Econometric methods are used in most branches of applied economics. By means of them we can test a theory or a relationship that has some importance for business decisions or policy analysis. An Empirical analysis uses data to test a theory or to estimate a relationship.
How to structure an economic analysis? It may seem obvious, but first of all we should carefully formulate the question of interest. In principle , econometric methods can be used to answer a wide range of questions, like:testing some aspects of an economic theory,or effects of a government policy.
In cases when we need to test an economic theory, a formal economic model is constructed.An economic model consists of mathematical equations that describe various relationships. For example, individual consumption decisions,subject to a budget constraint, are described by mathematical methods.The basic premise underlying these models is utility maximization.The assumptions that individuals are making these choices to maximize their well-being,subject to resources constraints, gives us a very powerful framework for making clear and efficient predictions. In context of consumption decisions, utility maximization leads to a set of demand equations. In a demand equation, the quantity demanded of each commodity depends on the price of the goods, the price of substitute and complementary goods,consumer’s income,and individual’s characteristics that affect taste. All these equations can form basis of an econometric analysis of consumer’s demand.
Economists have used basics economic tools, such as utility maximization framework, to explain some behaviors that seem to be non-economic in nature.