Principle Foundations Home Page
Functions of Econometrics
and
Format of Regression Analysis
Econometrics has basically
three closely interrelated functions. The first is to test economic
theories or hypotheses. For example, is consumption directly related to
income? Is the quantity demanded of a commodity inversely related to its
price? The second function of
econometrics is to provide numerical estimates of the coefficients of
economic relationships. These are essential in decision making. For
instance, a government policy maker needs to have an accurate estimate of
the coefficient of the relationship between consumption and income in
order to determine the stimulating ( ie the multiplier) effect of a
proposed tax reduction. A manager needs to know if a price reduction
increases or reduces the total sales revenues of the firm and by how much.
The third function of econometrics is the forecasting of economic events.
This, too, is necessary in order for policy makers to take appropriate
corrective action if the rate of unemployment or inflation is predicted to
rise in the future.
It is identified with regression analysis, according to which a dependent variable is related to one or more independent (ie. explanatory) variables. But since the relationships amongst the economic variables are inexact, a disturbance or error term must be included. Thus, econometrics can deduct or predict a wide variety of relationships among variables in models like a production function or a consumption function model etc.
Regression analysis studies the causal relationship between one economics variable to be explained (the dependent variable) and one or more independent or explanatory variables. When there is only one independent or explanatory variable, we have simple regression. In the more usual case of more than one independent or explanatory variable, we have multiple regression.
A (random)
disturbance error must be included in the exact relationship postulated by
economic theory and mathematical economics in order to make them
stochastic (i.e. in order to reflect the fact that in the year world,
economic relationships among economic variables are inexact and somewhat
erratic).
Copyright © 2002
Back to top
Evgenia Vogiatzi <<Previous Next>>
