FGV-EESP – MDPE Applied Microeconomics – 2/2023

Profs. Priscilla Tavares and Giovanni Di Pietra

Empirical Problem 4 - Differences-in-Differences

Theoretical Questions

Based on the content of CN 9 (Differences-in-Differences) or MHE 5.2, consider a

setup with two periods, t ∈ { 0 ( Pre ) ; 1(Post ) }, and two groups Di ∈ { 0 , 1(treated) }, where
the treated group receives the treatment only at t=1, thus
Y i ,t =Y i , t ( 1 ) ⋅ Di ⋅1 { t ≥ 1 }+Y i ,t ( 0 ) ⋅(1−D¿¿ i)⋅1 { t<1 } ¿.

1. State the parallel trends assumption in terms of Y i ,t (1 ) , Y i ,t ( 0 ).

How can we interpret it?

2. Assume that Y i ,t ( 0 )=γ D + λ t +ϵ ¿ ∧E [ ϵ i ,t ∣ D , t ]=0, with γ D representing group ( D )

effects that are constant over time and λ t representing time (t ) effects that are
constant over groups. Explain why the following estimand will recover the ATT:

δ =( E [ Y i , 1 ∣ Di =1 ]−E [ Y i , 0 ∣ Di =1 ] )−( E [ Y i ,1 ∣ D=0 ]−E [ Y i ,0 ∣ Di=0 ] )

did

Hint. Start by showing that E [ Y i ,1 ∣ Di=1 ]=δ+ γ D=1 + λ t=1 and then manipulate
other E [ Y t ∣ D ]. Recall ATT =E [ Y i ,1 (1)−Y i , 0(0)∣ Di =1 ].

3. How can you use a linear regression model to estimate δ did ? Write down this
model and interpret its parameters.

4. If you have data on Y for an additional period before the treatment ( t=−1), how
could you “falsify” (or test) the parallel trends assumption?
Card and Krueger (1994) popularized a great discussion in modern economics: basic
microeconomic theory of the firm in competitive factor markets tells you that factor
demand curves slope downwards. This implies that if minimum wages are binding, we
would expect employment to fall when minimum wages increase. This conventional
wisdom among economists was challenged by this paper. Their research design was
based on New Jersey (NJ) raising its minimum wage from $4.25 to $5.05 on 1 April
1992 while the minimum wage in neighboring Pennsylvania (PA) remained unchanged.
They collected data on wages and employment in 65 fast-food restaurants in PA and
284 in NJ in Feb/March 1992 (before the rise in the NJ minimum wage) and in Nov/Dec
1992 (after the rise). Based on CK1994, CN 9.2.3 (DD and the Minimum Wage) or
MHE 5.2:
5. What is the paper main identification assumption? How can it be stated?

6. What is their most basic estimate of the ATT? Why was this estimate
controversial?

7. In response to this criticism of their research, Card and Krueger published a

reply in 2000. This reply included the following figure, where trends indicate
employment in fast-food restaurants of NJ and of two selection of PA counties,
from October 1991 to September 1997:

The first vertical line is the rise in the NJ minimum wage studied in CK 1994;
The second vertical line was a further rise Dec/92. The final vertical line a rise in
the federal minimum wage which brought the NJ and PA minimum wages back
in line. Why this figure contains useful information to judge the quality of PA
employment levels as a counterfactual for NJ employment?
(Hint: Read MHE 5.2)
The provided dataset “ck-data.dta” is version of the data collected by CK1994. It
consists of 698 observations and the main variables are: store, an identifier for each
restaurant (each has two observations, pre- and post-), nj: dummy for whether a NJ
restaurant, after: dummy for whether post- observation; njafter ¿ nj×after and the
main outcome fte: full-time equivalent employment (Y i ,t ) and dfte: change in full-
time equivalent employment ( Δ Y i) which equals Y i ,1 −Y i ,0 , for each store i. With this
dataset:
8. Compare the mean difference of dfte for the NJ=1 and NJ=0 (PA) groups.
Compute this same difference using a linear regression model for dfte, with two
versions of SE: plain and heteroskedasticity-robust. The difference in the
standard errors is sizeable – why?

9. Compute ( Y NJ =1 , t=1−Y NJ=1 , t=0 )− ( Y NJ =0 ,t =1−Y NJ=0 , t=0 ). Obtain this same
coefficient with a linear regression model of fte on nj, after and njafter,
with two versions of SE: plain and clustering on store. What is the coefficient
of interest of this regression? Do the SE options make a difference?

10. Now estimate the linear regression model from Question 9 but using store
fixed effects (still clustering the SE on store). Do the coefficients change
between the two models? Which variables get dropped and why? Do the SE
change?

Additional References

Card, David and Krueger, Alan. (1994) “Minimum Wages and Employment: A Case-
Study of the Fast-Food Industry in New Jersey and Pennsylvania.” American Economic
Review, September 1994, vol. 84. https://www.jstor.org/stable/2118030
Card, D., & Krueger, A. B. (2000). Minimum wages and employment: a case study of
the fast-food industry in New Jersey and Pennsylvania: reply. American Economic
Review, 90(5), 1397-1420.