Internal Econometrics

Q.
What is Econometrics, Steps taken by econometrician in carrying out an

empirical Study. Different types of data sets-cross section, time series and panel
data and problem associated with them, Scaling and units of measurement,
Review of hypothesis testing, some examples of usage of econometrics in business
especially in marketing, introduction to econometric software. What is
Econometrics?
Econometrics is the application of statistical and mathematical methods to economic
data for analyzing and testing theories, making predictions, and solving real-world
problems. It helps in understanding relationships between different economic variables
(like income, price, demand) and making informed decisions.
Steps Taken by an Econometrician in an Empirical Study:

1. Formulate a Hypothesis: Identify the problem or question, e.g., “How does
advertising affect sales?”
2. Collect Data: Gather relevant data related to the variables of interest.
3. Specify a Model: Create an equation that represents the relationship between
variables, e.g.,
Sales=β0+β1Advertising+u\text{Sales} = \beta_0 + \beta_1 \text{Advertising} +
uSales=β0+β1Advertising+u.
4. Estimate Parameters: Use econometric software to calculate the coefficients
(like β0\beta_0β0 and β1\beta_1β1) that show the impact of each variable.
5. Test the Model: Check if the results align with the hypothesis using statistical
tests.
6. Interpret Results: Analyze the outcomes to draw conclusions, like whether
advertising significantly affects sales.
7. Refine or Extend the Model: Improve the model if necessary by adding more
variables or data.
Types of Data Sets:

1. Cross-Section Data:
o Definition: Data collected at a single point in time for different entities
(e.g., income of 100 families in 2023).
o Problem: Individual differences (heterogeneity) may create bias.
o Example in Business: Analyzing customer satisfaction scores across
stores.
2. Time Series Data:
o Definition: Data collected over time for the same entity (e.g., monthly
sales of a product from 2015–2023).
o Problem: Issues like trends, seasonality, and autocorrelation (past values
influencing current values).
o Example in Business: Forecasting sales based on past trends.
3. Panel Data:
o Definition: Combines cross-section and time series (e.g., yearly income
of 100 families from 2010–2023).
o Problem: Complex models and potential multicollinearity (variables too
closely related).
o Example in Business: Examining employee performance over multiple
years across departments.
Scaling and Units of Measurement:

• Data must often be scaled or standardized for consistency:
o Scaling: Transform variables to the same range (e.g., 0–1) for easy
comparison.
o Unit Adjustments: Convert variables to comparable units (e.g.,
thousands of dollars or millions of rupees).
• Importance: Avoids misleading results due to differences in measurement units.
Review of Hypothesis Testing:

• Null Hypothesis (H0H_0H0): Assumes no relationship or effect exists (e.g.,
"Advertising has no effect on sales").
• Alternative Hypothesis (H1H_1H1): Assumes a relationship or effect exists
(e.g., "Advertising increases sales").
• Steps:
1. Set up H0H_0H0 and H1H_1H1.
2. Choose a significance level (e.g., 5%).
3. Perform a statistical test (e.g., t-test, F-test).
4. Decide: If the p-value < significance level, reject H0H_0H0 and accept
H1H_1H1.
Examples of Econometrics in Business and Marketing:

1. Demand Estimation:
o Predict how changes in price or income affect product demand.
o Example: Estimating the price elasticity of coffee.
2. Marketing Campaigns:
o Analyze the impact of advertising spend on sales.
o Example: Assessing whether online ads drive more sales than traditional
TV ads.
3. Customer Segmentation:
o Use econometrics to classify customers based on spending habits.
o Example: Grouping customers into high, medium, or low spenders.
4. Forecasting:
o Predict future trends like sales, costs, or inventory needs.
o Example: Forecasting the demand for a product during festive seasons.
Introduction to Econometric Software:

1. Popular Software:
o R: Open-source, highly customizable.
o STATA: User-friendly for beginners, powerful for professionals.
o EViews: Best for time series analysis.
o Python: Widely used for econometrics and data analysis.
o Excel: Basic econometric analysis for small datasets.
2. Usage in Business:
o Automates calculations and statistical tests.
o Visualizes data trends (graphs, charts).
o Helps in building predictive models.
Q. Assumptions, Estimation and properties of estimators, Goodness of fit, test of
hypothesis
Assumptions in Econometrics
When creating econometric models, certain assumptions are made to ensure the results are
reliable. These are based on the Classical Linear Regression Model (CLRM):
1. Linearity: The relationship between variables should be linear (e.g., Y=β0+β1X+uY

= \beta_0 + \beta_1X + uY=β0+β1X+u).
2. No Multicollinearity: Independent variables shouldn’t be highly correlated with each
other.
3. Homoscedasticity: The variance of errors (residuals) remains constant across all
levels of the independent variable.
4. No Autocorrelation: Error terms shouldn’t influence each other (especially in time-
series data).
5. Normality of Errors: The error terms are normally distributed.
6. Exogeneity: Independent variables should not be correlated with the error term.
Estimation and Properties of Estimators
Estimators:
These are formulas or methods used to estimate unknown parameters in a model (like
β0\beta_0β0 and β1\beta_1β1) based on sample data.
Methods of Estimation:
1. Ordinary Least Squares (OLS): The most common method, which minimizes the
sum of squared errors to find the best-fitting line.
Properties of a Good Estimator (BLUE):
1. Best: Provides the most accurate estimation.

2. Linear: The estimator is a linear function of the data.
3. Unbiased: On average, the estimate is equal to the true parameter value.
4. Efficient: Among all unbiased estimators, it has the smallest variance.
Goodness of Fit
Goodness of fit shows how well the model fits the data. It tells you how much of the variation
in the dependent variable (e.g., sales) is explained by the independent variable(s) (e.g.,
advertising).
1. R-Squared (R2R^2R2):
oMeasures the percentage of variation in the dependent variable explained by
the model.
o R2=1R^2 = 1R2=1: Perfect fit.
o R2=0R^2 = 0R2=0: No fit.
o Example: If R2=0.8R^2 = 0.8R2=0.8, it means 80% of sales variation is
explained by the independent variable(s).
2. Adjusted R-Squared:
o Adjusts R2R^2R2 for the number of variables in the model to avoid
overfitting.
Test of Hypothesis
Hypothesis testing helps determine whether the assumptions or predictions of your model are
supported by the data.
Steps in Hypothesis Testing:
1. State the Hypotheses:

o Null Hypothesis (H0H_0H0): Assumes no effect or relationship (e.g.,
“Advertising has no impact on sales”).
o Alternative Hypothesis (H1H_1H1): Assumes an effect or relationship exists
(e.g., “Advertising increases sales”).
2. Choose a Significance Level:
o Usually 5% (α=0.05 \alpha = 0.05α=0.05), meaning there’s a 5% chance of
rejecting H0H_0H0 when it’s true.
3. Perform the Test:
o Use t-tests (for individual coefficients), F-tests (for overall model), or z-tests.
4. Decision Rule:
o If p-value < 0.05: Reject H0H_0H0 (significant result).
o If p-value > 0.05: Fail to reject H0H_0H0 (not significant).
Example:
• You test whether advertising affects sales.

• Null hypothesis (H0H_0H0): No effect of advertising.
• Alternative hypothesis (H1H_1H1): Advertising increases sales.
• If the p-value = 0.02 (less than 0.05), you reject H0H_0H0 and conclude advertising
does affect sales.

Internal Econometrics

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Q.

What is Econometrics, Steps taken by econometrician in carrying out an

Steps Taken by an Econometrician in an Empirical Study:

Types of Data Sets:

Scaling and Units of Measurement:

Review of Hypothesis Testing:

Examples of Econometrics in Business and Marketing:

Introduction to Econometric Software:

1. Linearity: The relationship between variables should be linear (e.g., Y=β0+β1X+uY

Estimation and Properties of Estimators

Properties of a Good Estimator (BLUE):

1. Best: Provides the most accurate estimation.

Steps in Hypothesis Testing:

1. State the Hypotheses:

• You test whether advertising affects sales.

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