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Introductory Econometrics
Introduction to Econometrics
Summation
The symbol means “the sum of” and the letter i is the index of summation (arbitrary letter
that may appear as t, j or k).
The numbers 1 and n are the lower and upper limits of the summation.
Properties of the Summation Operator
Use of Multiple Signs in One Expression:

Definitions
Integers: Are the whole numbers (without a fractional component). Eg: ∓1, 2, 3
Rational Numbers: Can be written as the quotient of 2 integers, a/b where b 0
Real Number: Is a quantity that can be represented by a point on a continuous line (whole,
rational, irrational).
Real numbers that cannot be expressed as a quotient of 2 integers are called irrational
numbers. Eg: √2 𝑜𝑟 𝑒
Numbers like √−2 are not real numbers and they are called imaginary numbers.
The absolute value of a number is denoted |a|
Inequalities
Inequalities among numbers obey certain rules.
If a < b, then a + c < b + c
If a < b, then
If a < b and b < c, then a > c
Exponents
Exponents are defined as follows:
Some common rules:

Scientific Notation
A number in scientific notation is written as a number between 1 and 10 and multiplied by a

power of 10 as in:
Logarithm
The logarithm of a number, say A, with base B, is the number of times B has to be multiplied
(ie the exponent or power) to get A.
Logarithms with base e are called natural logarithms and often written as ln. We will only
use natural logarithms in this unit.
By definition:
When there is an exponential function with a complicated exponent, the notation exp is
often used so that e(.) = exp (.)
The above shows that the exponential function is the antilogarithm. That is the exponential
function (antilog) of ln(x) is x.
Proportional (or Relative) Change
A proportional (or relative) change in y is defined as the change in y as a proportion of the

value of y before the change.
A proportional change may be expressed as a percentage (percentage change):
Note that a change in the natural log of y is approximately a proportional change in y,

provided that the change is small relative to the initial value. That is:
Linear Relationships
The standard form for a linear relationship is:
y = mx + b = f(x)
The slope of m is the marginal effect of a change in x on y:
The intercept parameter, b, indicates where the line crosses the vertical axis- that is, it is the
value of y when x is zero.
The first derivative of f(x) measures the slope of the tangent to f(x):
𝑑𝑦
=𝑚
𝑑𝑥
y and x represent a discrete change in y and x, respectively. ie:
y = y1 – y2 and x = x1 – x2
while dy and dx represent infinitesimal changes in y and x respectively.
When the function is linear:
𝑑𝑦 y
=
𝑑𝑥 x
Elasticity:
An elasticity is the percentage change in one variable associated with 1% increase in

another variable.
For a linear relationship, the elasticity of y with respect to a change in x is:

Non-Linear Relationship
The slope (derivative) of a nonlinear function is not constant, but changes as x changes and
must be determined at each point.
The slope of a curve at a point is the slope of the line that is tangent to the curve at that
point.
Quadratic Function:
Cubic Function:
Cubic functions have one inflection point where the function crosses its tangent line and
changes from concave to convex or vice versa.
Cubic functions can be used for the total cost or total product function in economics. Then,
the first derivative of the total cost is marginal cost and the first derivative of the total
product is marginal product.
If the “total” curves are cubic, then the “marginal” curves are quadratic (u-shaped curve for
marginal cost and inverted u-shape for marginal product).
Log Function:
The elasticity of salary with respect to sales is  2 and it is fixed for all values of sales. The
logarithmic changes are always percentage changes.
On the other hand, the effect of a marginal change in sales on salary is not constant but
changes with sales:
𝑑(𝑆𝑎𝑙𝑎𝑟𝑦) 𝑆𝑎𝑙𝑎𝑟𝑦
= 𝛽2
𝑑(𝑆𝑎𝑙𝑒𝑠) 𝑆𝑎𝑙𝑒𝑠
Log-Linear Function:
The slope of this function is and it changes with income

The Econometric Model
In economics, ideas of the relationships between economic variables are expressed using a
mathematical function. These functions have unknown parameters and economics provides
systematic methods to estimate those parameters and answer questions like:
• Can you predict the sales of the product?

• Can you estimate the effect on our sales if our competitor lowers their price by $1?
• Can you test whether our new advertising campaign is actually increasing our sales?
An econometric model consists of a systematic (or theoretical) part and a random and
unpredictable component e called a random error.
These functional form represents the relationship between the variables that we assume is
true (or close to the true relationship).
The coefficients  1,  2 are unknown parameters of the model that we estimate using
economic data and an econometric technique.
The systematic portion is the part we obtain from economic theory and includes an
assumption about the function form.
The random component represents a “noise” component which we represent using the
random variable e.
We use the econometric model as a basis for statistical inference. The ways with which
statistical inferences are drawn include:
1. Estimating economic parameters, such as elasticities, using econometric methods

2. Predicting economic outcomes such as enrolment in 2 year colleges in US for next 10
years
3. Testing economic hypotheses such as the question of whether newspaper
advertising is better than store displays for increasing sales
Economic Data Types
Economic data comes in a variety of flavours:
• Data may be collected at various levels of aggregation: Micro or Macro

• Data may also represent a flow or a stock:
o Flow: measured over a period of time
o Stock: measured at a particular point in time
• Data may be qualitative or quantitative:
o Quantitative: Expressed as numbers
o Qualitative: Expressed as an “either or” situation
A time series is data collected over discrete intervals of time. The key feature is that the
same economic quantity is recorded at regular time intervals.
A cross-section of data is collected across sample units in a particular time period. The
sample units are individual entities and may be firms, persons, states, households,
countries.
A panel of data, also known as “longitudinal” data has observations on individual micro-
units who are followed over time.
• The key aspect of panel data is that we observe each micro-unit for a number of
time periods
• If we have the same number of time period observations for each micro-unit, we
have a balanced panel
• Usually the number of time series observations is small relative to the number of
micro-units but not always

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Introductory Econometrics

Properties of the Summation Operator

Use of Multiple Signs in One Expression:

Rational Numbers: Can be written as the quotient of 2 integers, a/b where b 0

The absolute value of a number is denoted |a|

Inequalities among numbers obey certain rules.

If a < b, then a + c < b + c

If a < b and b < c, then a > c

Exponents are defined as follows:

Some common rules:

A number in scientific notation is written as a number between 1 and 10 and multiplied by a

Proportional (or Relative) Change

A proportional (or relative) change in y is defined as the change in y as a proportion of the

A proportional change may be expressed as a percentage (percentage change):

Note that a change in the natural log of y is approximately a proportional change in y,

The standard form for a linear relationship is:

The slope of m is the marginal effect of a change in x on y:

y and x represent a discrete change in y and x, respectively. ie:

while dy and dx represent infinitesimal changes in y and x respectively.

When the function is linear:

An elasticity is the percentage change in one variable associated with 1% increase in

For a linear relationship, the elasticity of y with respect to a change in x is:

The slope of this function is and it changes with income

• Can you predict the sales of the product?

1. Estimating economic parameters, such as elasticities, using econometric methods

Economic data comes in a variety of flavours:

• Data may be collected at various levels of aggregation: Micro or Macro

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