economy questions
stepheny
1.2EconomicMethodsandQuestions.pptx1.2 Economic Methods and Questions
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1.2 Economic Methods and Questions
The Scientific Method
Causation and Correlation
Economic Questions and Answers
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EBE Example
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Evidence-Based Economics Example: Is college worth it?
1. The Scientific Method
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The scientific method (also referred to as empiricism) is composed of two steps: 1. Developing models that explain some part of the world 2. Testing those models using data to see how closely the model matches what we actually observe
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Model
A simplified description of reality
Is this an airplane?
1. The Scientific Method
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What’s the shortest distance between two points?
Exhibit 2.1 Flying from New York to Tokyo Requires More Than a Flat Map
1. The Scientific Method
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Evidenced-Based Example:
Returns to education
Assumption—one more year of education results in a 10% increase in future earnings
1. The Scientific Method
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Returns to education:
If you would earn $15 per hour with 12 years of education, with one more year of education (your first year of college) you would earn:
$15 x 1.10 = $16.50
1. The Scientific Method
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Returns to education:
If you would earn $16.50 with 13 years of education, with one more year of education (2nd year of college), you would earn:
$16.50 x 1.10 = $18.15
1. The Scientific Method
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Returns to education:
The third year: $18.15 x 1.1 = $19.97
The fourth year: $19.97 x 1.1 = $21.97
1. The Scientific Method
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Returns to education:
Hypothesis:
Getting a college degree (years 13-16) increases wages from $15 to $21.97, or 46.5%
[(($21.97 - $15)/$15) = .4647]
1. The Scientific Method
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Two important features of models:
They are not exact. Not everyone will see their wages increase by 10% with every additional year of education
They generate predictions that can be tested with data
1. The Scientific Method
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Hypothesis: Each additional year of education increases wages by 10%
True or False?
1. The Scientific Method
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Exhibit 2.3 Average Annual Earnings of 30-Year-Old Americans by Education Level (2013 data)
1. The Scientific Method
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How much higher is the wage for college graduates than for high school graduates?
College = $59,086
High School = $39,376
College results in a wage that is 50% higher.
[(($59,086 - $39,376)/$39,376) = .50]
Model predicted 46.5%. Is that close enough?
1. The Scientific Method
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If college graduates earn, on average, $59,086/year, does that mean that all college graduates earn that much?
1. The Scientific Method
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Can Bill Gates make you rich?
1. The Scientific Method
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Speaking of Bill Gates…
How does his level of education affect his income?
1. The Scientific Method
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When you look at only a small amount of data, it is easy to jump to the wrong conclusions.
One exception Counterexample.
1. The Scientific Method
2. Causation and Correlation
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Causation
When one thing directly affects another
Example: pulling an all-nighter will make you tired
2. Causation and Correlation
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Correlation
When two things are related (causation could not be present)
Positive correlation – they both change in the same direction
Negative correlation – they change in opposite directions
2. Causation and Correlation
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Why isn’t correlation the same thing as causality?
Omitted variables
If we ignore something that contributes to cause and effect, then that something is an omitted variable. A correlation might not make sense until the omitted variable is added.
Example: Named Cows.
2. Causation and Correlation
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Why isn’t correlation the same thing as causality?
2. Reverse causality
Reverse causality is when there is cause and effect, but it goes in the opposite direction as what we thought.
Example: gambling and healthier older people
2. Causation and Correlation
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How can we tell the difference between causality and correlation?
Experiments
Controlled = subjects are randomly put into treatment (something happens) and control (nothing happens) groups by the researcher.
Problem: difficult to do with economics studies
2. Causation and Correlation
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How can we tell the difference between causality and correlation?
Experiments
Natural = subjects end up in treatment or control groups due to something that is not purposefully determined by the researcher
2. Causation and Correlation
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Evidence-Based Economics and Natural Experiments
How much is an extra year of school worth?
In 1947, the UK raised the minimum drop-out age from 14 to 15.
Those students reaching age 14 before 1947 = control group
Those students reaching age 14 in 1947 or after = treatment group
2. Causation and Correlation
3. Economic Questions and Answers
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Two Properties of a Good Economic Question:
Relevant and important
Economic research contributes to social welfare
Can be answered
Economic questions can be answered empirically
Key Ideas
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A model is a simplified description of reality.
Economists use data to evaluate the accuracy of models and understand how the world works.
Correlation is not the same thing as causality.
Key Ideas
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Experiments help economists to measure cause and effect.
Economic research focuses on questions that are important to society and can be answered with models and data.
