INTRODUCTION TO ECONOMETRICS II
ECO 306
NOUN
42 random factor known as the disturbance term. We shall start with the simplest possible model
...[2.01]
, the value of the dependent variable in observation i, has two components (1) the nonrandom (deterministic term) component
,
being described as the explanatory (or independent/descriptive) variable and the fixed quantities
and
as the parameters of the equation, and (2) the disturbance (stochastic term,
Figure 2.0 illustrates how these two components combine to determine Y. X
1
, X
2
, X
3
, and X
4
, which are four hypothetical values of the explanatory variable. If the relationship between Y and X were exact, the corresponding values of Y would be represented by the points Q
1
– Q
4
on the line. The disturbance term causes the actual values of Y to be different. In the diagram, the disturbance term has been assumed to be positive in the first and fourth observations and negative in the other two, with the result that, if one plots the actual values of Y against the values of X, one obtains the points P
1
– P
4
Figure Illustration of independent component combination to give a dependent
variable
In practice, the P points are all not what can be seen in Figure 2.0. The actual values of
and and hence the location of the Q points, are unknown, as these are the values of the disturbance term in the observations. The task of regression analysis is to
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