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Lecture 1: Introduction and Review of Probability

and Statistics

Moshe Buchinsky

Course Logistics

I Lectures (Econ 103): Tuesdays and Thursdays,

12:30AM-1:45PM, at Broad Art Center, 2160E.
I Lab lectures (Econ 103L): Fridays 11:00-11:50AM, Fowler
Museum, A103B.
I One has to register to BOTH Econ 103 AND Econ 103L.
You cannot take one without the other.
I Office hours: Fridays 1:00-2:00PM, Bunche Hall 8373.
The Teaching Assistants

I Changsu Ko - Head TA
I Changsu Ko (head TA)
I Yun Feng
I Dong Ook Eun
I Kun Hu
I Jeonghwan Kim
I Lu Liu
I Pavel Andreyanov
Textbooks and Other Material

I Principles of Econometrics. Hill, R. C., Griffiths, W. E. and G.

C. Lim, 4th Edition, 2011. Wiley and Sons. (Required!)
I Using Stata for Principles of Econometrics. Lee C. Adkins &
R. Carter Hill, 4th Edition. Wiley and Sons. (Strongly
I Other:
I Basic Econometrics. Gujarati, D. N., 5th Revised Edition,
2010, McGraw-Hill.
I Introductory Econometrics. Wooldridge, J., 6th Edition,2013,
Cengage Learning.
I Probability and Statistical Inference. Hogg, R. V. and E. A.
Tanis, 8th Edition, 2009, MacMillan.
I Lecture notes: Slides will be posted on the class website before
class. I will not bring copies!
I Course outline - see Syllabus
Course Requirements - Problem Sets

I Problem sets account for 20% of the final grade.

I Mix of multiple choice questions, analytic exercises, and
STATA work.
I Grading of problem sets:
I 5 points for completing homework.
I 5 points for correct answer to question chosen randomly by
I Schedule: See tentative schedule in the syllabus.
I Due at end of class on due date. No exceptions!
I Must hand in hardcopy.
I Note! You are encouraged to work together, but everyone
must hand in their own hardcopy, and do the computer work
Course Requirements - Midterm (20% or 0%

I Midterm account for 20% of grade if above the final.

I In class on Thursday, November 9, 2017.
I Very much like the problem sets.
I Optional I will compute the final grade both with and
without the midterm and use the better grade.
I No makeup exam!
Questions, Problems, etc.

I Come to my office hours or your TAs office hours.

I Post questions to the class website discussion board.
I TAs and myself will be monitoring the discussion board daily
to answer such questions.
I Emails to me or TAs on such questions will not be answered.

I You can email your TA to request a regrade.

I The entire exam or homework will be regraded.
Please Remember

Please check the online syllabus for any updates

Course Overview

I Econometrics...
I Uses statistical methods to analyze economic data.
I aims to answer quantitative questions.
I Main tool: regression analysis
I We want to determine the causal effect of one variable
(X ) on another variable (Y ).
I Econ 41: statistical analysis of one variable.
I Econ 103: analysis of the relationship between two (or more)
Examples of questions of interest:

I How does demand change with the price of the good?

I What is the effect of a new marketing campaign on sales?
I How does class size affect education outcomes (e.g. test
I How much an additional year of schooling increases wages?
I What is the relationship between credit scores and loan default
I How much does output grow if the Fed cuts interest rates by
I Do more policemen reduce crime?
Examples of questions of interest:

I Theory:
I How to interpret results in articles, or the results your
computer gives.
I To understand the caveats of regression analysis.
I Why it is essential to do good empirical work.
I How to do empirical analysis yourself:
I You will work with real datasets.
I You will use statistical software, namely STATA.

Review of Probability and Statistics

(Econ 41)
1. Definitions

I Random Variable (X): takes on different outcomes with certain

I Outcomes ( xi ): mutually exclusive potential results of a
random process.
I Probability of an outcome: proportion of times that the
outcome occurs in the long run.
I Types of Random Variables:
I Discrete Random Variable: takes on a finite number of values.
I Example: coin toss; the number of times a computer crashes.
I Continuous Random Variable: takes on any value in a real
interval, each specific value has zero probability.
I Example: height of an individual; time it takes to commute to
1. Definitions

I The function f that summarizes the information relating the

possible outcomes of a random variable X and the
corresponding probabilities is called the PDF, which stands for:

I the Probability Distribution Function, for discrete variables; or

I the Probability Density Function for continuous functions.
I PDFs must satisfy:
I f (xi ) 0; and
i f (xi ) = 1 (if discrete) or f (x)dx = 1 (if continuous)
1. Definitions

I Coin toss: x1 =heads, x2 =tails, f (x1 ) = f (x2 ) = 12 .

I Height of adult men in inches.

Figure: PDFs of Discrete (left) and Continuous (right) Random Variables

1. Definitions

I Cumulative Distribution Function (CDF): describes the

probability that the random variable is less than or equal to a
particular value.

Figure: CDFs of Discrete (left) and Continuous (right) Random Variables

1. Definitions

I Moments: summary statistics of the probability distribution:

I Expected Value or Expectation or Mean
i xi f (xi ) if X is discrete
X = E (X ) =
xf (x)dx if X is continuous

I Measure of central tendency

I Weighted average of the possible values of X with the
probability f (x) serving as weights
1. Definitions

I Moments (continued):
I Variance

X2 = Var (X ) = E (X X )2

P 2
i (xi X ) f (xi ) if X discrete
(x X )2 f (x)dx if X cont.

I Measure of dispersion. How the values of X are spread around

its mean
I Standard deviation
2. Definitions - Two Random Variables

I Joint Probability Density Function of X and Y : describes the

probability that the random variables simultaneously take on
certain values, x and y .
I It is the function

fX ,Y (x, y ) = Pr(X = x, Y = y ).

I Marginal Probability Distribution:

fY (y ) = Pr(X = xi , Y = y ) = fX ,Y (x, y )
xi x
2. Definitions - Two Random Variables

I Conditional Probability Distribution of Y given X : is the

probability that Y takes on the value y when X takes on the
value x.

fY |X (y | x) = Pr(Y = y | X = x)
Pr(X = x, Y = y )
Pr(X = x)
fX ,Y (x, y )
fX (x)
2. Definitions - Two Random Variables

I Example: Men say they will vote for the Republican candidate
rather than the Democratic candidate in their districts by a margin
of 45 percent to 32 percent. The numbers are nearly reversed for
women, with 36 percent saying they will vote Republican and 43
percent saying they will vote Democratic. New York Times,
September 20, 2010
I Assume that there are 50% men and 50% women.

 1 Democrat
1 male
X = Y = 2 Republican
2 female
3 other

2. Definitions - Two Random Variables

I The joint PDF of X and Y is:

x1 = 1 x2 = 2
y1 = 1 .16 .215
y2 = 2 .225 .18
y3 = 3 .115 .105
2. Definitions - Two Random Variables

I The marginal distributions of X and Y are in red:

x1 = 1 x2 = 2 xi
y1 = 1 .16 .215 .375
y2 = 2 .225 .18 .405
y3 = 3 .115 .105 .22
yj .5 .5 1
2. Definitions - Two Random Variables

I The conditional distribution of being a Democrat, given being


Pr(Democrat | Female)= Pr(Y = 1 | X = 2)

Pr(Y = 1, X = 2) .215
= = .43
Pr(X = 2) .5
I The conditional distribution of being a Republican, given being
a female:

Pr(Republican| Female)= Pr(Y = 2 | X = 2)

Pr(Y = 2, X = 2) .18
= = .36
Pr(X = 2) .5
2. Definitions - Two Random Variables

I Covariance: is a measure of linear association between two

random variables, and is defined as

XY = Cov (X , Y ) = E ((X X )(Y Y ))

I Correlation coefficient: is a unit-free measure of linear

association between two random variables, and is defined as
Cov (X , Y )
XY =
I It can be shown that

1 1
2. Definitions - Two Random Variables

I Independence:
fX ,Y (x, y ) = fX (x)fY (y )
I If two random variables are independent, then the conditional
distribution of each variable coincides with its marginal
distribution, that is

fY |X (y | x) = fY (y ), and
fX |Y (x | y ) = fX (x).
Properties of Expectations, Variance and Covariance

I E (a) = a
I E (aX + b) = aE (X ) + b
I E (X + Y ) = E (X ) + E (Y )
I Var (a) = 0
I Var (aX + b) = a2 Var (X )
I Cov (X , X ) = Var (X )Cov (X , Y ) = E (XY ) E (X )E (Y )
I Var (aX + bY ) = a2 Var (X ) + b 2 Var (Y ) + 2abCov (X , Y )
Properties of Expectations, Variance and Covariance

I If X and Y are independent, then

I E (XY ) = E (X )E (Y )
I Var (X + Y ) = Var (X ) + Var (Y )
I Cov (X , Y ) = 0, but the reverse is not true! Zero covariance
does not imply independence.
Special Probability Distributions - Normal

I Normal distribution: N(, 2 )

I Standard normal distribution: N(0, 1)
I A variable that follows a standard normal distribution is often
denoted by Z .
I Its CDF is often denoted by , that is, Pr(Z c) = (c) for
any c.
I Note that if X N(, 2 ), then Z = N(0, 1).
I Note also that if X and Y are normally distributed, so is
X + Y (and any other linear combination).
Special Probability Distributions - Normal

Figure: Standard Normal Density

Special Probability Distributions - Chi-Squared

I Chi-Squared distribution: assume that Zi N(0, 1), i. Then

W = Zi2 2m ,

where m is the degrees of freedom.

I 2 distribution with m degrees of freedom.
Special Probability Distributions - Chi-Squared

Figure: Chi-Squared Density

Special Probability Distributions - Student-t

I Student t distribution: assume that Z N(0, 1),

W 2m ,and Z and W are independent. Then

p tm
W /m

I t distribution with m degrees of freedom

I Note: t = N(0, 1)
Special Probability Distributions - Student-t

Figure: Student-t Density

Special Probability Distributions
I Standard Normal vs. Student t distributions

Figure: Standard Normal Density

Special Probability Distributions - F distribution

I Assume that W 2m , V 2n , and W and V are

I Then
W /m
V /n
I F distribution with m and n degrees of freedom
I Note: mFm, = 2m and F1,n = tn2
Special Probability Distributions - F distribution

Figure: F -Distribution Density

Computing Probabilities

I Assume that adult male heights are normally distributed with

mean 70 inches (178 cm) and standard deviation 4 inches (7.6
I If you are 65 inches tall (165 cm), what percentage of men are
shorter than you?
I Let X denote the height of men. X N(70, 16).
I Let us standardize X :
X 70
Z= N(0, 1)
I We have to do the same manipulation for 65.
65 70
= 1.25
Computing Probabilities

I What is the probability that Z 1.25? This is given by its

(1.25) = 10.56%
I You can compute this value in Stata using command di
I Alternatively, see Appendix Table 1 in textbook.
Computing Probabilities

Figure: 1.25 in a Standard Normal Distribution

Computing Probabilities
Computing Probabilities

I Computing (1.25) from Standard Normal table:

1 0.8944 = 0.1056!