Lecture 1

Question 1

What are the 3 major uses of econometrics

Answer 1

1. Describe economic reality
2. Test hypotheses about economic theory
3. Forecast future economic activity

Question 2

Explain the 3 steps involved in quantifying economic relationship

Answer 2

1. Specifying/ Identifying theoretical economic relationships between variables
2. Collecting data on those variables identified by the theoretical model.
3. Obtaining estimates of the parameters in the theoretical relationships

Question 3

Explain what correlation measures

Answer 3

Measures the linear relationship between x and Y from a probability distribution.

Question 4

Explain the main advantage and disadvantage of using the correlation measure

Answer 4

Correlation divides by the variance which ensures it produces a scale-free measure with value always between -1 and 1. The main disadvantage of using correlation is that it only takes into account linear relationships. For example, if there was a quadratic relationship between 2 variables correlation would fail to take this into account.

Question 5

Explain what the covariance measures

Answer 5

The covariance measures the average cross product of devotions of X around its mean.

Question 6

What is linear regression used to measure

Answer 6

Linear regression models the relationship between 2 variables that are assumed to be linear,

Question 7

What does ei (epsilon) measure?

Answer 7

Epsilon measures the error and this is calculated by subtracting the estimated value of Y from the estimated value of Y.

Question 8

What is the equation for a standard linear regression equation

Answer 8

Y=A + Bx + e

Question 9

What are the 4 assumptions of the CLRM?

Answer 9

1. E(e|x)=0 the error term is independent of xi see notes for full proof.
2. V(e|x)=O^2 ( theta squared) This shows that the variance of the error term conditioned on x equals a constant. How far the estimated value is from the actual value is assumed to be constant throughout.
3. Cov(ei,ej|x)=0, information about the ith person had no info about the Jth person.
4. Ei|x-N(0,0^2), The regression model follows a normal distribution with a mean of 0 and a standard deviation of theta squared.

Question 10

How do you derive a from the residual ei

Answer 10

1. Sqaure the residual ei and then replace with y-a-bx

2. Differentiate with respect to a and replace with y bar and x bar and then you should have a=

Question 11

How do you derive b from the residual ei

Answer 11

1. Replace ei with y-a-bx squares and then differentiate with respect to b.
2. replace a with the equation derived and rearrange for b see notes for full detail.