Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion

. ..... .. ... .. ........

Economic Methods and Economic Questions

Chapter 2 of Acemoglu et al. (2015)

Danilo L. B. Wegner

School of Economics
The University of Queensland

Econ 7950, Lecture I

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Overview of the Lecture

Scientific method (models and data)

Correlation and causality
Experiments
Research questions in economics
Discussion: hapiness and productivity

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Scientific Method

Scientific method: name for the ongoing process that

economists and other scientists use to:
1. Develop models of the world
2. Test models with data

Useful models should be able to:

1. Explain the past
2. Predict the future with some confidence

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Models

Model: simplified description, or representation, of the

world. Models are not perfect replicas of reality
Example: maps
Models are used to the extent that they are well suited to
analyze the problem at hand
Even if based on wrong assumptions, a model may still
help us to make good predictions: usefulness vs accuracy

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Data and Hypotheses

Empirical evidence, i.e., a set of facts established by

observation and measurement, are used to check the
predictions made by scientific models
The predictions generated by a model that can be tested
with data are called hypotheses

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

An Economic Model

Example: investigating whether it is worth to invest in

college education: what are the returns to education?
Assumption: investing in one extra year of education
increases your future wages by 10%
Implications from the postulated assumption: n additional
years of education will lead to an increase in earning by
(1 + 10%)n 1
For example, 2 extra years of education (n = 2) will
increase earnings by 21%, whereas 4 extra years (n = 4) by
46%

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Testing the Returns to Education Model

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Correlation and Causality (I)

Example: Red ad campaign. Hypotesis: campaigns using

the red color are good at catching peoples attention, with
empirical research showing that sales go up 25% during
campaigns with red images
Clear association between increase in sales and the use of
the red color. Can we claim that the use of red color causes
sales to go up?
Probably not. Why?
Causation occurs when one thing directly affects another
through a cause-and-effect relationship
Correlation means only that there is a natural
relationship between two things

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Correlation and Causality (II)

Two reasons why correlation does not necessarily imply

causality
1. Omitted variables
2. Reverse causality
Omitted variable: something that has been left out of a
study that, if included, would explain why two variables are
correlated. Example: Xmas season in the red ad campaign
Reverse causality: the direction of cause and effect is the
opposite of that originally thought, or else is mixed.
Example: wealth-health relationship

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Experiments (I)
Experiments: a controlled method to discern between
cause and effect, i.e., causal relationships among variables
An experiment usually consists of two groups of people,
assigned randomly into either a treatment or a control
group
It is very important that the assignment of individuals to
groups is performed in a random way, i.e., by chance rather
than by individuals own choices (why?)
The treatment and the control groups differ only along a
single dimension, the impact of which is the focus of the
experiment
Example: impact of a college degree on wages
Experiments can be expensive, and must be very well
designed (garbage in, garbage out)
. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Experiments (II)
Natural experiment: empirical study in which some
process - out of the control of the experimenter - has
assigned subjects to control and treatment groups in a
random or nearly random way
Example: educational reform in the United Kingdom in
1947. Schooling laws increased the minimum school leaving
age from 14 to 15
The fraction of children dropping out of school by age 14
fell by 50% between 1946 and 1948
Control group is composed of kids reaching age 14 before
1947, whereas the treatment group by those reaching age
14 after 1947
The study conducted by Philip Oreopoulos found that the
students forced to stay in school one extra year earned 10%
more on average . . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Experiments (III)

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Economic Questions and Answers

Research: process in which we pose and answer questions

Two properties shared by many exciting economic
questions:
1. Good questions address topics that are important to
individual economic agents and/or to our society
2. Good economic questions can be answered
Look for questions with significant implications for you and
for the society as a whole, questions that can be answered
with enough hard work and careful reasoning

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Some Questions

Is college worth it?

Can markets composed of only self-interested people
maximize the overall well-being of society?
What caused the recession of 2007-2009?
How should you bid in an eBay auction?
What is the optimal size of government?

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Per Capita GDP and Hapiness

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Easterlin Paradox

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Paradox Revisited (Stevenson and Wolfers, 2008)

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Hapiness and Productivity (Sgroi, 2010)

Sgroi studies how hapiness impacts economic variables

Does hapiness make people more productive in a paid task?
Experiment: 276 subjects drawn from the University of
Warwick. A hapiness shock is induced in the subjects of
the treatment group, who are subsequently asked to
perform a task (correctly add 5 2-digit numbers as many
times as possible)

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Timeline of the Experiment

1. Entry: Subjects are welcomed and given basic instructions
on etiquette
2. Hapiness shock: Subjects in the treatment group view a
comedy clip for 10 minutes, otherwise not
3. Instructions: Subjects are given additional instructions,
including a statement that their final payment relates to
the number of correct answers
4. Productivity task: Subjects undertake numerical
additions for 10 minutes
5. Ability control: Subjects undertake GMAT MATH-style
test for 5 minutes
6. Questionnaire: Subjects complete the final questionnaire
and are paid
7. End: Experiment is declared finished
. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Does the comedy clip boost hapiness?

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Impact of the Treatment (I)

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..
Overview Economic Science Correlation and Causality Experiments Economics Q&A Discussion
. ..... .. ... .. ........

Impact of the Treatment (II)

. . . . . . . . . . . . . . . . . . . .
.. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..