## Basic Econometrics

FIGURE I.4 Anatomy of econometric modeling.

Hypothesis testing

Using the model for control or policy purposes

Forecasting or prediction

Estimation of econometric model

Economic theory

Data

### Econometric model of theory

Mathematical model of theory current level of about 4.2 percent (early 2000). What level of income will guarantee the target amount of consumption expenditure?

If the regression results given in (I.3.3) seem reasonable, simple arithmetic will show that

which gives X = 7197, approximately. That is, an income level of about 7197 (billion) dollars, given an MPC of about 0.70, will produce an expenditure of about 4900 billion dollars.

As these calculations suggest, an estimated model may be used for control, or policy, purposes. By appropriate fiscal and monetary policy mix, the government can manipulate the control variable X to produce the desired level of the target variable Y.

Figure I.4 summarizes the anatomy of classical econometric modeling.

### Choosing among Competing Models

When a governmental agency (e.g., the U.S. Department of Commerce) collects economic data, such as that shown in Table I.1, it does not necessarily have any economic theory in mind. How then does one know that the data really support the Keynesian theory of consumption? Is it because the Keynesian consumption function (i.e., the regression line) shown in Figure I.3 is extremely close to the actual data points? Is it possible that an-

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