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Lecture Public finance (10/e): Chapter 2 - Harvey S. Rosen, Ted Gayer

Chapter 2 - Tools of positive analysis. The main contents of the chapter consist of the following: Economic theory provides a framework for analyzing the causal relationship between government policy and individuals’ behavior, empirical work tests hypothesis arising from economic theory to determine if it is consistent with real-world phenomena, various methods for conducting empirical work exist. | TOOLS OF POSITIVE ANALYSIS Chapter 2 Public Finance and Positive Analysis One goal of Public Finance is to estimate how government policy affects individuals’ behavior. 2- The Role of Theory Economic models Provide frameworks for thinking about the factors that might influence behavior. Generate hypotheses whose validity can be assessed through empirical work. Virtue of simplicity: reduces a problem to its essentials. Empirical analysis: Analysis based on observation and experience. Used to test hypotheses. 2- Causation vs. Correlation Conditions required for government action X to cause societal effect Y rather than just correlate (move together) with effect Y. X must precede Y X and Y must be correlated Other explanations for any observed correlation must be eliminated The importance of the distinction for policy. Example: There is a positive correlation between being married and wages Does that mean government should enact a policy encouraging marriage as a way of . | TOOLS OF POSITIVE ANALYSIS Chapter 2 Public Finance and Positive Analysis One goal of Public Finance is to estimate how government policy affects individuals’ behavior. 2- The Role of Theory Economic models Provide frameworks for thinking about the factors that might influence behavior. Generate hypotheses whose validity can be assessed through empirical work. Virtue of simplicity: reduces a problem to its essentials. Empirical analysis: Analysis based on observation and experience. Used to test hypotheses. 2- Causation vs. Correlation Conditions required for government action X to cause societal effect Y rather than just correlate (move together) with effect Y. X must precede Y X and Y must be correlated Other explanations for any observed correlation must be eliminated The importance of the distinction for policy. Example: There is a positive correlation between being married and wages Does that mean government should enact a policy encouraging marriage as a way of increasing wages? 2- Empirical Work: Experimental Studies Experimental (or randomized) study: subjects are randomly assigned to either a treatment group or control group. Treatment Group: Group of people who are subject to the intervention being studied. Control Group: Comparison group of people who are not subject to the intervention being studied. 2- Empirical Work: Experimental Studies Randomization improves the chances that the control and treatment groups have similar characteristics Focus can then be on possible causation between treatment and outcome. Randomization has a large potential to eliminate biased estimates. Biased estimate: conflates the true causal impact with the impact of outside factors. 2- Pitfalls of Experimental Studies Ethical issues Technical problems Response bias Impact of limited duration of experiment Generalization of results to other populations, settings, and related treatments Black box aspect of experiments 2- Empirical