Nature of Econometrics

Econometrics is a branch of economics which deals with economic economic phenomena based on the concurrent development of theory and observation, related by appropriate method of inference [Samuelson Koopmans and Stone, 1954]. We should notice three issues being emphasized in the above statement. First. econometrics deals with quantitative analysis of economic relationship. Second, it is based on economic theory and logic. Third, it requires appropriate methods to draw inferences.

Through logic and experience economists have attempted to establish relationship between several variables Movements in certain economic variables are explained in terms of changes in some other variables. For example, the law of demand states that as price increases the quantity demanded of a commodity decreases. You will find numerous examples of such relationships. Some of these are apparent while others are quite complex. As we do not know what exactly is happening we often make conjectures based on logic and our understanding of things. Due to differences in perception, often different persons explain the same phenomenon differently.

Some of the economic relationships have been proved through empirical studies and validated under several situations. Some more are put forth as hypothesis and unequivocal conclusions are- yet to be drawn. In both the cases, however, logic needs to be supported by empirical observation. An advantage with the subject matter of economics, unlike many other disciplines
in social sciences, is that many of the economic variables can be quantified. This has helped in empirical measurement of economic variables and validation of economic theory.

We will show how econometrics is different from other branches of economics such as mathematical economics or economic statistics. Mathematical economics usually presents economic theory in mathematical form. It does not bother about empirical measurement of economic theory. Econometrics on the other hand is mainly concerned with empirical verification of economic theory. In doing so, econometrics makes use of the mathematical equations suggested in mathematical economics. Economic statistics deals with collection, processing and presentation of data. Statistics provides many theories on the basis of which inferences can be drawn. For example, the probability laws and sampling distribution are quite important in hypothesis testing. The application of these laws to economic theory through empirical research is a part of econometrics. An important application of econometrics is prediction and forecasting on the basis of econometric models. By taking into account actual data it helps estimation of the parameters of a model and on the basis of those estimates how to make predictions. Thus, econometrics is helpful in policy analysis where we can simulate different values of exogenous variables and interpret their effects on endogenous variables.