ECO 3104

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ECO 3104

• Lecture 1

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Economic Theory and Empirical Analysis

• Why do we need theory?
• theory guides analyst in terms of what factors
  are important to include in the analysis
• theory provides guide for specifying specific
  structure of relationships in empirical analysis
• theory often predicts relationships between
  variables and thus provides a check on empirical
  results
• if results are inconsistent with theory, may
  indicate a problem with empirical analysis

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Economic Theory and Empirical Analysis

• Scientific method and economic research
• Step 1 use established theories to generate
  testable propositions
• statements or predictions are falsifiable
  (potentially could be found to be wrong)
• could be falsifiable but currently untestable
  given available technology
• example The Hubble Telescope

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Economic Theory and Empirical Analysis

• Scientific method and economic research
• Step 2 testing
• want to set up test to see if predictions of
  theory are correct
• if test is positive, theory is corroborated, but
  not proven
• if test is negative, first want to check test
  conditions
• were conditions of theory maintained?
• was statistical analysis properly done?

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Economic Theory and Empirical Analysis

• Scientific method and economic research
• Step 2 testing
• if test conditions are appropriate and result is
  negative, theory is refuted
• theory must be reexamined to determine what went
  wrong
• must be careful to avoid ad-hoc theory
  adjustments whose sole purpose is to make theory
  consistent with a given set of results

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Economic Theory and Empirical Analysis

• Explanations vs. predictions
• prediction
• state assumptions and then given a set of
  conditions hypothesize what will happen
• working with fixed set of assumptions
• explanation
• start with observed phenomenon
• stating set of assumptions that are consistent
  with an observed outcome

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Economic Theory and Empirical Analysis

• must be careful to predict or explain, but not do
  both at the same time
• if you make a prediction based on theory (and
  assumed conditions) which is incorrect, you can
  state that assumptions were not valid but dont
  try to explain observed phenomenon

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Economic Theory and Empirical Analysis

• Questions
• How can economic theory be used to predict the
  impact of tuition increases and mandatory
  deposits on applications to FSU?
• If tuition increases and applications rise, does
  that mean economic theory is wrong?
• What should you do?

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End of Lecture 1