Microeconomics

Second Edition, Global Edition

EC 101.03

Chapter 2
Economic
Methods and
Economic
Questions

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Learning Objectives

2.1 The Scientific Method

2.2 Causation and Correlation

2.3 Economic Questions and Answers

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Key Ideas (1 of 2)

1. A model is a simplified description of reality.

2. Economists use data to evaluate the accuracy of
models and understand how the world works.

3. Correlation does not imply causality.

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Key Ideas (2 of 2)

4. Experiments help economists to measure

cause and effect.

5. Economic research focuses on questions that

are important to society and can be answered
with models and data.

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Evidence-Based Economics (1 of 2)
Is college worth it?

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Evidence-Based Economics (2 of 2)
Evidenced-Based Example:
2015-2016 academic year tuition averaged
$3,435 for community colleges
$9,410 for instate public colleges
$23,893 for out-of-state public colleges $32,405
for nonprofit private colleges
At least $15,000 per year in opportunity cost

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The Scientific Method (1 of 17)
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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The Scientific Method (2 of 17)
What is this?
Does it look like anyone you know?

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The Scientific Method (3 of 17)

Model

A simplified description of
reality
Is this an airplane?

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The Scientific Method (4 of 17)
Exhibit 2.1 Flying from New York to Tokyo Requires More Than
a Flat Map
What’s the shortest distance between two points?

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The Scientific Method (5 of 17)

Evidenced-Based Example:

Returns to education

Assumption—one more year of education results in

a 10% increase in future earnings

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The Scientific Method (6 of 17)
Returns to education:

If you would earn $15 per hour with 13 years of

education, with one more year of education (your 1 st

year of college) you would earn:

First Year $15 × 1.10 = $16.50

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The Scientific Method (7 of 17)
Returns to education:

If you would earn $16.50 with 14 years of

education, with one more year of education (2 nd
year of college), you would earn:

Second Year $16.50 x 1.10 = $18.15

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The Scientific Method (8 of 17)

Returns to education:

The third year: $18.15 x 1.1 = $19.97

The fourth year: $19.97 x 1.1 = $21.97

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The Scientific Method (9 of 17)
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) = 0.4647]

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The Scientific Method (10 of 17)
Two important features of models:

1. They are not exact. Not everyone will see his or

her wages increase by 10% with every additional
year of education

2. They generate predictions that can be tested

with data

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The Scientific Method (11 of 17)
Hypothesis: Each additional year of education
increases wages by 10%. True or False?

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The Scientific Method (12 of 17)
Exhibit 2.3 Average Annual Earnings of 30-Year-Old
Americans by Education Level (2014 data)

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The Scientific Method (13 of 17)
How much higher is the wage for college graduates
than for high school graduates?
College = $51,215
High School = $32,912

College results in a wage that is 56% higher.

$51, 215
32, 912  1.56
Model predicted 46% higher. Is that close enough?

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The Scientific Method (14 of 17)

If college graduates earn, on average,

$51,215/year, does that mean that all college

graduates earn that much?

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The Scientific Method (15 of 17)

The median is the value in the middle of a group of

numbers, and the mean is the average value of the

group of numbers (also mode).

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The Scientific Method (16 of 17)

Can Bill Gates make

you rich?

When the range of

incomes is skewed
the mean is not a very
accurate measure

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The Scientific Method (17 of 17)
Speaking of Bill
Gates…

How does his level of

education affect his
income?

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Causation and Correlation (1 of 13)

Buttercup

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Causation and Correlation (2 of 13)
A study from England showed that cows who were
named gave more milk than unnamed cows

Causation? or Correlation?

Buttercup
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Causation and Correlation (3 of 13)

A study here in the US found that gamblers over 65

are healthier than non-gamblers over 65

Causation? or Correlation?
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Causation and Correlation (4 of 13)

Causation - When one thing directly affects

another.

Example: pulling an all-nighter will make you tired

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Causation and Correlation (5 of 13)

Correlation - When two things are related

• Positive correlation – they both change in the
same direction
(Increase in health over 65 => Increase over 65
gambling)
• Negative correlation – they change in opposite
directions
• https://www.tylervigen.com/spurious-correlations
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Causation and Correlation (6 of 13)

Why isn’t correlation the same thing as causality?

1. 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.

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Causation and Correlation (7 of 13)

Omitted
Buttercup Variables

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Causation and Correlation (8 of 13)

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.
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Causation and Correlation (9 of 13)

Reverse Causality

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Causation and Correlation (10 of 13)
How can we tell the difference between causality
and correlation?

Experiments

1. Controlled = subjects are randomly put into

treatment (something happens) and control
(nothing happens) groups by the researcher.
Problem: difficult to do with economics studies
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Causation and Correlation (11 of 13)

Experiments

2. Natural = subjects end up in treatment or control

groups due to something that is not purposefully
determined by the researcher

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Causation and Correlation (12 of 13)
Evidence-Based Economics and Natural Experiments

How much is an extra year of school worth?

In 1947, the U.K. 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
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Causation and Correlation (13 of 13)

How much is an extra year of school worth?

On average, staying in school an extra year

increased earnings by 10%, which is the basis of
the assumption we made in the beginning of the
chapter.

Economic assumption was based on a robust data

set
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Economic Questions and Answers

Two Properties of a Good Economic Question:

1. Relevant and important

Economic research contributes to social welfare

2. Can be answered

Economic questions can be answered empirically

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