Why should students take econometrics? Thank you Peter Kennedy.

On August 30, we lost Dr. Peter Kennedy, author of the book A Guide to Econometrics and my econometrics professor when I was at Simon Fraser University. He taught me, and a lot of other instructors, how to teach. This blog is dedicated to his memory.

There was a story from Reuters on Friday that indicates that BP has denied claims by Alabama for lost govenment revenue. The argument used by Alabama was that the drop in tourism as a direct result of the oil spill caused the State budget to be $148 million in deficit and that BP should pay that $148 million. (Click here for article)

BP has set aside $20 billion to pay for damages. That may or may not be enough. The equity markets had, at one point, knocked $200 billion of BPs market capitalization.

The issue here is that Alabama should have hired an econometrician before they made their claim, and now BP should hire one to defend the action. There are several reasons why Alabama's revenues were down this year. The oil spill is certainly one of them. Tourism demand depends on the condition of the beaches, but it also depends on some other factors such as income, prices at competing locations and airfares. The US economy has been in recession for a couple of years. Tourism is a normal good and reduced income reduces demand. Major US airlines responded to the recession by reducing the number of flights. This reduction in supply caused airfares to rise in 2010 over the prices in 2009. Destinations in Florida, particularly hard hit by the recession reduced their prices and advertised heavily to attract tourism dollars. (We did enjoy our visit to Key West this year.)

Separating out the effect of these different variable is why we use econometrics. Use theory to develop a mathematical demand model, get data on the exogenous variables that we deem relevant and run a regression. The results tell us how much of Alabama's claim is directly related to the oil spill and how much is due to the other factors.

No doubt this will come up in the trial and perhaps one of Peter's former students or someone that used his book will stand up before a judge and explain how we do it.