Theory Behind the Model

You must answer this question before you begin running any statistical technique, what is your theory about the true underline model? If you do not have a theory find one, any one. Read the literature or ask an expert. Without a theory you may find an answer but only by dumb luck will it be right.

Suppose you were given a task to estimate demand for your product. Without any theory you put in the price of the product and the quantity purchased and, low and behold, as you increase price the quantity purchased also increase! You run to the marketing department who use your advice and double the price. The next week you go out of business because no one bought your product. Why?  The theory of supply and demand tells us why. Quantity purchased rose when price rose because the demand was increasing for the product while the data was collected. Your model violated an assumptions of OLS, no simultaneous models.

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You need to understand the theory of supply and demand to model the problem correctly. This is true of all problems. There is a growing trend to use software without any theoretical forethought. Do not follow this trend.