6 Economic theory, modeling, and connecting this to empirical work

6.1 (From theory to) empirical work

6.2 Doing economic modelling and theory

Economic models usually involve one or more of:

  • Individual (or firm or other actor) optimization… maximization of a utility, profit or welfare function (over time, perhaps involving uncertainty) subject to one or more constraints

  • Aggregation of the above and consideration of an ‘equilibrium’ outcome, usually involving an equilibrium price

  • Game theoretic (or principle-agent/mechanism design) treatment of a strategic interaction between multiple ‘actors’, considering the equilibrium (or other reasonable predicted outcome) and the ‘comparative statics; of this as key factors (’parameters’) are varied

Doing economic theory

You may have heard that ‘you should not do a theory dissertation as an undergraduate.’ That is the case that it is difficult to make a substantial contribution to pure economic theory. This work is highly mathematical. The models stemming from our basic framework and beyond have been explored in great depth and sophistication. The frontiers have been pushed very far in terms of ‘what are the implications of our standard assumptions and in what ways can they be relaxed’.

However, this does not mean that you should not do theory and modeling in your undergraduate dissertation. You should try to incorporating and adapting existing models (remember Economic theory=models=maths… approximately). You can also make this the main focus of your dissertation.

Remember, you are not writing this dissertation to advance the frontiers of Economics. In large part, you are trying to show your understanding and ability to apply techniques to specific questions.

If you can explain and adapt a rigorous theoretical model to apply to particular case, yielding intuition, you have done well. (For example… )

Even if you’re not doing a “theory paper”, specifying a model will benefit your paper in several ways:

  1. Fixing your ideas and arguments precisely and demonstrating internal consistency

  2. Motivating your (empirical) analysis

E.g., why might we expect an impact of education on income? Why might the private returns exceed the social returns? What are the channels by which education could yield personal and social gains (or losses)?

  1. Providing structure and ‘restrictions’ for your empirical analysis

  2. Connecting to the Economic literature and incorporating the general insights of the field

  3. Helping you consider and estimation ‘policy implications’ of your results

Building an economic model

Posing your hypothesis as an empirical test

Writing an empirical/econometric model

6.3 Economic theory and empirical research: writing about your work

Explain the limitations of your analysis to the reader, and what the next step would be. Perhaps you are aware there is an advanced estimation technique, or a larger data set, that could better answer your thesis question. However, this might be “too difficult” considering your abilities and resources. If you can explain this, do so.

If you’re doing a theory paper (also useful in an empirical paper) try to explicitly state and clearly explain a formal economic model, using mathematical notation.

If you’re doing an empirical paper clearly explain and describe your data, techniques, and results. Explain the econometrics behind your techniques as clearly as you can.

6.4 Empirical work: techniques and econometrics

Techniques. Understand what techniques others have used to answer your question, what technique you are using and why, and the arguments for each technique. Understand the limitations of each technique, previous papers, and of your own work.

Show you understand economic theory and the connection between theory and econometrics and empirical work. Understand the difference between these, and what each can do.

Use of techniques: use the tools you can handle, understand, and explain. Try to use the right techniques, but also try to limit yourself to techniques you can explain, at least in general terms.

Justify the techniques you use; don’t merely hide behind the rationalisation that “other authors did it”. If other authors jumped off the Brooklyn bridge, would you jump?

Know your limits. Set reasonable goals for your dissertation, and do not claim to have achieved more than you have done.