Hypothesis testing

Introduction

Very similar in a way to estimation, but there are some important and subtle differences.

The nature of hypotheses and scientific method

We have to be very careful about believing hypotheses to be ‘true’ or not, since if we are
careless in our methods we will not make progress (or make false progress). It is better if we
take a cautious approach, and be sceptical about any so-called truths. For centuries it was
believed that the sun revolved around the Earth rather than vice versa, until Galileo proved
otherwise (at much personal cost).

There are many different philosophical approaches to proving or disproving hypotheses. Karl
Popper argued that we can only ever disprove hypotheses, never prove them (e.g. all swans
are white). Thus the ‘truth’ consists only of those hypotheses which have not yet been
proved false. Language should reflect this caution. We ‘reject’ or ‘do not reject’ a
hypothesis, rather than ‘prove’ or ‘disprove’ it. We have the ‘maintained’ or ‘null’
hypothesis that is, for the moment, assumed to be true. All scientific truths should be
subjected to the most rigorous testing, and independently checked. Unfortunately Economics
does not always live up to these ideals.

The null and alternative hypotheses

The null hypothesis (or maintained hypothesis) is the one that is assumed to be true until it
is proved otherwise, when the alternative hypothesis replaces it. Thus when carrying out
hypothesis tests, these are done on the basis of the assumed truth of the null hypothesis.

Thus the null hypothesis has to be precise enough for statistical testing to take place. For
example, the hypothesis:

H0: Average UK income is £10,000 p.a.

is satisfactory, but not:

H0: Average UK income is above £10,000

since the latter is not precise enough to permit proper testing.

The alternative hypothesis has the advantage of being less precise. It consists of everything
that is not in the null. In the above case, the alternative hypothesis would be:

H1: Average UK income is not £10,000 p.a.

H0: and H1: are the conventional symbols denoting the null and alternative hypotheses,
respectively.
Note that the null is so precise and the alternative so vague, that the null is bound to be
strictly false: it is very unlikely that average UK income is exactly £10,000. However, we
would not want to reject the null if a sample had an average income of £10,001. Hence when
deciding between these two hypotheses we have to derive a reasonable dividing line between
accepting (loosely speaking) and rejecting the null hypothesis. The position of the dividing
line is influenced by the types of error we can make.