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Methodology of Econometrics
S K KotheAssistant Professor
Department of Economics
University of Mumbai
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Methodology of Econometrics
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Statement of theory or hypothesis:yKeynes stated: Consumption increases as
income increases, but not as much as the
increase in income. It means that Themarginal propensity to consume (MPC) for aunit change in income is grater than zero
but less than unit
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Specification of the mathematical
model of the theory
yY = 1+ 2X ; 0 < 2< 1
y
Y= consumption expenditureyX= incomey 1 and 2 are parameters; 1 is intercept, and 2 is slope
coefficients
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Specification of the econometric model
of the theory
yY = 1+ 2X + u ; 0 < 2< 1;
y
Y = consumption expenditure;yX = income;y 1 and 2 are parameters; 1is intercept and 2 is slope
coefficients; u is disturbance term or error term. It is arandom or stochastic variable
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Obtaining Data
y
Y= Personal consumption expenditureyX= Gross Domestic Product all in Billion
US Dollars
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Obtaining Data
Year X Y
1980
19811982
1983
1984
1985
1986
1987
1988
1989
1990
1991
2447.1
2476.92503.7
2619.4
2746.1
2865.8
2969.1
3052.2
3162.4
3223.3
3260.4
3240.8
3776.3
3843.13760.3
3906.6
4148.5
4279.8
4404.5
4539.9
4718.6
4838.0
4877.5
4821.0
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Estimating the Econometric Modely Y^ = - 231.8 + 0.7194 X (1.3.3)
y MPC was about 0.72 and it means that for the
sample period when real income increases 1USD, led (on average) real consumptionexpenditure increases of about 72 cents
y Note: A hat symbol (^) above one variable willsignify an estimator of the relevant population
value
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Hypothesis Testingy Are the estimates accord with the
expectations of the theory that is being
tested? Is MPC < 1 statistically? If so, itmay support Keynes theory.
yConfirmation or refutation of
economic theories based on sampleevidence is object of StatisticalInference (hypothesis testing)
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Forecasting or Prediction With given future value(s) of X, what is the future
value(s) ofY?
GDP=$6000Bill in 1994, what is the forecastconsumption expenditure?
Y^= - 231.8+0.7196(6000) = 4084.6
Income Multiplier M = 1/(1 MPC) (=3.57). decrease
(increase) of $1 in investment will eventually lead to$3.57 decrease (increase) in income
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Using model for control or policy
purposesy Y=4000= -231.8+0.7194 X Xb 5882
y MPC = 0.72, an income of $5882 Bill will produce an
expenditure of $4000 Bill. B y fiscal and monetarypolicy, Government can manipulate the control
variableXto get the desired level of target variableY
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Economic Theory
Mathematic Model Econometric Model Data Collection
Estimation
Hypothesis Testing
Forecasting
Applicationin control or
policystudies
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ThankYou