Course Convenor/Lecturer:

Anh-Tuan Doan, Ph.D.

[email protected]

All emails should insert “Applied Econometrics – class –

student name” at the start of subject.

Without this course code, I will not reply to your email.

1
Learning resources
Prescribed Wooldridge, J.M. (2013). Introductory
Textbook Econometrics: A Modern Approach, 5th or 6th
Edition, South-Western Cengage Learning.

Recommended Gujarati, D.N. (2009). Essentials of Econometrics,

readings McGraw-Hill/Irwin.
Gujarati, D.N. (2008). Basic Econometrics,
McGraw-Hill.
Ramanathan, R. (2002).Introductory Econometrics
with Applications, Harcourt CollegePublishers.

2
3
Assessment
ASSESSMENT VALUE
ASSESSMENT ITEM AND DUE DATE
NUMBER (/100)

1. Class attendance & participation (Individual) 10%

Mid-term exam (Closed book,15-minute

2. reading + 1-hour writing) (Individual) 20%
Due: Session 10
Two home assignments (Individual)
3. 20%
Due: Sessions 10 and 20
Final exam (Closed book,15-minute reading +
4. 2-hour writing) (Individual) 50%
Due: TBA

4
The Nature of
Chapter 1
Econometrics
and Economic
Data

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What is Econometrics?

6
Why do we study econometrics?
• Rare in economics (and many other areas without
labs!) to have experimental data
• Need to use non-experimental, or observational data to
make inferences
• Important to be able to apply economic theory to real
world data

7
The Nature of Econometrics
and Economic Data
● What is econometrics?
• Econometrics = use of statistical methods to analyze economic data
• Econometricians typically analyze nonexperimental data

● Typical goals of econometric analysis

• Estimating relationships between economic variables
• Testing economic theories and hypotheses
• Forecasting economic variables
• Evaluating and implementing government and business policy

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The Nature of Econometrics
and Economic Data
● Steps in econometric analysis
• 1) Economic model (this step is often skipped)
• 2) Econometric model

● Economic models
• Maybe micro- or macromodels
• Often use optimizing behaviour, equilibrium modeling, …
• Establish relationships between economic variables
• Examples: demand equations, pricing equations, …

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Why is it so important?
• An empirical analysis uses data to test a theory or to
estimate a relationship
• A formal economic model can be tested
• Theory may be ambiguous as to the effect of some
policy change – can use econometrics to evaluate the
program

10
RESEARCH PROCESS

11
The Nature of Econometrics
and Economic Data
● Economic model of crime (Becker (1968))
• Derives equation for criminal activity based on utility maximization

Hours spent in
criminal activities

Age
“Wage” of cri-
minal activities Probability of Expected
Wage for legal
Other Probability of conviction if sentence
employment
income getting caught caught

• Functional form of relationship not specified

• Equation could have been postulated without economic modeling

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The Nature of Econometrics
and Economic Data
● Model of job training and worker productivity
• What is effect of additional training on worker productivity?
• Formal economic theory not really needed to derive equation:

Hourly wage

Years of formal
education Weeks spent
Years of work- in job training
force experience

• Other factors may be relevant, but these are the most important (?)

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The Nature of Econometrics
and Economic Data
● Econometric model of criminal activity
• The functional form has to be specified
• Variables may have to be approximated by other quantities

Measure of cri- Wage for legal Other Frequency of

minal activity employment income prior arrests
Unobserved deter-
minants of criminal
activity

e.g. moral character,

wage in criminal activity,
Frequency of Average sentence Age family background …
conviction length after conviction

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The Nature of Econometrics
and Economic Data
● Econometric model of job training and worker productivity

Unobserved deter-
minants of the wage

e.g. innate ability,

Hourly wage Years of formal Years of work- Weeks spent quality of education,
education force experience in job training family background …

● Most of econometrics deals with the specification of the error

● Econometric models may be used for hypothesis testing

• For example, the parameter represents “effect of training on
wage”
• How large is this effect? Is it different from zero?
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Why does econometric model always include an
error term (u)?
• Cannot identify exactly all factors impacting dependent
variable Y

• All necessary data elements are not included

• Measurement errors from data collection

16
The Nature of Econometrics
and Economic Data
● Econometric analysis requires data

● Different kinds of economic data sets

• Cross-sectional data
• Time series data
• Pooled cross sections
• Panel/Longitudinal data

● Econometric methods depend on the nature of the data used

• Use of inappropriate methods may lead to misleading results

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The Nature of Econometrics
and Economic Data
● Cross-sectional data sets
• Sample of individuals, households, firms, cities, states, countries,
or other units of interest at a given point of time/in a given period
• Cross-sectional observations are more or less independent
• For example, pure random sampling from a population
• Sometimes pure random sampling is violated, e.g. units refuse to
respond in surveys, or if sampling is characterized by clustering
• Cross-sectional data typically encountered in applied
microeconomics

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The Nature of Econometrics
and Economic Data
● Cross-sectional data set on wages and other characteristics

Indicator variables
(1 = yes, 0 = no)

Observation number Hourly wage Years of Years of

education experience
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The Nature of Econometrics
and Economic Data
● Cross-sectional data on growth rates and country
characteristics

Average growth rate of real Government consumption Adult secondary

per capita GDP as a percentage of GDP education rates

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The Nature of Econometrics
and Economic Data
● Time series data
• Observations of a variable or several variables over time
• For example, stock prices, money supply, consumer price index,
gross domestic product, annual homicide rates, automobile sales, …
• Time series observations are typically serially correlated
• Ordering of observations conveys important information
• Data frequency: daily, weekly, monthly, quarterly, annually, …
• Typical features of time series: trends and seasonality
• Typical applications: applied macroeconomics and finance

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The Nature of Econometrics
and Economic Data
● Time series data on minimum wages and related variables

Average minimum Average Unemployment Gross national

wage for the given year coverage rate rate product

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The Nature of Econometrics
and Economic Data
● Pooled cross sections
• Two or more cross sections are combined in one data set
• Cross sections are drawn independently of each other
• Pooled cross sections often used to evaluate policy changes
• Example:
• Evaluate effect of change in property taxes on house prices
• Random sample of house prices for the year 1993
• A new random sample of house prices for the year 1995
• Compare before/after (1993: before reform, 1995: after reform)

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The Nature of Econometrics
and Economic Data
● Pooled cross sections on housing prices
Property tax
Size of house
in square feet
Number of bedrooms
Number of bathrooms

Before reform

After reform

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The Nature of Econometrics
and Economic Data
● Panel or longitudinal data
• The same cross-sectional units are followed over time
• Panel data have a cross-sectional and a time series dimension
• Panel data can be used to account for time-invariant unobservables
• Panel data can be used to model lagged responses
• Example:
• City crime statistics; each city is observed in two years
• Time-invariant unobserved city characteristics may be modeled
• Effect of police on crime rates may exhibit time lag

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The Nature of Econometrics
and Economic Data
● Two-year panel data on city crime statistics

Each city has two time

series observations

Number of
police in 1986

Number of
police in 1990

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The Nature of Econometrics
and Economic Data
● Causality and the notion of ceteris paribus
Definition of causal effect of on :

“How does variable change if variable is changed

but all other relevant factors are held constant”

● Most economic questions are ceteris paribus questions

● It is important to define which causal effect one is interested

in

● It is useful to describe how an experiment would have to be

designed to infer the causal effect in question

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The Nature of Econometrics
and Economic Data
● Causal effect of fertilizer on crop yield
• “By how much will the production of soybeans increase if one
increases the amount of fertilizer applied to the ground”
• Implicit assumption: all other factors that influence crop yield such
as quality of land, rainfall, presence of parasites etc. are held fixed

● Experiment:
• Choose several one-acre plots of land; randomly assign different
amounts of fertilizer to the different plots; compare yields
• Experiment works because amount of fertilizer applied is unrelated
to other factors influencing crop yields

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The Nature of Econometrics
and Economic Data
● Measuring the return to education
• “If a person is chosen from the population and given another
year of education, by how much will his or her wage increase?”
• Implicit assumption: all other factors that influence wages such as
experience, family background, intelligence etc. are held fixed

● Experiment:
• Choose a group of people; randomly assign different amounts of
education to them (infeasable!); compare wage outcomes
• Problem without random assignment: amount of education is
related to other factors that influence wages (e.g. intelligence)

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The Nature of Econometrics
and Economic Data
● Effect of law enforcement on city crime level
• “If a city is randomly chosen and given ten additional police officers,
by how much would its crime rate fall?”
• Alternatively: “If two cities are the same in all respects, except that
city A has ten more police officers than city B, by how much would
the two cities‘ crime rates differ?”

● Experiment:
• Randomly assign number of police officers to a large number of
cities
• In reality, number of police officers will be determined by crime rate
(simultaneous determination of crime and number of police)

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The Nature of Econometrics
and Economic Data
● Effect of the minimum wage on unemployment
• “By how much (if at all) will unemployment increase if the minimum
wage is increased by a certain amount (holding other things fixed)?”

● Experiment:
• Government randomly chooses minimum wage each year and
observes unemployment outcomes
• Experiment will work because level of minimum wage is unrelated
to other factors determining unemployment
• In reality, the level of the minimum wage will depend on political
and economic factors that also influence unemployment

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distributed with a certain product or service or otherwise on a password -protected website or school-approved learning management system for classroom use. 31
The Nature of Econometrics
and Economic Data
● Testing predictions of economic theories
• Economic theories are not always stated in terms of causal effects
• For example, the expectations hypothesis states that long term
interest rates equal compounded expected short term interest rates

• An implicaton is that the interest rate of a three-months T-bill

should be equal to the expected interest rate for the first three
months of a six-months T-bill; this can be tested using econometric
methods

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distributed with a certain product or service or otherwise on a password -protected website or school-approved learning management system for classroom use. 32
Statistics Review
– Mean – Standard Deviation
– Median – Histograms
– Mode – Skewness
– Range – Kurtosis
– Interquartile Range – Covariance
– Variance – Correlation Coefficient

33
Measures of central tendency – Review

• Measures of the location of the middle or

the center of a distribution
• Mean
• Median
• Mode

34
Mean – Review

• Mean – Average value of a distribution; Most

commonly used measure of central tendency

• Median – This is the value of a variable such

that half of the observations are above and half
are below this value, i.e., this value divides the
distribution into two groups of equal size

• Mode - This is the most frequently occurring

value in the distribution
35
An Example Data Set
• Daily low temperatures recorded in Chapel Hill
(01/18-01/31, 2005, °F)
Jan. 18 – 11 Jan. 25 – 25
Jan. 19 – 11 Jan. 26 – 33
Jan. 20 – 25 Jan. 27 – 22
Jan. 21 – 29 Jan. 28 – 18
Jan. 22 – 27 Jan. 29 – 19
Jan. 23 – 14 Jan. 30 – 30
Jan. 24 – 11 Jan. 31 – 27
• For these 14 values, we will calculate all three
measures of central tendency - the mean, median,
and mode 36
Mean – Review
• Mean –Most commonly used measure of central
tendency
• Procedures
• (1) Sum all the values in the data set
• (2) Divide the sum by the number of values in the
n

x
data set
i

• Watch for outliers x i 1

n 37
Mean – Review
• (1) Sum all the values in the data set
 11 + 11 + 11 + 14 + 18 + 19 + 22 + 25 + 25 + 27 +
27 + 29 + 30 + 33 = 302
n

x
• (2) Divide the sum by the number
of values in the data set i

 Mean = 302/14 = 21.57

x i 1
n
• Is this a good measure of central tendency for this
data set?
38
Median – Review
• Median - 1/2 of the values are above it & 1/2 below
• (1) Sort the data in ascending order
• (2) Find the value with an equal number of values
above and below it
• (3) Odd number of observations  [(n-1)/2]+1 value
from the lowest
• (4) Even number of observations  average (n/2)
and [(n/2)+1] values
• (5) Use the median with asymmetric distributions,
particularly with outliers
39
Median – Review
• (1) Sort the data in ascending order:
 11, 11, 11, 14, 18, 19, 22, 25, 25, 27, 27, 29, 30, 33

• (2) Find the value with an equal number of values

above and below it
Even number of observations  average the
(n/2) and [(n/2)+1] values
 (14/2) = 7; [(14/2)+1] = 8
 (22+25)/2 = 23.5 (°F)

• Is this a good measure of central tendency for this

data? 40
Mode – Review
• Mode – This is the most frequently occurring value
in the distribution
• (1) Sort the data in ascending order
• (2) Count the instances of each value
• (3) Find the value that has the most occurrences
• If more than one value occurs an equal number of
times and these exceed all other counts, we have
multiple modes
• Use the mode for multi-modal data
41
Mode – Review
• (1) Sort the data in ascending order:
 11, 11, 11, 14, 18, 19, 22, 25, 25, 27, 27, 29, 30, 33
• (2) Count the instances of each value:
 11, 11, 11, 14, 18, 19, 22, 25, 25, 27, 27, 29, 30, 33

3x 1x 1x 1x 1x 2x 2x 1x 1x 1x
• (3) Find the value that has the most occurrences
 mode = 11 (°F)

• Is this a good measure of the central tendency of

this data set? 42
Measures of Dispersion – Review
• Measures of dispersion are concerned with the
distribution of values around the mean in data:
– Range

– Interquartile range

– Variance

– Standard deviation

43
An Example Data Set
• Daily low temperatures recorded in Chapel Hill
(01/18-01/31, 2005, °F)
Jan. 18 – 11 Jan. 25 – 25
Jan. 19 – 11 Jan. 26 – 33
Jan. 20 – 25 Jan. 27 – 22
Jan. 21 – 29 Jan. 28 – 18
Jan. 22 – 27 Jan. 29 – 19
Jan. 23 – 14 Jan. 30 – 30
Jan. 24 – 11 Jan. 31 – 27
• For these 14 values, we will calculate all measures
of dispersion
44
Range – Review
• Range – The difference between the largest and
the smallest values
• (1) Sort the data in ascending order
• (2) Find the largest value
 max
• (3) Find the smallest value
 min
• (4) Calculate the range
 range = max - min
• Vulnerable to the influence of outliers 45
Range – Review
• Range – The difference between the largest and
the smallest values
• (1) Sort the data in ascending order
 11, 11, 11, 14, 18, 19, 22, 25, 25, 27, 27, 29, 30, 33
• (2) Find the largest value
 max = 33
• (3) Find the smallest value
 min = 11
• (4) Calculate the range
 range = 33 – 11 = 22 46
Interquartile Range – Review

• Interquartile range – The difference between the

25th and 75th percentiles

• (1) Sort the data in ascending order

• (2) Find the 25th percentile – (n+1)/4 observation

• (3) Find the 75th percentile – 3(n+1)/4 observation

• (4) Interquartile range is the difference between

these two percentiles
47
Interquartile Range – Review
• (1) Sort the data in ascending order
 11, 11, 11, 14, 18, 19, 22, 25, 25, 27, 27, 29, 30, 33

• (2) Find the 25th percentile – (n+1)/4 observation

 (14+1)/4 = 3.75  11+(14-11)*0.75 = 13.265

• (3) Find the 75th percentile – 3(n+1)/4 observation

 3(14+1)/4 = 11.25  27+(29-27)*0.25 = 27.5

• (4) Interquartile range is the difference between

these two percentiles
 27.5 – 13.265 = 14.235 48
Variance – Review

• Variance is formulated as the sum of squares of

statistical distances (or deviation) divided by
the population size or the sample size minus one:
n

 (x  x)
i
2

s 
2 i 1
n 1
49
Variance – Review
• (1) Calculate the mean
 x
• (2) Calculate the deviation for each value
 xi  x
• (3) Square each of the deviations
 ( xi  x ) 2

• (4) Sum the squared deviations

  i
( x  x ) 2

• (5) Divide the sum of squares by (n-1) for a sample

  i
( x  x ) 2
/( n 1)
50
Variance – Review
• (1) Calculate the mean
 x  21.57
• (2) Calculate the deviation for each value
 xi  x
Jan. 18 (11 – 21.57) = -10.57 Jan. 25 (25 – 21.57) = 3.43
Jan. 19 (11 – 21.57) = -10.57 Jan. 26 (33 – 21.57) = 11.43
Jan. 20 (25 – 21.57) = 3.43 Jan. 27 (22 – 21.57) = 0.43
Jan. 21 (29 – 21.57) = 7.43 Jan. 28 (18 – 21.57) = -3.57
Jan. 22 (27 – 21.57) = 5.43 Jan. 29 (19 – 21.57) = -2.57
Jan. 23 (14 – 21.57) = -7.57 Jan. 30 (30 – 21.57) = 8.42
Jan. 24 (11 – 21.57) = -10.57 Jan. 31 (27 – 21.57) = 5.42
51
Variance – Review
• (3) Square each of the deviations
 ( xi  x ) 2

Jan. 18 (-10.57)^2 = 111.76 Jan. 25 (3.43)^2 = 11.76

Jan. 19 (-10.57)^2 = 111.76 Jan. 26 (11.43)^2 = 130.61
Jan. 20 (3.43)^2 = 11.76 Jan. 27 (0.43)^2 = 0.18
Jan. 21 (7.43)^2 = 55.18 Jan. 28 (-3.57)^2 = 12.76
Jan. 22 (5.43)^2 = 29.57 Jan. 29 (-2.57)^2 = 6.61
Jan. 23 (7.57)^2 = 57.33 Jan. 30 (8.43)^2 = 71.04
Jan. 24 (-10.57)^2 = 111.76 Jan. 31 (5.43)^2 = 29.57

• (4) Sum the squared deviations

  (x  x)
i
2
= 751.43

52
Variance – Review

• (5) Divide the sum of squares by (n-1) for a

sample

 i
( x  x ) 2
/( n 1)

= 751.43 / (14-1) = 57.8

• The variance of the Tmin data set (Chapel Hill)

is 57.8

53
Standard Deviation – Review
• Standard deviation is equal to the square root
of the variance

 (x  x)
i
2

s i 1
n 1
• Compared with variance, standard deviation
has a scale closer to that used for the mean and
the original data
54
Standard Deviation – Review
• (1) Calculate the mean
 x
• (2) Calculate the deviation for each value
 xi  x
• (3) Square each of the deviations
 ( xi  x ) 2

• (4) Sum the squared deviations

  i
( x  x ) 2

• (5) Divide the sum of squares by (n-1) for a sample

  i
( x  x ) 2
/( n 1)
• (6) Take the square root of the resulting variance
  i
( x  x ) 2
/( n  1) 55
Standard Deviation – Review

• (1) – (5)
 s2 = 57.8

• (6) Take the square root of the variance

 57.8  7.6
• The standard deviation (s) of the Tmin
data set (Chapel Hill) is 7.6 (°F)
56
Histograms – Review
• We may also summarize our data by constructing
histograms, which are vertical bar graphs
• A histogram is used to graphically summarize
the distribution of a data set
• A histogram divides the range of values in a data
set into intervals
• Over each interval is placed a bar whose height
represents the percentage of data values in the
interval.
57
Building a Histogram – Review
• (1) Develop an ungrouped frequency table
 11, 11, 11, 14, 18, 19, 22, 25, 25, 27, 27, 29, 30, 33

11 3
14 1
18 1
19 1
22 1
25 2
27 2
29 1
30 1
33 1
58
Building a Histogram – Review
• 2. Construct a grouped frequency table
 Select a set of classes

11-15 4

16-20 2
21-25 3

26-30 4

31-35 1

59
Building a Histogram – Review
• 3. Plot the frequencies of each class

60
Skewness – Review
• Skewness measures the degree of asymmetry
exhibited by the data
• Positive skewness – More observations below
the mean than above it
• Negative skewness – A small number of low
observations and a large number of high ones
n

 (x  x)
i
3
For the example data set:
skewness  i 1
3
ns Skewness = -0.2069
61
Skewness – Review

Source: http://library.thinkquest.org/10030/3smodsas.htm

62
Skewness – Review
n
Mode
Median
 i
( x  x ) 3

skewness  i 1
3
Mean
ns

Skewness > 0 (Positively skewed)

63
Skewness – Review
n

 i
( x  x ) 3
Mode
skewness  i 1
ns 3 Median

Mean

A B

Skewness < 0 (Negatively skewed)

64
Skewness – Review

 i
( x  x ) 3

skewness  i 1
3
ns

Source: http://mathworld.wolfram.com/NormalDistribution.html

Skewness = 0 (symmetric distribution) 65

Skewness – Review

Skewness = -0.2069 (Negatively skewed) 66

Kurtosis – Review
• Kurtosis measures how peaked the histogram is
• Leptokurtic: a high degree of peakedness
– Values of kurtosis over 0
• Platykurtic: flat histograms
– Values of kurtosis less than 0
n

 (x  x)
i
4
For the example data set:
kurtosis  i
4
3
ns Kurtosis = 1.6891 > 0
67
Kurtosis – Review
n

 (x  x)
i
4

kurtosis  i
4
3
ns

68
Kurtosis – Review

Source: http://espse.ed.psu.edu/Statistics/Chapters/Chapter3/Chap3.html 69
Kurtosis – Review
• Platykurtic– When the kurtosis < 0, the
frequencies throughout the curve are closer to be
equal (i.e., the curve is more flat and wide)
• Thus, negative kurtosis indicates a relatively flat
distribution
• Leptokurtic– When the kurtosis > 0, there are
high frequencies in only a small part of the curve
(i.e, the curve is more peaked)
• Thus, positive kurtosis indicates a relatively
peaked distribution
70
Kurtosis – Review

Kurtosis = 1.6891 > 0 (Leptokurtic)

71
Covariance – Review
• Random variables X and Y have a joint distribution
• The covariance between X and Y is
1 n
  
Cov  X ,Y    X i  X Yi  Y   XY
n i 1
• The covariance is a measure of the linear association
between X and Y; its units are units of X  units of Y
• cov(X,Y) > 0 means a positive relation between X and Y
• If X and Y are independently distributed, then cov(X,Y) = 0
(but not vice versa!!)

72
An Example - Covariance
• The covariance between Test Score and STR is negative:

so is the correlation…
73
Correlation Coefficient – Review
• The correlation coefficient is defined in terms of the
covariance:

cov( X ,Y )  XY
corr  X ,Y    r XY
var( X )var(Y )  X  Y

• –1 < corr(X,Y) < 1

• corr(X,Y) = 1 mean perfect positive linear association
• corr(X,Y) = –1 means perfect negative linear association
• corr(X,Y) = 0 means no linear association

74
The correlation
coefficient
measures
linear
association

75
Exercise
Obs 1 2 3 4 5 6 7 8 9 10 11 12 13
wage 3.1 3.2 3 6 5.3 8.8 11 5 3.6 18 6.3 8.1 8.8
educ 11 12 11 8 12 16 18 12 12 17 16 13 12

Calculate : – Mean – Standard Deviation

– Median – Skewness
– Mode – Kurtosis
– Range – Covariance
– Interquartile Range – Correlation Coefficient
– Variance
76
Introduction to STATA
• Data input

• Manual data entry

• Copy Excel file and paste
• Import data

• Obtain statistics value

• Data transformation

77