The large scale econometric models.
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The first large-scale econometric model was built by Professor Lawrence Klein in the 1950s. The equations which formed the model represented a “synthetic” or artificial economy.The modelwent through various iterations and evolved into the MIT-FR-Wharton model
Consider the following economy:
Yt = Ct + It + Gt + Xt – Mt [5.5]
Equation [5.5] can be read as follows: Total output in period t is equal to total spending for new goods and services in period t , or consumption plus investment plus government expenditure plus imports minus exports.
Equation [5.5] is an identity—that is, it is true by definition
Ct = a + b(Yt – Tt) + dPt – 1 [5.6]
Tt = e + fYt [5.7]
It = h + jYt – 1 + kRt [5.8]
Mt = n + qYt [5.9]
Pt = s + uYt + vPt – 1 [5.10]
We call these behavioral equations because they describe the way the way the spending category has behaved in the past as a function of the explanatory variables.
First, we substitute the behavioral equations [5.6] through [5.10] into [5.5] to obtain the following (we have dropped the t subscripts to economize on notation):
Y = [a + b(Y – e – fY) + dPt – 1] + (h + jYt-1 + kR) + G + X – (n + qY)
By rearranging this equation, we obtain the following reduced form equation
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Y = C + I + G (1)
C = 20 + 0.7(Y - T) (2)
I = 2 + .01Yt - 1 (3)
T = 0.2Y (4)
aDaniel Suits.” Forecasting and Analysis with an Econometric Model,” American Economic Review, March 1962: 104-132.
Consider a closed economy with government
GDP = C + I + G
GDP is the dependent variable.Hence, to get solution for GDP, we mustfirst specify and estimate models for C, I, and G
a The following is based on A. Migliario. “The National Econometric Model: A Layman’s Guide,” Graceway Publishing, 1987.
GDP t + 1 = C t + 1 + I t + 1 + G t + 1 (2)
C t + 1 = 1 + 2DYt + et (3)
I t + 1 = 3 + 4it + et (4)
G t + 1 = 5 + 6Gtb (5)
b Migliaro used the trend component to forecast G.
C t + 1 = DUR t + 1 + NONDUR t + 1 + SERVICES t + 1
DUR t + 1 = AUTOS t + 1 + FURNITURE t + 1 + APPLIANCES t + 1 + . . .
Now let:AUTOS t + 1 = Passenger Cars t + 1 + Vans t + 1 + Trucks t + 1 + . . .
Trucks t + 1 = 1 + 2DYt + 3AGEt + 4PRICEt + et