Understanding Econometrics in Economics

Econometrics In Economics

Econometrics is a method in economics which takes concepts from mathematics, statistics and economics for studying various economic phenomena. An econometrician has to be a competent mathematician and statistician who is an economist by training. Fundamental knowledge of mathematics, statistics and economic theory are a necessary prerequisite for this field. It is the unification of economic theory, mathematics and statistics into econometrics. Each view point, by itself is necessary but not sufficient for a real understanding of the quantitative relations in modern economic life.

Ragnar Frisch is credited with coining the term ‘econometrics’ and he is one of the founders of the Econometrics Society. Econometrics aims at giving empirical content to economic relationships. The three key ingredients are economic theory, economic data and statistical methods. Neither ‘theory without measurement’, nor ‘measurement without theory’ are sufficient for explaining economic phenomena.

Econometrics also provides quantitative estimates of price and income elasticities of demand, estimates of returns to scale in production, technical efficiency, the velocity of money, etc. It also provides predictions about future interest rates, unemployment, or GNP growth.

Econometrics has evolved as a separate discipline from mathematical statistics because the former focuses on the problems inherent in collecting and analyzing nonexperimental economic data. Nonexperimental data are not accumulated through controlled experiments on individuals, firms, segments of the economy. Experimental data are often collected in laboratory environments in the natural sciences, but they are much difficult to obtain in the social sciences. Although some social experiments can be devised, it is often impossible, prohibitively expensive, or morally repugnant to conduct the kind of controlled experiments that would be needed to address economic issues.

Many of the econometric methods represent application of standard statistical models to study economic theories. Econometrics is an observational study of events which is unlike the classical approach of statistics which deal with controlled experiments. In order for obtaining reasonably valid results, econometrics must apply those statistical equations which hold true for observations rather than experiments.

Econometric methods are relevant in virtually every branch of applied economics. They come into play either when we have an economic theory to test or when we have a relationship in mind that has some importance for business decisions or policy analysis. An empirical analysis uses data to test a theory or to estimate a relationship.

In cases which involve the testing of economic theories, a formal economic model is constructed. An economic model consists of mathematical equations that describe various relationships. Economists are well known for their building of models to describe a vast array of behaviors.

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Our other articles on Economics include Labor Economics, Inflation, Demand for Money, Balance of Payments and Balance of Payment (contd)