Demand Estimation: The Econometric Method

The econometric methods combine statistical tools with economic theories to estimate economic variables and to forecast the intended economic variables. An econometric model may be single equation regression model or it may consist of a system of simultaneous equations.

Regression method

Regression analysis is the most popular method of demand estimation. This method combines economic theory and statistical techniques of estimation. Economic theory is employed to specify the determinants of demand and to determine the nature of the relationship between the demand for a product and its determinants. Economics theory thus helps in determining the general form of demand function. Statistical techniques are employed to estimate the values of parameters in the estimation equation.

Simultaneous Equation Method

It involves estimating several behavioral equations. These equations are generally behavioral equations, Mathematical equations and Market – clearing equations. The first step in this technician is to develop a complete model and specify the behavioral assumption regarding the variables included in the model. The variables that are included in the model are

1. Endogenous variables
2. Exogenous variables

Endogenous variables – the variables that are determined within the model are called endogenous variables. Endogenous variables are included in the model as depended variables that are the variables that are to be explained by the model. These are also called controlled variables. The number of equations included in the model must be equal to number of endogenous variables.

Exogenous variables – are those that are determined outside the model. Exogenous variables are inputs of the model whether a variable is treated endogenous variables or exogenous variables depend on the purpose of the model. The examples of exogenous variables are “ Money Supply”, tax rates, govt. spending etc. The exogenous variables are also known as uncontrolled variables.