Chapter 2

Economic Methods and Economic

Questions
Questions
1. Why do economists use the scientific method? Explain your answer by arguing for and against the
use of this method.
Answer: The scientific method is the name for the ongoing process that economists and other scientists
use to develop models of the world, test those models with data, and evaluate how well they predict or
describe behavior. Data is needed in order to know what was happening, and models are needed to know
what the interaction is between the data.
When arguing for the usage of the scientific method, imagine a situation where you are responsible for
the production of cars. Your task is to know, in advance, what colors customers will want their cars to
have. Using empirics, you can collect data on consumer preferences in advance, thus, you will know what
percentage of consumers prefer black, white, or blue cars. You can also create a model based on your
collection of data plus previous purchases, social background, wages etc. to extrapolate which car color
will be more popular for consumers.
When arguing against the use of the scientific method, it usually is done by mentioning the difficulties of
obtaining data, the expenses involved, and the challenges of statistical analysis. However, all of these
arguments are false. We simply cannot make well-grounded, general observations about our world
without having models that are backed by data.
2. Explain how economists study the economic behavior of a society empirically. By using hypotheses,
confirmed by empirical evidence, how do the economists and the empirical evidence contribute to the
welfare of the society?
Answer: Economic behaviors and patterns help economists to understand the effects of psychological,
cognitive, social, emotional, and other factors on economic decisions made by individuals and institutions
and the consequences for market prices, returns, and resource allocation. These studies are mostly
confirmed by empirical data collected by the economists themselves or other individuals and
organizations.
Suppose economists study the amount of tax (10 percent) that will need to be paid by citizens of two
states in order to construct a bridge that will connect the two states, which are divided by a river. For this
purpose they gather data on the income of the citizens (based on which the 10 percent tax will be
calculated); how much the government should receive; how much tax will be evaded; what is the
estimated cost of building the bridge versus the actual cost.
Such empirical data on constructing a bridge helps economists plan better when creating a good that
contributes to public welfare.
3. Are economic models detailed or simplified versions of reality? Could economists build perfect
economic models? Why?
Answer: Economists create simplified descriptions that enhance an individual’s understanding of how
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things work, based on which economic models are built. Such economic models are designed to yield
hypotheses about economic behavior that can be tested. Because they are built on assumptions they have
no objective measures of economic outcomes and are mostly subjective in nature. Different economists
will make will draw different conclusions to explain their interpretations of reality.
Because economics models are based on real-world factors that are hard to control, condition, or simulate
because of complex and dynamic variables, they cannot be perfect representations of reality.
4. How is the mean calculated from a series of observations? Suppose a supermarket near you sells 4
types of fruit juice (apple, orange, lemon, and grape). The price of the apple juice is €3, the price of
the orange is €5, the lemon juice is €6, and the grape juice is €4. What is the average price of the
juice?
Answer: The mean is the average value of a set of observations. It is calculated as the sum of all the
different items divided by the number of items.
The average value is the sum of all types of the fruit juice divided by, in this case, four. That is (3 + 5 + 6
+ 4) / 4 = €4.5.
That means that the average type of fruit juice costs €4.5.
5. Why does the size of the sample matter in an empirical argument?
Answer: The size of the sample used to test the argument can affect the results. A small sample may bias
the results of a study. Bias means that the sample will not reflect accurately the entire population for
which you were trying to obtain information. For example, you wish to obtain information on the
consumption habits of European Union (EU) citizens. If you are using a small sample of 50 people it
might be possible that all of them are only from Germany and France and the other EU member countries
are not represented. However, if a random sample of 1,000 people is used you will be getting a
representative result. For details on what are the minimal acceptable sample sizes, check with you
statistics tutor or use the following website: https://www.surveysystem.com/sscalc.htm
6. Explain why correlation does not equal causation. Give examples where the cause and effect
relationship between events is not necessarily clear.
Answer: Correlation means that there is a relationship between two variables; as one variable changes,
another variable changes. Causation occurs when one variable directly affects another through a cause-
and-effect relationship. Correlation suggests that there is some kind of connection, but not necessarily a
cause and an effect.
a. You bought a very fast sports car which you use for getting to work. You are always on time.
Your neighbor has a slow car and works at the same place as you do. He is always late for work.
Is it because your car is faster? Not necessarily. In most countries there are speed limits, thus your
sports car probably cannot go any faster than your neighbor’s car. Presumably your neighbor is
taking either a longer route to get to work, or gets bogged down in traffic etc.
b. One of your classmates attended all classes in the statistics module the previous semester and
received an A. Does this mean if you sit in all the classes you will also receive an A? Not
necessarily, you shall also have to study for the class, otherwise it is unlikely you will get top
marks.
c. The newest superhero movie is released and it is a major financial success. Does this mean that
the film is actually good? Once again not necessarily as the cartoon character may have such a
major following that people will be paying to see him/her on the large screen.
7. Consider the following examples and state whether there is positive correlation, negative correlation,
or zero correlation between the variables.
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a. A person’s gender and how well they drive a car.

b. The number of sunglasses sold and the number of sunny days.
c. The amount of gas (petrol) sold and its price.
Answer:
a. A person’s gender is unlikely to influence how well they can drive a car. This is also called
stereotyping. Best drivers are typically the ones who practice a lot. Therefore, zero correlation.
b. The more sunny days a region has the more likely people will be wearing sunglasses, therefore
there is positive correlation.
c. If the price of gas drops people will be more likely to use their cars often. As opposed to the case
when the price of gas increases, less people will use cars. Therefore, negative correlation.
8. What it meant by data? Is data always numerical? How is data used in empirical analysis? Give an
example.
Answer: Data refers to facts that can be observed or measured. It is also referred to as empirical evidence.
Data can be either numerical (quantitative) or qualitative in nature. For example, Mia paid €200 in taxes
in the year 2017 is numerical data. On the other hand, Mia prefers to pay by credit card over check is
qualitative data.
Data can be collected and organized to for empirical analysis in order to establish facts or truths about
various phenomena. For example, if you survey your classmates about their incomes from part-time jobs,
you can analyze those data to determine their average income. You can then calculate the standard
deviation and range to find out the income disparity among your classmates and so on.
9. Why is it necessary to conduct experiments before releasing new drugs in a market? Why is
randomization needed for experiments?
Answer: In order to know whether a drug works on people they have to test it. Best way to test it is to
administer the drug to a treatment group (those who do get the drug) and to a control group (who get a
placebo). If there is a significant increase in the treatment group’s health vis-á-vis the control group the
drug could be working. However, the drug may have side effects; therefore, a large pool of people should
be tested. The best results are obtained when a large sample is selected randomly.
10. Suppose you had to find the effect of smoking on cancer. Would you choose to run a randomized
experiment or would it make sense to use natural experiments here? Explain.
Answer: It would be unethical to conduct a randomized experiment and ask people to smoke cigarettes, in
order to test whether they might contract lung cancer or not. Therefore, it might make more sense to
conduct surveys or analyze medical records to find the linkage between smoking and cancer.

Problems
1. Please calculate the mean and median values for the following populations. The median is the value
separating the higher half of a data sample, from the lower half.
a. Suppose firm A has five employees making annually €30,000; €32,000; €36,000; €40,000; and
€50,000. What are the mean and median wages?
b. Suppose firm B has six employees making annually €25,000; €35,000; €38,000; €40,000;
€45,000 and €50,000. What are the mean and median wages?

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c. Suppose firm C has five employees making annually €28,000; €31,000; €39,000; €40,000; and
€45,000. What are the mean and median wages?
d. Which firm provides higher wages for its workers?
Answer:
a. We can find the mean by summing the observations and dividing by the number of observations.
So, the mean income in Firm A is (30,000 + 32,000 + 36,000 + 40,000 + 50,000) / 5 = €37,600.
The median income is the income of the worker in the middle (the middle value) in this case
€36,000.
b. A similar argument shows that the mean income in Firm B is (25,000 + 35,000 + 38,000 + 40,000
+ 45,000 + 50,000) / 6 = €38,833. Median income in Firm B is the mean of the two central
numbers: (38,000 + 40,000) / 2 = €39,000.
c. A similar argument shows that the mean income in Firm C is (28,000 + 31,000 + 39,000 + 40,000
+ 45,000) / 5 = €36,600. The median income is the income of the worker in the middle (the
middle value) in this case €39,000.
d. The average wage is highest in Firm B. The median in Firm B and C are equal, but since the
average wage is higher in Firm B we can infer that wages are higher in firm B.
2. The average score for a class of 30 students is 70. The top 20 students in the class averaged at 75.
What is the average score of the remaining 10 students in the class?
Answer: The total score of 30 students = 30 × 70 = 2,100. The total score of 20 students = 75 × 20 =
1,500. Thus, the total score for the remaining 10 students = 2,100 – 1,500 = 600. Therefore, the average
score of the remaining 10 is 600/10 = 60.
3. This chapter stressed the importance of using appropriate samples for empirical studies. Consider the
following two problems in that light.
a. Imagine you are a sociologist and your task is to find out the average wage in a small town in
rural Europe. Since you are short on time you travel to the city and ask 10 random people waiting
at the train station about their wages, then travel back and report on the data. Are you going to get
an accurate number?
b. Your friend is visiting a European capital city for two days and comes home saying that this city
has the best restaurants in the world. Do you think his/her conclusion is justified?
Answer:
a. Even though an attempt at randomization has been made there are all sorts of bias in the sample.
First of all, your sample is small, second you are interviewing people at a special place and time
which may not accurately reflect on the whole small town. Say, the interviews are conducted in
the morning and maybe the interviewed people are commuters to the capital city nearby where
wages are higher. Thus, you will be reporting on the wage of the city and not your small town.
b. No, as the sample your friend was using was more than likely limited to a couple of experiments
on restaurants. Again, they could have gotten lucky and tried the only good ones.
4. Some studies have found that people who owned guns were more likely to be killed with a gun. Do
you think this study is strong evidence in favor of stricter gun control laws? Explain.
Answer: Not necessarily. It is quite possible that people who thought they were at risk (perhaps because
they live in dangerous neighborhoods) were more likely to buy a gun for self-protection. This is an
example of a case where correlation may not imply causation. There has been a good deal of research on

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this question. See, for example, a Harvard School of Public Health 2011 interview with David Hemenway
(http://www.hsph.harvard.edu/news/features/review-guns-politics-hemenway).

5. As the text explains, it can sometimes be very difficult to sort out the direction of causality.
a. In Germany for instance in many places there are no speed limits on the motorway. This means
that you can easily travel at 200 kilometers per hour. As opposed to the United States, which has
serious speed limits. Does the lack of a speed limit on the motorway mean that there are likely to
be more fatalities due to car accidents in Germany?
b. Europe experienced the hottest summer in 2017 since 2003. The heatwave was aptly named
Lucifer. Temperatures passed 40°C. Do you think it is likely that more people would have bought
an air-conditioning device for their home?
Answer:
a. Essentially it should, however, the higher quality roads, the skill, and the training of the drivers,
the better quality of the cars and strict penalties for tailgating ensures that fatalities are lower in
Germany than in the United States.
b. Probably yes. If they have experienced high temperatures and personally did not like the heat it is
likely they bought buying an air-conditioner.
For further reference, students may refer to:
a. Evans, Leonard (2014), ‘Traffic Fatality Reductions: United States Compared With 25 Other
Countries’, Am J Public Health. 2014 August; 104(8): 1501–1507,
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4103211/; and Aaron Brown, “8 Reasons That
Germany's Autobahn Is so Much Better than Us Highways,” Business Insider, March 31, 2016.
b. Stan Cox, “Climate Risks Heat up as World Switches on to Air Conditioning,” The Guardian,
July 10, 2012.
6. During the summer of 2015, the European Union (EU) experienced a record number of applications
from asylum seekers. Some said they are economic migrants who just want to take advantage of the
relatively good social protection system of the EU, whereas others pointed out that the majority of
asylum applications come from countries experiencing civil war. Why do you think asylum seekers
were trying to get into the EU? List at least 5 possible explanations.
Answer: Migration can be best analyzed by looking and push and pull factors. Push factors are the factors
that push people from their home country. These can include intensity of civil war; political, sexual, or
religious repression; climate change; and a lack of job opportunities. Pull factors are those that draw
migrants to a new country such as safety; tolerance; job prospects; higher wages; minorities from the
same country of origin; and common spoken language.
[For further reading, students may refer to: Timothy Hatton, “Refugees, Asylum Seekers, and Policy in
OECD Countries,” American Economic Review: Papers & Proceedings, 106(5): 441–445, 2006.]
7. What is a dependent / independent variable? Let’s assume that ACT scores are our dependent
variable.
a. What kind of independent variables might we use in order to predict how a student might perform
in secondary school?
b. Assuming that in order to pass their calculus module students on average have to spend 100 hours
studying. If they study more they will of course improve on their ACT score. If someone i) has a
higher IQ ii) has better teachers iii) has more committed classmates iv) has to work part time, will
these people have to spend more or less hours on average to pass calculus?
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Answer: ACT scores are measures for a scholar’s performance. An independent variable is a variable
whose value does not depend on another variable, whereas a dependent variable is a variable whose value
depends on another variable.
a. In this case possible independent variables to check could be: IQ level, number of hours spent
studying, family income, number of people in the classroom, qualification of teaching staff, etc.
b. i) if someone has a higher IQ they might have to study less; ii) better teachers mean students
might understand the topic already in class, thus people might have to study less at home; iii) peer
pressure can be a highly influential factor in improving grades, although it does not mean that
students will have to study less; iv) if someone has to work part time it means they will have less
time to spare on obtaining a better grade, however they will have to spend on average at least 100
hours as well to pass the course.
8. In 2016, a majority of British voters decided that the United Kingdom should exit the European
Union (EU). This withdrawal is popularly known as Brexit. How can we use this to demonstrate the
effects of EU membership? Is this a natural experiment? What kind of economic impact will this have
on the United Kingdom?
Answer: Brexit in a way is a natural experiment. This is the first time that a country has decided to
voluntarily exit the EU and, so far, we have no experience on what happens to the economy of a country
that does exit. We can analyze how the British economic growth will unfold in the future and compare it
to the larger countries of the EU such as France, Germany, or Italy. It is difficult to predict the economic
impact of Brexit; however, growth is estimated to be less dynamic as without Brexit occurring. Another
consequence of Brexit was illustrating how difficult it is to leave the EU to other member states.
Sources: The Guardian (2017), ‘Gloomy Brexit forecasts for UK are coming true, says IMF’,
https://www.theguardian.com/business/2017/dec/20/imf-christine-lagarde-brexit-forecasts-growth-uk-
economy
9. The consumption function of a household can be expressed by the following equation: C = a + bI,
where I is the income, a denotes a positive number, and b a percentage.
a. Is this equation a model?
b. How would you test this model?
Answer:
a. Yes. A model is a simplified version of the economic reality. This equation simplifies a
household’s consumption behavior. So, we can consider it as a model.
b. The consumption is simplified by a model with two main variables. The first variable denotes the
irreducible consumption: we consume even when we don’t have an income. The second set of
variables denote that a certain proportion (b) of the income (I) is devoted to consumption.
A1. How would you represent the following graphically?
a. Income inequality in the U.S. has increased over the past 10 years.
b. All the workers in the manufacturing sector in a particular country fit into one (and only one) of
the following categories: 31.5 percent are high school dropouts, 63.5 percent have a high school
diploma, and the rest have vocational training certificates.
c. The median income of a household in Alabama was $43,464 in 2012, and the median income of a
household in Connecticut was $64,247 in 2012.
Answer:
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a. Since the graph needs to show how income inequality increases over a period of time, a time-
series graph needs to be used here.
b. A pie chart is a circular chart split into segments to show the percentages of parts to the whole.
Since the given data is in percentages, a pie-chart can be used to represent each category of
workers.
c. A bar chart would be a good way to compare income in Alabama and Connecticut. The height of
each bar would represent the income in each one of the states.
A2. Consider the following data that shows the quantity of coffee produced in Brazil from 2004-2012.

Year Production (in tons)

2004 2,465,710
2005 2,140,169
2006 2,573,368
2007 2,249,011
2008 2,796,927
2009 2,440,056
2010 2,907,265
2011 2,700,440
2012 3,037,534
a. Plot the data in a time series graph.
b. What is the mean quantity of coffee that Brazil produced from 2009 to 2011?
c. In percentage terms, how much has the 2012 crop increased over the 2009-2011 mean?
Answer:
a. A time-series graph can be used to represent the quantity of coffee produced from 2004 to 2012.

b. The average quantity of coffee that Brazil produced during the 2009-11 period is 2,682,589 587
tons. This is the sum of the total quantity produced divided by the number of years.
c. The coffee crop in 2012 is 14.6% larger than the average coffee crop in 2009-2011. The increase
in production is 3,073,534 – 2,682,589 = 390,945. In percentage terms, the change is 390,945 /
2,682,589 587 = 14.6%.

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Data taken from: http://faostat.fao.org/site/567/default.aspx#ancor

A3. Suppose the following table shows the relationship between revenue that the Girl Scouts earn and the
number of cookie boxes that they sell.
Number of cookie
boxes Revenue ($)
50 200
150 600
250 1,000
350 1,400
450 1,800
550 2,200
a. Present the data in a scatter plot.
b. Do the two variables have a positive relationship or do they have a negative relationship?
Explain.
c. What is the slope of the line that you get in the scatter plot? What does the slope imply about the
price of a box of Girl Scout cookies?
Answer:
a. The following line chart shows the relationship between the Girl Scouts’ revenue and the number
of cookie boxes that they sell:

b. Since the values of both variables increase together in the same direction, they have a positive
relationship. This means that as more cookie boxes are sold, the revenue earned increases.
c. The slope is constant in this problem and so we can choose any two points to calculate the slope.
Suppose we use the first and last data points. The slope is calculated as
. The slope implies that one extra box of

cookies sold is associated with $4 more in revenue.

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