Econometrics: Measurement in Economics

ECONOMETRICS: MEASUREMENT IN ECONOMICS

In this article, it talks about the econometric approach in economics and explain how he see this branch of study, ‘applied econometrics’, fitting into the work of a Division of Economic Studies.

Using econometric approach, it illustrates a problem of measurement with two examples. First, they show the ratio through relationship between imports and total expenditure. The ratio is called the average propensity to import with respect to final expenditure, and over the post-war years has been of the order of about 17 to 18 per cent. Total final expenditure is a measure of that final demand which results in economic activity in a country. The level of demand, is a measure of the driving force which generates economic activity. As the level of final expenditure rises, there is an increasing demand for goods and services. To handle this relationship quantitatively, they express it in an explicit mathematical form. Based on the graph given in the article, a straight line is defined by two constants, one of which measures the slope of the line, the other its spatial position. The two constants are the parameters in their function, and they estimate that they shall have estimated the structural relationship derived from their simple analysis. Then, they require a technique which enables them to make these estimates from observed empirical data, and, of course, an adequate amount of suitable data. The technique is a statistical one the properties of which are investigated and developed in the theory of statistics, namely elementary linear regression. Relevant data are available from the estimates of imports and final expenditure which are made regularly for British National Income Accounts, adjusted to constant prices to avoid the effects of price change. Then, using British post-war data, the measurement is 0.31, which indicates that on the average an increase of 1000 pound in final expenditure leads to an increase of some 300 pound in imports. Finally, they conclude that the exercise useful in three ways. First, if the relationship can be convincingly established, it is a confirmation of our economic thinking and economic theory. Secondly, by quantifying the relationship it adds to our knowledge of economic magnitudes which are used in economic theorizing, and thirdly, by implication, it provides results which may be used in the formulation of economic policy.

Next example is consumer demand analysis, they show the relation between changes in demand and changes in real income. Demand related to these influences is expressed as a demand function, the parameters, or the structural constants, of which measure how demand for the good will be affected by changes in the explanatory factors. This restricted relationship is usually estimated from data collected from a sample of households. Same as the previous example, they also using mathematical form to show the relationship. Consider a diagram which plots on one axis the household incomes recorded in the sample, and on the other, the household’s expenditure. The scatter of points represented by a smooth curve which swings up as income increases, expenditure on a good usually increasing with income. This curve is called an Engel curve, specifying the form of functional relationship in the present context means specifying the mathematical shape of the Engel curve. This example conclude that, given a 1 per cent increase in real income, and increase less than quarters 1 percent of demand of particular goods. And they simply that, these results reflect differences in the demand for goods which are basic necessities and those which are in the nature of luxuries, the demand for which responds more to high incomes.