econ 495 - university of michigan

Econ 495Research Strategies

Kathryn M. E. Dominguez, Winter 2010 2

Economic Research Economic research typically involves

examining a topic or question in the context of a specific “theory” or “hypothesis”, and then: if the research is empirical: testing the theory If the research is theoretical: providing a

mathematical framework


Examples of economic theories In microeconomics, examples include:

Supply and demand Production and cost Theories of the firm Consumer behavior

In macroeconomics, examples include: Aggregate demand and supply Consumption expenditure Investment demand Money demand


More examples of economic theory A number of economic issues involve

information asymmetries. Two theoretical concepts that allow us to

think about how these asymmetries may influence incentives are: Moral Hazard

The classic example is in the insurance industry, where coverage against a loss might increase the risk-taking behavior of the insured.

Adverse Selection Often referred to as the “lemons problem” which

arises over the inability of buyers to ascertain quality.


Comparative Advantage Nobel laureate Paul Samuelson was once

challenged by the mathematician Stanislaw Ulam to "name me one proposition in all of the social sciences which is both true and non-trivial."

It was several years later than he thought of the correct response: comparative advantage. "That it is logically true need not be argued before a

mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them."


Models of Growth Help us understand how standards of

living evolve over time in different countries

“Exogenous” growth models (the Solow growth model is a classic example) start with the (key) assumption that capital is subject to diminishing returns.

“Endogenous” growth models relax this assumption and focus on the role of technological progress.


An increase in the saving rate

Investment and

depreciation

k

k

s1 f(k)

*k 1

An increase in the saving rate raises investment……causing k to grow toward a new steady state:

s2 f(k)

*k 2

Presenter

Presentation Notes

Next, we see what the model says about the relationship between a country’s saving rate and its standard of living (income per capita) in the long run (or steady state). An earlier slide said that the model’s omission of G and T was only to simplify the presentation. We can still do policy analysis. We know from Chapter 3 that changes in G and/or T affect national saving. In the Solow model as presented here, we can simply change the exogenous saving rate to analyze the impact of fiscal policy changes.


Solow Model Prediction: Higher s ⇒ higher k*.

And since y = f(k) , higher k* ⇒ higher y* .

Thus, the Solow model predicts that countries with higher rates of saving and investment will have higher levels of capital and income per worker in the long run.

Presenter

Presentation Notes

After showing this slide, you might also note that the converse is true, as well: a fall in s (caused, for example, by tax cuts or government spending increases) leads ultimately to a lower standard of living. In the static model of Chapter 3, we learned that a fiscal expansion crowds out investment. The Solow model allows us to see the long-run dynamic effects: the fiscal expansion, by reducing the saving rate, reduces investment. If we were initially in a steady state (in which investment just covers depreciation), then the fall in investment will cause capital per worker, labor productivity, and income per capita to fall toward a new, lower steady state. (If we were initially below a steady state, then the fiscal expansion causes capital per worker and productivity to grow more slowly, and reduces their steady-state values.) This, of course, is relevant because actual U.S. public saving has fallen sharply since 2001.


International evidence on investment rates and income per person

100

1,000

10,000

100,000

0 5 10 15 20 25 30 35

Investment as percentage of output (average 1960-2000)

Income per person in

2000 (log scale)

Presenter

Presentation Notes

Figure 7-6, p.197. Source: Penn World Table version 6.1. Number of countries = 97 High investment is associated with high income per person, as the Solow model predicts.


The impact of population growthInvestment, break-even investment

Capital per worker, k

sf(k)

(δ+n1)k

k1*

(δ+n2)k

k2*

An increase in ncauses an increase in break-even investment,leading to a lower steady-state level of k.


Prediction: Higher n ⇒ lower k*.

And since y = f(k) , lower k* ⇒ lower y*.

Thus, the Solow model predicts that countries with higher population growth rates will have lower levels of capital and income per worker in the long run.

Presenter

Presentation Notes

This and the preceding slide establish an implication of the model. The following slide confronts this implication with data.


International evidence on population growth and income per person

100

1,000

10,000

100,000

0 1 2 3 4 5Population Growth

(percent per year; average 1960-2000)

Income per Person

in 2000(log scale)

Presenter

Presentation Notes

Figure 7-13, p.210. Number of countries = 96. Source: Penn World Table version 6.1. The model predicts that faster population growth should be associated with a lower long-run income per capital The data is consistent with this prediction. So far, we’ve now learned two things a poor country can do to raise its standard of living: increase national saving (perhaps by reducing its budget deficit) and reduce population growth.


Alternative perspectives on population growthThe Kremerian Model (1993) Posits that population growth contributes to

economic growth. More people = more geniuses, scientists &

engineers, so faster technological progress. Evidence, from very long historical periods:

As world pop. growth rate increased, so did rate of growth in living standards

Historically, regions with larger populations have enjoyed faster growth.

Presenter

Presentation Notes

Michael Kremer, “Population Growth and Technological Change: One Million B.S. to 1990,” Quarterly Journal of Economics 108 (August 1993): 681-716.


How do you “apply” economic theory (or thinking) to an issue? Three questions you need to answer:

1. What are the essential concepts involved in the problem being researched?

2. How are the essential concepts related?3. What implications or predictions can be drawn

from these relationships?


An example of how to go from a “topic” to a research strategy… Sample topic: Is the US Macroeconomic

slowdown caused by the decline in the stock market?

What are the major concepts involved? Economic slowdown Decline in the stock market

What theories might connect the two concepts? Consumer spending Investment demand


Connecting a macroeconomic slowdown with a decline in the stock market…

Weaving a story: A decline in the stock market makes individuals feel less

wealthy and may cause a decrease in consumer spending

Reduced consumer spending leads to less demand for business output and therefore business investment

At the same time, a declining stock market makes it more difficult for businesses to raise capital (also potentially reducing investment)

Y = C+I+G; if “C” and “I” decline (due to the decline in the stock market) then (assuming “G” does not rise to offset these declines) “Y” will fall.


Narrative and Mathematical Reasoning Both these approaches start with a

hypothesis and reason through the “economic logic” either: in words (the narrative approach)

Keynes’ General Theory is a (classic) example of this approach

with mathematical equations Most academic economic research currently involves

mathematical modeling


Common shortcut: Modifying an Existing Model Idea here is to “customize” a more general

economic model to the particular question you are interested in. In some cases this will involve simply re-defining

variables and in other cases it will involve adding additional variables or components to a standard model.

In these instances it is very important to make clear what contribution you are making (realizing that a model set up for a different question is relevant, is a contribution) and to whom credit should go for the original formulation…


Elements of a good research hypothesis1. You should be able to state it clearly and

specifically2. It should be possible to discriminate it

clearly from alternative hypotheses3. It should be capable of being proven

false4. It should be empirically testable5. It should be derived from a theoretical

analysis


Some additional readings on research design Rowan Hooper, Happiness is the Best Medicine,

Wired News, April 18, 2005. Interesting article summarizes research on the

relationship between health and happiness, including a good discussion of the pitfalls of direction of causation possibly going both directions

Daniel S. Hamermesh, Doing Applied Economics: Normative and Positive Aspects, Chapter 8 in Stephen G. Medema and Warren J. Samuels, (Eds.) Foundations of Research in Economics: How Do Economists Do Economics? Edward Elgar: Northampton, MA. 1996. Excellent reflection on what makes for a good empirical

research design.


A provocative source for research ideas: Steven D. Levitt and Stephen J. Dubner, Freakonomics,

William Morrow: New York, 2005. NY Times blog: http://freakonomics.blogs.nytimes.com/

Authors examine social issues/problems in an economic context by developing chains of deductive and inductive reasoning. This work has been criticized (often for good reason) for not being carried out as carefully as it should be (urban legends etc…). Their key (often provocative) assertions include: People respond to incentives in predictable ways, seeking benefits

and avoiding costs. The conventional wisdom is often wrong. Dramatic effects often have distant, even subtle causes. Experts often use their informational advantage for their own

interest. Knowing what to measure and how to measure it is a good way to

sort out problems.

http://freakonomics.blogs.nytimes.com/�

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