Latent and observable variables

Latent variables, as opposed to observable variables, are those variables that cannot be directly observed but are rather inferred from other variables that can be observed and directly measured. Examples of latent variables include quality of life, business confidence, morale, and happiness. Latent variables are also called as hypothetical variables or hypothetical constructs. The use of latent variables is common in social sciences and to an extent in the economics domain. The exact definition of latent variables varies in different domains.

One advantage of using latent variables is that it reduces the dimensionality of data. A large number of observable variables can be aggregated to represent an underlying concept, making it easier for human beings to understand and assimilate information.