Chapter 1: Introduction
In this chapter we discuss the contents of this book, including the basic
we attempt to convey and the tools of analysis used. We begin with our definition of the subject: Econometrics is the application of statistical techniques and analyses to the study of problems and issues in economics.
The term econometrics was coined in 1926 by Ragnar A. K. Frisch, a Norwegian economist who shared the first Nobel Prize in Economics in 1969 with another econometrics pioneer, Jan Tinbergen. Although many economists had used data and made calculations long before 1926, Frisch felt he needed a new word to describe how he interpreted and used data in economics. Today, econometrics is a broad area of study within economics. The field changes constantly as new tools and techniques are added. Its center, however, contains a stable set of fundamental ideas and principles. This book is about the core of econometrics. We will explain the basic logic and method of econometrics, concentrating on getting the core ideas exactly right. We divide the study of econometrics in this book into the following two fundamental parts:
- Part 1. Description
Part 2. Inference
In each part, regression analysis will be the primary tool. By showing regression again and again in a variety of contexts, we reinforce the idea that it is a powerful, flexible method that defines much of econometrics. At the same time, however, we describe the conditions that must be met for its proper use and the situations in which regression analysis may lead to disastrously erroneous conclusions if these conditions are not met.
In addition to regression analysis, we will use Monte Carlo simulation throughout the second part of the book to model the role of chance in the data generation process. The Monte Carlo method is an integral part of our teaching approach, which emphasizes concrete, visual understanding. Section 1.2 uses the example of the study of the demand for cigarettes to illustrate the goals and methods of econometric analysis and how regression fits into this enterprise. We will further discuss the concept of Monte Carlo analysis in Chapter 9, the first chapter of Part 2 of the book.