Econometrics

Econometrics is a major field in contemporary mainstream/empirical economic research. It involves the use of statistical tools to analyze numerical data, estimate relationships between economic variables, and predict unobserved values of the given data based on the parameters estimated in the regression analysis.

Overview

The most basic, fundamental starting point of econometrics is linear regression by Ordinary Least Squares (OLS), in which econometricians estimate the slope(s) of a given linear mathematical function (called “regression analysis”) comprised of economic variables (both dependent and independent), represented by observed data points. OLS is a tool for finding the “line of best fit” through a plotted data set, in which each entry in the given X data is paired with an entry in the Y data, i.e., the two are “observed” together.

The linear regressions require at least one dependent variable (or “outcome variable” or “left-hand-side (LHS) variable”), at least one explanatory variable (or “independent variable” or “right-hand-side (RHS) variable”), an intercept term, and an error term. These components are combined to make one equation showing y (dependent variable) as a function of x (explanatory variable):

Y = α + βX + ε

where α is the intercept, β is the slope, and ε is the error term (disturbance).

Least Squares

Ordinary Least Squares, as implied by the name, seeks to minimize the sum of the squared errors (distance between actual data points and the prediction (estimation) based on the linear relationship between the variables.