Overview
Econometric models typically refer to a model that consists of a set of equations that relate various economic quantities. Models can run from a single equation, to hundreds of variables and equations. Larger size models do not necessarily perform better. In fact, as a general rule, increasing complexity can harm a model, and not necessarily just from overfitting.Sample Model
The seciont presents a sample simple econometric model. The model consists of the following- {% Y %} - national income
- {% C %} - consumer spending
- {% G %} - Government spending
- {% I %} - investment spending
- {% r %} - the interest rate
It consists of the following equations:
{% C = 220 + 0.6 \times Y %}
This expresses that consumer spending is a fraction of the national income. That is, there is a marginal propensity to consume, which is a number less than one,
which describes the fraction of ones income that is typically spent. The parameters in this equation are estimated using a
regression.
{% I = 150 - 40 r + 0.2 \times Y_{last} %}
Investments are a fraction of the nations income, and dependent on the interest rate. This equation is also estimated with a
regression.
{% Y = C + I + G %}
The
national accounts identity
Model Components
- Identities - equations that are identically true, many times are simply definitions. Example: {% Y = C + I + G %}
- Exogenous Variables - exogenous variables are variables in the model whose value is an observed value that is just plugged into the equations. In the above model, government spending {% G %} is an exogenous variable.
- Structural Equations - equations that express relationships between variables that may only be true on average, and typically need to be estimated with a regression.