History of Economic Thought Lecture 6

Econometrics

Economics lacked mathematical formulation in the early years and over time, more sophisticated models were needed to analyze empirical data.

• Econometric models solve NOTHING, they help prove economic theories.

Frisch and Tinbergen Models.. what is econometrics?

They were pioneers of econometric model building

Frisch:  

• According to Frisch econometrics was a research methods that consists of:

  1. Mathematical formulations of economic theories and,

  2. Systematic tests of those using mathematical statistics 

• Frisch’s model focused on identification: methods developed to identify patterns/relationships in data  

Tinbergen

• Expanded on Frisch’s work by adding more variables and he introduced large numerical estimation.

Frisch-Tinbergen policy planning 

• Frisch: Expanded business cycle theory  

  • Macroeconomic model that describes the demand for money as a function of consumption and investment  

  • Model was able to generate business cycles (able to predict how the economy would behave)

• Tinbergen: business cycle theory 

  • Extended Frisch’s model as a tool for formulating anti-depression policies by utilizing a large numerical model wherein different variables are simultaneously estimated.

    • Still used for forecasting and policy in many countries 

Trygve Haavelmo 

• Economic theory and the statistical estimation of theoretical relationships must be regarded in close connection with each other 

  • In girly pop language: Economic theory and statistics go together… real bad. Purrr.

• He had pioneering contributions to the foundation of econometrics, i.e., methods used to estimate and test quantitative economic relations 

Haavelmo and the Principles of econometrics

1. Autonomy: A relationship is unaltered by changes in other relationships that characterize the economy 

   • Relationship between A and B, should not be affected by random variable C (its giving fidelity to variables)

2. Identification problem: extended analysis of Frisch, mainly, how many variables are needed to estimate a relation

3. Simultaneity: all equations in a model should be estimated simultaneously especially when data is used for different markets

 

Granger and Engle on time series analysis

Granger

• Cointegration methods:

  • to differentiate between, and combine the analysis of, short-term fluctuations and long-term trends 

  • Two variables are both affected by a third variable, which leads to a misinterpretation of their relationship  » Cointegration detects and corrects this!

Engle

• Developed methods to study the volatility properties of time series in economics 

  • Error terms not randomly distributed over time  

  • Variables exhibit greater fluctuations in some periods than in others  

  • ARCH-models deal with this 

Heckman and self-selection bias/ What is the Heckman correction procedure?

Self-selection bias: if groups were different from the beginning this may be problematic if characteristics are difficult to measure/observe.

• Solution: random assignment experiments, though not always possible  

• Heckman correction procedure:  

  • Define the problem and ensure that researchers understand limitations of their findings  

  • Developed statistical techniques to correct for bias 

• Note: Read over married women in labour force. But in a nutshell:

  • Estimate if the woman works, then for those women, estimate the determinants of wages.

Inheritance Heckman  

• Classicals: rational, self-interested behaviour  

• Chicago School policy evaluation: Heckman was against laissez-faire of his Chicago colleagues  

• Earlier econometricians: building on existing methods and techniques 

 

McFadden Discrete choice analysis

Discrete choice models: regression methods that take into account the binary nature of a variable of interest 

• McFadden showed how to statistically handle fundamental aspects of microdata!

• Before him, all models focused on continuous outcomes

Card and the minimum wage natural experiment

Card, (like Angrists & Imbens) had a focus on causality and decided to test this with the help of randomized controlled trials and natural experiments » » » Design based approach!

• Natural experiments: study design in which subjects are exposed to as good as random variation caused by nature, institutions, or policy changes 

Minimum wage natural experiment:

• What is the impact of minimum wage on employment? 

• Treatment: rise minimum wage in New Jersey 

• Control: Pennsylvania  

• Sample: employment in fast-food restaurants 

• Finding: minimum wage had no impact on the number of employees 

Guido Imbens and Joshua Angrist, returns to school natural experiment 

How much more would you earn if you chose to study longer? 

• Natural variation in amount of schooling arising from variation in birth month: People born later in the year tend to study for longer.

Difficulties with natural experiments: 

• Treatment heterogeneity: different people or groups respond differently to the same treatment

• Imperfect compliance: when participants in a study don't fully follow the treatment they were assigned.

They also provided conditions under which we can use a natural experiment to estimate the effects of an intervention  

Local average treatment effect (LATE)  

Deductive vs Inductive approach

• Deductive: Based on theory. Facts speak for themselves

  • all dogs have fleas ⇒ this is a dog ⇒ therefore this dog has fleas 

  • Frisch, Tinbergen and Haavelmo applied this type of reasoning

• Inductive approach: Based on empirical evidence

  • I have observed 100 dogs and every dog had fleas ⇒ all dogs must have fleas

  • McFadden and Heckman applied this type of reasoning 

Becker’s preferred form of reasoning

Abductive approach: He rejected purely deductive and inductive reasoning, a combination of both is needed. Theory backed by evidence.

Becker and Economic Imperialism and his model

• Extending economic approach to topics that were not characterized by markets or prices (e.g. sociology, political science, law, social biology, anthropology) 

   

• Main economic principles of economic liberalism and his model 

  • Maximizing, rational behaviour  

  • Importance of equilibrium as part of a theory 

  • Emphasis on efficiency allow complicated problems to be written in simple, abstract terms. 

  • Preferences are stable but can evolve.

Becker and Discrimination

Discrimination has to do with taste components is unrelated to the worker’s productivity.

• This “taste component” is costly, and thus decreases profits, hence discrimination will not exist in competitive markets.

  • No need for government intervention/anti-discrimination laws (Bestie its not that easy)

Inheritance for Discrimination theory and Becker’s contribution

• Inheritance 

  • Relation to Adam Smith’s invisible hand:  

    • Focus on efficiency 

    • Individuals acting in their self-interest further the general goals of society  (How naive.)

  • Relation to Marshall: the idea that competitive equilibrium is efficient

  • Relation to Marginalists: focus on individual choice behaviour and utility maximization 

• Contribution 

  • Becker was the first to looked at origins of preferences! 

  • Preferences can change over time through consumption decisions and choices of lifestyle e.g. rational habit formation can include addiction 

Becker and Fertility/Family and Inheritance

Low income families became larger than rich families in the 20th century due to the income and time cost effects.

• As richer women became more educated, they earned higher wages and thus the opportunity costs of having children increased (income effect)

• Time effect: If a woman works, she will not have sufficient time for raising children and vice versa.

Becker: Family is a ‘factory’ which produces goods it wants to consume  

Ui=f(xi,ti)

• x = number of kids

• t = mother’s time

  Inheritance

  • Malthus’ theory not consistent with facts 

  • Mincer (1963) – importance of the price of women’s time as a relevant opportunity cost 

  • Becker formalized this idea in a household production function: theory that treated children as household outputs valued in final utility, where mother’s time was a leading input 

  • Becker used dynamic general equilibrium theory to generalize Malthus’ population theory: 

    • Including nonmarket activities  

    • Trade-off child quantity – quality (Becker, 1991) 

Becker’s Theory of Human Capital

• Becker made the distinction between: formal schooling (general) vs on-the-job training (specific)  

• Education enhance wages  

• Policy implications: is there under- or overprovision of education? Should the state subsidize education?  

• Implication for policy: Education was a public good and should be subsidized.

  Inheritance 

  • Friedman and Kuznets (1945) implicit theory of human capital, with an empirical emphasis 

  • Becker: comprehensive theoretical framework on human capital – abductive approach (data-driven model building)  

Becker’s Impact

1. Discrimination: perfect competition is very unrealistic in today’s market, so discrimination seems to be a fact of life (although governments will try to reduce it as much as possible)  

2. Family/fertility  

   • Investing in education for girls is the main programs in developing countries 

   • Specific case: even now China relaxed the one-child policy, its fertility will not rise much given the huge economic development in China  

3. Crime: are criminals really rational? Serial murders are almost by definition irrational (unless they have a very high discount rate) 

4. Human capital: opportunity cost of investing in schooling still very relevant in everyday life choices 

 Moreover, Becker did pioneering microeconomic analysis in a time where large-scale data were beginning to be collected  and Becker was more interested in the mechanisms at work than overall treatment effects.

Note: Just read this over sis.

Development of economic thought 

• History of economic thought is the development of economics as profession 

• Economics was regarded an investigation of 

  • The nature and causes of the wealth of nations (Smith)  

  • The laws which regulate the distribution of the produce of the earth (Ricardo)  

  • Laws of motion of capitalism (Marx)  

  • Human behaviour as a relationship between given ends and scarce means which have alternative uses (since Marginalists) 

• Main issues remained since Adam Smith  

  • What determines prices?  

  • What causes economic growth?  

  • What factors determine the income distribution?  

 

Broadening and deepening of perspective  

• Deepening  

  • Competitive equilibrium theories  

  • Markets with asymmetric information  

  • Research on the microeconomic foundations of macroeconomic theories  

• Broadening 

  • Theories imperfect competition  

  • More specialized topics 

  • New fields of interest 

 

Trends 

1. Economic imperialism 

   • Marshall: Economics is the study of men “in the ordinary business of life” 

   • Economic ideas and economic tools are now extended to new areas, which – according to Marshall – would not be part of traditional economics 

   • At the same time, ideas from other sciences have been adopted and tested in economics 

2. Increasing formalisation  

   • 19th century: economics was a “literary” field of study 

   • Marginalist breakthrough: formalization of economic theory began, increasingly more after WWII 

3. Greater role for empirical research  

   • Increased importance of empirical research  

   • Both theoretical and empirical methods became more rigorous, and empirical analysis is subject to higher standards  

   • Reasons for change:  

     • Data availability improved  

     • Progress in econometrics  

     • Development of data processing technology  

     • Increasing use of lab experiments 

4. Economics becomes profession  

   • Early years, university affiliation was the exception rather than the rule for leading economists, in particular, no economics degree  

   • This situation changed radically around the marginalist breakthrough 

5. Globalisation of economics 

   • Early years, Great Britain was leading country in development of economics as a scientific discipline 

   • During the 20th century, centre of gravity toward US 

   • Internet allows rapid dissemination of research results