are applied to empirical testing over time and space. However, economic theory cannot provide tools for empirical testing. The tools for such empirical testing are specifically designed by econometrics with the use of statistics and mathematics.
- Econometrics is complicated for layman to understand. Econometrics is very technical and difficult for common people to understand.
It is easier for common people to read economic relations and theory than understand them in econometrics.(we introduced in 1933)
Econometrics goes beyond mathematical economics. Mathematical economics refers to the application of mathematics to the purely theoretical aspects of economic analysis with little or no concern about such statistical problems as the errors of measurement of the variable under study.
Mathematical economics concentrates only on the application of mathematics to deductive reasoning rather than inductive study and the results primarily deal with theoretical rather than empirical material.
i. Mathematical economics does not deal with errors.
ii. Mathematical economics uses deductive logic rather than inductive logic.
iii. Mathematical economics gives results which have greater theoretical implications rather than empirical implications.
However, theories must be tested against empirical date for validity before they can be applied with confidence.
Thus, economic research requires a theoretical foundation, a framework which is provided by mathematics; and measurement provided by statistics and empirical measurements which is provided by econometrics.
Statistics and mathematics are only tools and they need economic theory and mainly economic theory to determine the most relevant and fruitful directions of research.
On the other hand we can say that though economics, mathematics statistics and econometrics are different from on another, they are also complementary to one another in a successful economic research.
A classical illustration of the complementary nature of theoretical and empirical studies is found in the study of aggregate consumption function.
The theoretical framework of Keynes of the consumption function led to the statistical estimation of the propensity to consume, but the statistical findings of Kuznets and Goldsmith regarding the relative long run constancy of the propensity to consume (in contradiction to Keynesian theory) stimulated the refinement of aggregate consumption function, theory by Dussenberry, Friedman and others.
Thus, mathematics is the basic tool for framework but does not provide data. Statistics provide data but does not make the model concrete whereas econometrics makes a model highly significant or nearer to perfect.
Methodology of Economic Research:
Since econometrics deals with measurement of economic variables;
Ø It relies heavily upon mathematics, statistics and economic theory.
Ø The methodology of economic research is derived from the following framework:
Goals of Econometrics Research:
There are three important goals of econometrics:
1) Analysis/testing of economic theory: - Econometrics primarily aims at verification of economic theories. In other words the purpose of econometrics is analysis i.e. obtaining empirical evidences and test the “power of economic theory to decide; how well explain the observed behavio0iur of economic units.
This goal comes from the facts that the early economic theories were stated from a set of observations concerning the behaviour of individuals, consumers, producers and some basic assumptions were set regarding the motivation of individual economic units and of the study itself.
Form these assumptions, by pure logical reasoning economists derived general conclusions, thus, theories were developed in an abstract manner and were not tested against economic reality.
2) Policy Making: - Econometrics aims at obtaining numerical estimate of the co-efficient of economic relationships for policy formation.
In many cases we apply various econometrics technical in order to obtain reliable estimates of individual co-efficient of the economics relationships.
The numerical values of these co-efficient are important because they help to compose the effects of alternative policy decisions.
For example, the decision of the govt. regarding devaluing the currency will depend for considerable extent on the numerical value of the marginal propensity to import, as well as on the numerical values of price elasticity of exports and imports. [When you devalue currency, export increases and imports decreases.]
3) Forecasting the future values of economic magnitude: - In formulating policy decisions it essential to be able to forecast the economic values and magnitude. Such forecasts will enable the policy makers to judge if it is necessary to take any measures in order to import the relevant economic variables.
Suppose the govt. wants to decide its employment policy and it is necessary to know not just the current situation of employment/unemployment as well as that for a future period. After these forecasts the govt. can decide on an employment policy. An econometric once again helps it current benefits and forecasts its future impacts.
Advantages and Disadvantages
Ø Econometrics models make measurement of economic relationships and parameters.
Ø Accurate nearer to exact new, precise, reliable, acceptable.
Limitations
Ø Although it is a very useful tool of a economic measurement econometrics has several weaknesses.
Ø It is highly technical and can’t be understood by laymen.
Ø Measurements obtained are nearer to accurate but not accurate.
Ø Econometrics model introduce a random error term which once again makes econometrics complicated, though accurate.
Ø Sometimes econometrics models are very complicated and difficult and make the simple nature of theory unnecessary technical and complicated. However this criticism can be counter argued.
Ø It depends on the researcher to create simple econometrics models. Therefore, complication is not a limitation o econometrics but of the econometricians.
Relationships between econometrics and other related branches:
- Mathematical economics and econometrics: - The main concern of mathematical economics is to express economic theory in mathematical form of equations or models. Without any regard to measurability of empirical purification of the theory.
Econometrics on the other hand is interested in empirical test of economic theory. The nature of econometrics depends more on mathematics, statistics than on mathematical econometrics. Though, it goes much beyond mathematics, statistics also. For example – economic theory establishes an inner relationship between PX and DX and a positive relationship between price of x and supply of X.
Economic theory as assumes here that all other factors affecting DD and SS except price are held constant.
Which means the influence of such factors while studying the price of DD and price of SS (PX DX / PX SX) relationships is taken as a “Constant Value”. This is model or symbolized by mathematical economics as
D = a – bp
S = - c + dp
and the market equilibrium is obtained.
D = S
\a – bp = - c + dp
Mathematical economics stops at establishing this model.
However, there issues to be answered like:
- Collection of samples (statistics).
- Sampling errors (statistics).
- Error due to determinant the influence of which is not included or ignored by economic theory e.g. psychological, social factors influencing demand which are not included as determinants by economic theory.
Mathematical econometrics does not fit such influences in the model, econometrics include these in the model.
- Besides, this mathematical model must be empirically tested to verify its validity for different goods and different time periods.
Mathematical economics does not do that. But it is within the scope of econometric to do so.
- Econometrics and statistics: - Economics makes use of various types of statistical data for example population data, production data, irrigation data and so on.
Ø Statistics helps to collect, organize and tabulate these data systematically.
Ø Mathematics, statistics provide in number of tools to analyze these data collected by the statisticians.
Ø However, mathematics, statistics poses problems for data which are non experimental in nature for those which directly not controllable.
Econometrics however, provides measures and methods to test various types of data provided by the statisticians as also it provides methods to deal various errors of measurement which are not easily dealt with by mathematics and statistics. Econometrics uses statistical methods after adopting them to economic life.
Mathematical, statistics is inferential which deals with methods of measurement which are developed in the basis of control experiments in laboratories such statistical methods of measurement are not appropriate for economic relationship because they can not explain under controlled experiment while econometrics can measure such economic relationships also because it uses statistical tools after adopting to economic life.
- Economics and econometrics: - Economics only provides principle/laws pertaining to socio-economic behaviour of various economic units at a micro and macro levels. It is confusing to express all relationship in descriptive terms.
Besides, collection and measurement of various socio-economic parameters is also required to be done to verify the economic theory/economic principle/laws.
In order to do so mathematical economics, statistics and economics are extensibility used to express economic relationships.
These tools make econometrics exact measurable verifiable and comparable.
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