Econometrics: Essential Concepts and Applications

Econometrics is used to create the values for economic relationships. Let's know its concept, model types, aims, methodology, and practical applications.

Team Desklib

2022-03-10

Econometrics can be a common topic to some and a completely alien subject to most. So, I would start with asking a basic question, have you ever understood the economic decisions and policies that government induces in our country? Have you ever understood truly the terms and conditions and policies of your health insurance? Do you understand the economic changes in the labour, financial, or development sector?

The common person cannot understand everything unless they have gathered up a degree in economics or researched a lot in this department. So in this blog, we will explain the concept of econometrics today and determine how it is essential. Learning this can be beneficial for you to identify and understand how it affects the consumer market, government decisions, prices of goods, and other real-life issues of financial and economic changes you face on a day-to-day basis.

What is Econometrics?

Econometrics is used to create the values for economic relationships with the help of the integration of economics, along with mathematical and statistical objectives of these parameters. In a general language, econometrics uses economics theories with mathematical forms and combines them with empirical economics. With the help of econometrics methods, it is easy to obtain parameter values to identify the coefficient relationship of mathematics and economics.
In every aspect, such as engineering science, medical science, and agriculture, where there is a need to find a mathematical format to identify a solution or policy, this econometrics tool can be helpful.

Econometrics Model

There are generally two types of models: economic and econometrics models. Now you would ask the difference between these two models, which is the objective of both the models.

The Economic Model is different from the econometric model as the econometric model has the objective of explaining the complex model with the help of developing a simple model. It can lead to getting an oversimplified result or an unrealistic assumption. Another difference between an economic and econometric model is that an economic model is based on a set of assumptions that can describe the economy's behaviour. On the other hand, an econometric model is based on equations that can describe the economy's impact on business management. It can be an observed variable or disturbance equation, but there is a statement to derive the variables instead of assumptions.

Different Types Of An Econometric Model

1. Linear Regression Models

We all have studied the concept of linear regression and linear equations in the mathematics of higher studies. The concept of X and Y. is the most common statistic economic tool used in econometrics, and its relationship is varied from independent and dependent variables and their different circumstances. For example, if X is the income and Y is the consumption, it will help find the necessary logistics of their relationship and parameters.

2. Panel Data Models

This econometrics model determines the cross-sections study of a time series and integrates it with both space and time. It determines the status of a time frame, for example, 10 years of study; however, the panel data model also determines the space and place which needs to be considered in that study.

3. Probit and Logit Models

Identifying decisions such as eligibility of a person to vote or take a loan is done through this econometrics model with a common code of 0 or 1 variable and achieving the binary response to derive a conclusion.

4. Count Data Models

This econometrics model is used consciously or unknowingly; it is the basic counting of the system. For example, counting the number of students and identifying their validity. Such as identifying a total number of doctors, a total number of people, a total number of employees in a company, and several managers handling them. This model determines to create the policies for increasing or decreasing the number.

5. Survival Analysis

This model is used to determine the result based on observation and samples, such as total deaths during the treatment, performance of the loan, and default of a person to repay it. The survival analysis is taken from the failure of an event and is tracked to determine those samples for the analyses for the result of time and events.

6. Spatial Econometrics

When there is a requirement of determining the geographical condition and its proximity, when there is a requirement to identify the coordinates of units or distance between those units, then the spatial model of econometrics is applied. For example, when it is required to identify a real estate price, population a region, or postal address, it can use in those scenarios.

7. Propensity Score Matching Model

This econometrics model is applied when there is a requirement of estimating the effectiveness of any policy, treatment, or intervention of any cause. It evaluates the earlier situation with the future outcome resulting in determining the control or effectiveness of that policy or treatment. Such as when a company identifies the effect of their training program or when the government needs to identify their policy or program effectiveness.

Aims Of Econometrics

There are various aims of econometrics that are created to derive its model.

Specification of its model- The first aim of econometrics is to formulate the econometric model. An economic model can be a base to derive an econometric model, but stochastic variables, which need specific, such as mathematic numerical terms, require econometrics.
Testing and estimation of the model- The estimation of the model is also an aim of econometrics as its models are estimated and tested based on their set of data and are compared for their suitability. Whichever model is suitable is later selected as the appropriate model, which is dependent on its being the unknown parameter of its model.
Usage of the econometric model- the model later is used to formulate policies, another aim of econometrics. The application of these models very much helps the policy decision, and it also helps in forecasting the adjustment required for the economic variables to be helped.

Methodology Of Econometrics

Creating a statement of a theory- the first step of this econometrics analysis is to determine the statement of theory or create a hypothesis of the situation. Such as, if you want to identify the expenditure and income of a household, the hypothesis is to determine the income and consumption of all the working and earning members and determine the increase and decrease in their income.
Specifying the mathematical model for the theory- If the mathematical model is required, that needs to be specified. Income can be X, consumption can be Y, and can explain an independent variable through their specified model.
Specifying the econometric model- after creating the specific model, there is a requirement to specify the econometric model, such as if the mathematical model needs to determine the exact relationship between consumption and income. Then there needs to be a specific econometrics model such as time series, linear regression, etc.
Obtaining data for the same- After determining the model of both mathematical and econometrics, obtaining data for the theory is important. For example, if the data needs to be derived for the last 10 years or different age groups, then the specific data of that period, place, or community is required.
Estimating the parameters of the selected model- Now, when there is all the collected data, the estimation of parameters is essential, and the concluded data will be interpreted needs to be determined. It can be estimated by determining the parameters of that model based on geographical and coordinates analysis.
Testing of Hypothesis- The data analyzed and interpreted now needs to be tested about their assurance and clarity.
Future forecasting- if the selected model is not going according to the hypothesis, can use it to consider and predict the future variable of the situation and explain how the predicted variable can and cannot be applied according to the future expectation.
Using the model by deriving policies- the final part of econometrics is to use the derived model to create policies for the future and determine their future expectations. It has a better chance of going according to the expectation as it is mathematically derived.

Practical Application Of Econometrics

To forecast the macroeconomic indicators - When a government official or even a commoner needs to identify the use and effectiveness of government fiscal policy or monetary policy which was expected to deliver an aggregate performance. At that time, econometrics can be applied with the time-series model or the propensity score matching model.
To identify the factors affecting business entry and exit in a new market - Factors such as the current level of profit, government policies, market structure, fixed cost of business, and other aspects can influence its exit and entry. A firm can determine its factors and the best possible solution with the help of econometrics estimation and its models.
Determining the employment law and its influence - The price floor affects the minimum wage law can determine the employment wage to be higher and lower. This change in a high or lower wage is determined by the change in the demand and supply curve of the labour condition in the market. The econometrics model helps estimate the effect of such policies and their impact on the labour force.
Calculation of Tax credits and R&D expenditure in business - When a firm needs to calculate their innovation and access of incentives and also engage in their activities such as the development of their product or improve the quality of their product which is only possible by research and development it can vary by the size of a firm. It is also affected by the government's tax credit policy, which eventually will determine their higher expenditure. The firm can analyze their situation of profit and expenditure with the help of econometrics and use it resourcefully in better research and development to earn profit.
Estimating immigration impact on native workers - When a country has many immigrant workers, such as Canada, their supply of workers increases and decreases all workers' equilibrium wages. It affects the native workers of a country and the country's labour market, increasing unemployment and recession. Although immigration has positive effects, econometrics and its models can determine a negative impact.

Econometrics can be identified as a complex term; however, this study can be useful in various areas of life. Economics is not only restricted to its means of theoretical aspect and learning. Similarly, econometrics can help determine policy and how these policies are applied, applying its usage to the current unpredictable market conditions.

Frequently Asked Questions

Q1- How can I learn basic econometrics?

Answer- To learn basic econometrics, one can join an academy or a course that can teach the basics of econometrics. Also, there are certain online courses such as MIT Open course Ware, CrunchEconometrix.com, and others such as Linear Regression and modelling course, model thinking, etc.

Q2- How is econometrics important for finance?

Answer- Econometrics can help in the management and development of various financial institutes with its risk assessment and pricing model, through which econometrics can become an essential component of finance.

Q3- What are Econometrics' goals?

Answer- Econometrics aims to conclude its various formats by analyzing, forecasting, and estimating the exact conclusion.

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