Chapter

1 The Nature of
Econometrics and
Economic Data

Learning Objectives
1.1 Describe how econometric methods are used to conduct convincing data analysis in business,
economics, and other social sciences.
1.2 Identify, and describe the features of, the most common types of data sets used in economics and
related fields: cross-sectional data, time-series data, pooled (or repeated) cross sections, panel (or
longitudinal) data.
1.3 Apply the principle of causality using examples from policy analysis and business decision making.
1.4 List the challenges in trying to infer causality when one only has access to retrospective,
nonexperimental data.
1.5 Explain the ideas of “ceteris paribus” and counterfactual reasoning when considering problems of
causal inference in economics.

Chapter 1 discusses the scope of econometrics and raises general issues that arise in the application of econo-
metric methods. Section 1-1 provides a brief discussion about the purpose and scope of econometrics and how
it fits into economic analysis. Section 1-2 provides examples of how one can start with an economic theory
and build a model that can be estimated using data. Section 1-3 examines the kinds of data sets that are used in
business, economics, and other social sciences. Section 1-4 provides an intuitive discussion of the difficulties
associated with inferring causality in the social sciences.

1-1 What Is Econometrics?

Imagine that you are hired by your state government to evaluate the effectiveness of a publicly funded job
training program. Suppose this program teaches workers various ways to use artificial intelligence software
in the manufacturing process. The 20-week program offers courses during nonworking hours. Any hourly
manufacturing worker may participate, and enrollment in all or part of the program is voluntary. You are to
determine what, if any, effect the training program has on each worker’s subsequent hourly wage.
Now, suppose you work for an investment bank. You are to study the returns on different investment strat-
egies involving short-term U.S. treasury bills to decide whether they comply with implied economic theories.
The task of answering such questions may seem daunting at first. At this point, you may only have a vague
idea of the kind of data you would need to collect. By the end of this introductory econometrics course, you
should know how to use econometric methods to formally evaluate a job training program or to test a simple
economic theory.

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 2 Chapter 1 The Nature of Econometrics and Economic Data

Econometrics is based upon the development of statistical methods for estimating economic relationships,
testing economic theories, and evaluating and implementing government and business policy. A common
application of econometrics is the forecasting of such important macroeconomic variables as interest rates,
inflation rates, and gross domestic product (GDP). Of course, forecasting is important in many other areas
of social policy, such as trying to predict outcomes of elections or rates of infection of a new virus. Whereas
forecasts of economic indicators are highly visible and often widely published, econometric methods can be
used in economic areas that have nothing to do with macroeconomic forecasting. For example, we will study
the effects of political campaign expenditures on voting outcomes. We will consider the effect of school
spending on student performance in the field of education. In addition, we will learn how to use econometric
methods for forecasting economic time series.
Econometrics has evolved as a separate discipline from mathematical statistics because the former focuses
on the problems inherent in collecting and analyzing nonexperimental economic data. Nonexperimental data
are not accumulated through controlled experiments on individuals, firms, or segments of the economy.
(Nonexperimental data are sometimes called observational data, or retrospective data, to emphasize the fact
that the researcher is a passive collector of the data.) Experimental data are often collected in laboratory envi-
ronments in the natural sciences, however, they are more difficult to obtain in the social sciences. Although
some social experiments can be devised, it is often impossible, prohibitively expensive, or morally repugnant
to conduct the kinds of controlled experiments that would be needed to address economic issues. We give
some specific examples of the differences between experimental and nonexperimental data in Section 1-4.
Naturally, econometricians have borrowed from mathematical statisticians whenever possible. The
method of multiple regression analysis is the mainstay in both fields, but its focus and interpretation can differ
markedly. In addition, economists have devised new techniques to deal with the complexities of economic
data and to test the predictions of economic theories.

1-2 Steps in Empirical Economic Analysis

Econometric methods are relevant in virtually every branch of applied economics. They come into play either
when we have an economic theory to test or when we have a relationship in mind that has some importance
for business decisions or policy analysis. An empirical analysis uses data to test a theory or to estimate a
relationship.
How does one go about structuring an empirical economic analysis? It may seem obvious, but it is worth
emphasizing that the first step in any empirical analysis is the careful formulation of the question of interest.
The question might deal with testing a certain aspect of an economic theory, or it might pertain to testing the
effects of a government policy. We might use econometric methods to study controversial topics, such as the
presence of racial discrimination in mortgage lending markets or the deterrent effects of capital punishment.
In principle, econometric methods can be used to answer a wide range of questions.
In some cases, especially those that involve the testing of economic theories, a formal economic model
is constructed. An economic model consists of mathematical equations that describe various relationships.
Economists are well known for their building of models to describe a vast array of behaviors. For example, in
intermediate microeconomics, individual consumption decisions, subject to a budget constraint, are described
by mathematical models. The basic premise underlying these models is utility maximization. The assumption
that individuals make choices to maximize their well-being, subject to resource constraints, gives us a very
powerful framework for creating tractable economic models and making clear predictions. In the context of
consumption decisions, utility maximization leads to a set of demand equations. In a demand equation, the
quantity demanded of each commodity depends on the price of the goods, the price of substitute and comple-
mentary goods, the consumer’s income, and the individual’s characteristics that affect taste. These equations
can form the basis of an econometric analysis of consumer demand.
Economists have used basic economic tools, such as the utility maximization framework, to explain
behaviors that at first glance may appear to be noneconomic in nature. A classic example is Becker’s (1968)
economic model of criminal behavior.

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 Chapter 1 The Nature of Econometrics and Economic Data 3

Example 1.1 Economic Model of Crime

In a seminal article, Nobel Prize winner Gary Becker postulated a utility maximization framework to
describe an individual’s participation in crime. Certain crimes have clear economic rewards, but most
criminal behaviors have costs. The opportunity costs of crime prevent the criminal from participating in
other activities such as legal employment. In addition, there are costs associated with the possibility of
being caught and then, if convicted, the costs associated with incarceration. From Becker’s perspective, the
decision to undertake illegal activity is one of resource allocation, with the benefits and costs of competing
activities taken into account.
Under general assumptions, we can derive an equation describing the amount of time spent in criminal
activity as a function of various factors. We might represent such a function as
y = f ( x1 , x 2 , x3 , x 4 , x5 , x6 , x 7 ), [1.1]
where
y = hours spent in criminal activities,
x1 = “wage” for an hour spent in criminal activity,
x2 = hourly wage in legal employment,
x3 = income other than from crime or employment,
x4 = probability of getting caught,
x5 = probability of being convicted if caught,
x6 = expected sentence if convicted, and
x7 = age.
Other factors generally affect a person’s decision to participate in crime, but the list above is represen-
tative of what might result from a formal economic analysis. As is common in economic theory, we have
not been specific about the function f (·) in (1.1). This function depends on an underlying utility function,
which is rarely known. Nevertheless, we can use economic theory—or introspection—to predict the effect
that each variable would have on criminal activity. This is the basis for an econometric analysis of individual
criminal activity. Becker’s insights have been used to study factors that may affect crime even very recently.
For example, Abrams (2021) studies the early effects of the COVID-19 pandemic on crime rates in cities
in the United States.

Formal economic modeling is sometimes the starting point for empirical analysis, but it is more common
to use economic theory less formally, or even to rely entirely on intuition. You may agree that the determinants
of criminal behavior appearing in equation (1.1) are reasonable based on common sense; we might arrive at
such an equation directly, without starting from utility maximization. This view has some merit, although
there are cases in which formal derivations provide insights that intuition can overlook.
Next is an example of an equation that we can derive through somewhat informal reasoning.

Example 1.2 Job Training and Worker Productivity

Consider the problem posed at the beginning of Section 1-1. A labor economist would like to examine the
effects of job training on worker productivity. In this case, there is little need for formal economic theory.
Basic economic understanding is sufficient for realizing that factors such as education, experience, and
training affect worker productivity. Also, economists are well aware that workers are paid commensurate
with their productivity. This simple reasoning leads to a model such as
wage = f (educ, exper , training), [1.2]
Continues

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 4 Chapter 1 The Nature of Econometrics and Economic Data

where
wage = hourly wage,
educ = years of formal education,
exper = years of workforce experience, and
training = weeks spent in job training.
Again, other factors generally affect the wage rate, but equation (1.2) captures the essence of the problem.

After we specify an economic model, we need to turn it into what we call an econometric model. Because
we will deal with econometric models throughout this text, it is important to know how an econometric model
relates to an economic model. Take equation (1.1) as an example. The form of the function f (·) must be spec-
ified before we can undertake an econometric analysis. A second issue concerning (1.1) is how to deal with
variables that cannot reasonably be observed. For example, consider the wage that a person can earn in crim-
inal activity. In principle, such a quantity is well defined, but it would be difficult if not impossible to observe
this wage for a given individual. Even variables such as the probability of being arrested cannot realistically
be obtained for a given individual, but at least we can observe relevant arrest statistics and derive a variable
that approximates the probability of arrest. Many other factors affect criminal behavior that we cannot even
list, let alone observe. We must somehow account for them.
The ambiguities inherent in the economic model of crime are resolved by specifying a particular econo-
metric model:
crime = b 0 + b1 wage + b 2 othinc + b 3 freqarr + b 4 freqconv + b 5 avgsen + b 6 age + u, [1.3]
where

crime = some measure of the frequency of criminal activity,

wage = the wage that can be earned in legal employment,
othinc = the income from other sources (assets, inheritance, and so on),
freqarr = the frequency of arrests for prior infractions (to approximate the probability of arrest),
freqconv = the frequency of conviction, and
avgsen = the average sentence length after conviction.
The choice of these variables is determined by the economic theory as well as data considerations. The term
u contains unobserved factors, such as the wage for criminal activity, moral character, family background,
and errors in measuring things like criminal activity and the probability of arrest. We could add family back-
ground variables to the model, such as number of siblings and parents’ education, but we can never eliminate
u entirely. In fact, dealing with this error term or disturbance term is perhaps the most important component
of any econometric analysis.
The constants b 0 , b1 , … , b 6 are the parameters of the econometric model, and they describe the directions
and strengths of the relationship between crime and the factors used to determine crime in the model.
A complete econometric model for Example 1.2 might be
wage = b 0 + b1educ + b 2 exper + b 3training + u, [1.4]
where the term u contains factors such as “innate ability,” quality of education, family background, and the
myriad of other factors that can influence a person’s wage. If we are specifically concerned about the effects
of job training, then 3 is the parameter of interest.
For the most part, econometric analysis begins by specifying an econometric model, without consideration
of the details of the model’s creation. We generally follow this approach, largely because careful derivation
of something like the economic model of crime is time consuming and can take us into some specialized and
often difficult areas of economic theory. Economic reasoning will play a role in our examples, and we will

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 Chapter 1 The Nature of Econometrics and Economic Data 5

merge any underlying economic theory into the econometric model specification. In the economic model of
crime example, we would start with an econometric model such as (1.3) and use economic reasoning and
common sense as guides for choosing the variables. Although this approach loses some of the richness of
economic analysis, it is commonly and effectively applied by careful researchers.
Once an econometric model such as (1.3) or (1.4) has been specified, various hypotheses of interest can be
stated in terms of the unknown parameters. For example, in equation (1.3), we might hypothesize that wage,
the wage that can be earned in legal employment, has no effect on criminal behavior. In the context of this
particular econometric model, the hypothesis is equivalent to b1 = 0.
An empirical analysis, by definition, requires data. After data on the relevant variables have been col-
lected, econometric methods are used to estimate the parameters in the econometric model and to formally
test hypotheses of interest. In some cases, the econometric model is used to make predictions in either the
testing of a theory or the study of a policy’s impact.
Because data collection is so important in empirical work, Section 1-3 will describe the kinds of data that
we are likely to encounter.

1-3 The Structure of Economic Data

Economic data sets come in a variety of types. Whereas some econometric methods can be applied with
little or no modification to many different kinds of data sets, the special features of some data sets must be
accounted for or should be exploited. We next describe the most important data structures encountered in
applied work.

1-3a Cross-Sectional Data

A cross-sectional data set consists of a sample of individuals, households, firms, cities, states, countries, or
a variety of other units, taken at a given point in time. Sometimes, the data on all units do not correspond to
precisely the same time period. For example, several families may be surveyed during different weeks within
a year. In a pure cross-sectional analysis, we would ignore any minor timing differences in collecting the
data. If a set of families was surveyed during different weeks of the same year, we would still view this as a
cross-sectional data set.
An important feature of cross-sectional data is that we can often assume that they have been obtained by
random sampling from the underlying population. For example, if we obtain information on wages, education,
experience, and other characteristics by randomly drawing 500 people from the working population, then we
have a random sample from the population of all working people. Random sampling is the sampling scheme
covered in introductory statistics courses, and it simplifies the analysis of cross-sectional data. A review of
random sampling is contained in Math Refresher C.
Sometimes, random sampling is not appropriate as an assumption for analyzing cross-sectional data.
For example, suppose we are interested in studying factors that influence the accumulation of family wealth.
We could survey a random sample of families, but some families might refuse to report their wealth. If, for
example, wealthier families are less likely to disclose their wealth, then the resulting sample on wealth is not
a random sample from the population of all families. This is an illustration of a sample selection problem, an
advanced topic that we will discuss in Chapter 17.
Another violation of random sampling occurs when the sampling scheme involves first sampling “clus-
ters” from the population—say, schools, villages, or census tracts—and then sampling units from within
these clusters in a second stage. For example, a relatively small number of villages might be sampled from
a large population of villages in a developing country. Then, farmers within the village are sampled and sur-
veyed about their farming practices. As another example, schools might be sampled from a large population
of schools, and then we obtain information for each student within a school. With these so-called “cluster
sampling” schemes, we cannot treat the outcomes on the farmers as independent of each other when they live
in the same village; nor can we treat the outcomes on the students within a school as independent when we

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 6 Chapter 1 The Nature of Econometrics and Economic Data

first sample schools. In Chapter 14, we will discuss the special methods of statistical inference that arise in
the context of cluster sampling.
A more subtle issue arises when a policy that we are analyzing is determined at a higher level than the
unit we sample. For example, a policy may apply at the school level, and then all students within a school are
subjected to the same intervention (such as more spending at the school level). In these cases, even though
we may have a random sample of students from a population—we might even observe the entire population
of students—the policy variable will be correlated within a school. This is true even if the policy is assigned
differently to students within a school as long as the policy is initially determined at the school level. For
example, perhaps some schools are given extra teachers so that some class sizes can be made smaller. Within
a school, class size is made smaller for some students but not necessarily all students within the same school.
An introduction to inference methods appropriate to such situations is provided in Chapter 14. Fortunately,
all of the estimation methods we study up until that point can be applied in these more complicated settings.
A related problem is when using data on relatively large geographic units. For example, if we want to
explain new business activity across counties as a function of wage rates, energy prices, corporate and property
tax rates, services provided, quality of the workforce, and other county characteristics, we must acknowledge
the possibility that decisions on how to set, say, corporate tax rates will be correlated across nearby counties.
Moreover, a policy change in one county—perhaps changing a minimum wage, a property tax rate, and so
on—could have spillover effects on surrounding counties. Modeling such spillover effects is an important
topic in advanced econometrics. In this introductory text, we will largely ignore the intricacies that arise in
analyzing such situations until Chapter 14.
Cross-sectional data are widely used in economics and other social sciences. In economics, the analysis of
cross-sectional data is closely aligned with the applied microeconomics fields, such as labor economics, state
and local public finance, industrial organization, urban economics, demography, and health economics. Data
on individuals, households, firms, and cities at a given point in time are important for testing microeconomic
hypotheses and evaluating economic policies.
The cross-sectional data used for econometric analysis can be represented and stored in computers.
Table!1.1 contains, in abbreviated form, a cross-sectional data set on 526 working individuals for the year
1976. (This is a subset of the data in the file WAGE1.) The variables include wage (in dollars per hour), which
can be roughly turned into 2022 dollars by multiplying by four; educ (years of education); exper (years of
potential labor force experience); female (an indicator for gender); and married (marital status). These last
two variables are binary (zero-one) in nature and serve to indicate qualitative features of the individual. The
variable married indicates whether a person is married or not. In this data set, the variable female is equal to
one if the respondent identifies as female and zero otherwise. We will have much to say about binary variables
in Chapter 7 and beyond.

Table 1.1 A Cross-Sectional Data Set on Wages and Other Individual Characteristics
obsno wage educ exper female married
1 3.10 11 2 1 0
2 3.24 12 22 1 1
3 3.00 11 2 0 0
4 6.00 8 44 0 1
5 5.30 12 7 0 1
. . . . . .
. . . . . .
. . . . . .
525 11.56 16 5 0 1
526 3.50 14 5 1 0

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 Chapter 1 The Nature of Econometrics and Economic Data 7

The variable obsno in Table 1.1 is the observation number assigned to each person in the sample. Unlike
the other variables, it is not a characteristic of the individual. All econometrics and statistics software pack-
ages assign an observation number to each data unit. Intuition should tell you that, for data such as that in
Table 1.1, it does not matter which person is labeled as observation 1, which person is labeled observation 2,
and so on. The fact that the ordering of the data does not matter for econometric analysis is a key feature of
cross-sectional data sets obtained from random sampling.
Different variables sometimes correspond to different time periods in cross-sectional data sets. For exam-
ple, to determine the effects of government policies on long-term economic growth, economists have studied
the relationship between growth in real per capita GDP over a certain period (say, 1960 to 1985) and variables
determined in part by government policy in 1960 (government consumption as a percentage of GDP and adult
secondary education rates). Such a data set might be represented as in Table 1.2, which constitutes part of the
data set used in the study of cross-country growth rates by De Long and Summers (1991).
The variable gpcrgdp represents average annual growth in real per capita GDP over the period 1960 to
1985. The fact that govcons60 (government consumption as a percentage of GDP) and second60 (percentage
of adult population with a secondary education) correspond to the year 1960, while gpcrgdp is the average
growth over the period from 1960 to 1985, does not lead to any special problems in treating this information
as a cross-sectional data set. The observations are listed alphabetically by country, but nothing about this
ordering affects any subsequent analysis.

1-3b Time Series Data

A time series data set consists of observations on a variable or several variables over time. Examples of
time series data include stock prices, money supply, consumer price index, GDP, annual homicide rates, and
automobile sales figures. Because past events can influence future events and lags in behavior are prevalent
in the social sciences, time is an important dimension in a time series data set. Unlike the arrangement of
cross-sectional data, the chronological ordering of observations in a time series conveys potentially important
information.
A key feature of time series data that makes them more difficult to analyze than cross-sectional data is
that economic observations can rarely, if ever, be assumed to be independent across time. Most economic and
other time series are related, often strongly related, to their recent histories. For example, knowing something
about the GDP from last quarter tells us quite a bit about the likely range of the GDP during this quarter,
because GDP tends to remain fairly stable from one quarter to the next. Although most econometric procedures
can be used with both cross-sectional and time series data, more needs to be done in specifying econometric
models for time series data before standard econometric methods can be justified. In addition, modifications
and embellishments to standard econometric techniques have been developed to account for and exploit the
dependent nature of economic time series and to address other issues, such as the fact that some economic
variables tend to display clear trends over time.

Table 1.2 A Data Set on Economic Growth Rates and Country Characteristics
obsno country gpcrgdp govcons60 second60
1 Argentina 0.89 9 32
2 Austria 3.32 16 50
3 Belgium 2.56 13 69
4 Bolivia 1.24 18 12
. . . . .
. . . . .
. . . . .
61 Zimbabwe 2.30 17 6

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 8 Chapter 1 The Nature of Econometrics and Economic Data

Another feature of time series data that can require special attention is the data frequency at which the
data are collected. In economics, the most common frequencies are daily, weekly, monthly, quarterly, and
annually. Stock prices are recorded at daily intervals (excluding Saturday and Sunday). The money supply in
the U.S. economy is reported weekly. Many macroeconomic series are tabulated monthly, including inflation
and unemployment rates. Other macro series are recorded less frequently, such as every three months (every
quarter). GDP is an important example of a quarterly series. Other time series, such as infant mortality rates
for states in the United States, are available only on an annual basis.
Many weekly, monthly, and quarterly economic time series display a strong seasonal pattern, which can
be an important factor in a time series analysis. For example, monthly data on housing starts differ across
the months simply due to changing weather conditions. We will learn how to deal with seasonal time series
in Chapter 10.
Table 1.3 contains a time series data set obtained from an article by Castillo-Freeman and Freeman (1992)
on minimum wage effects in Puerto Rico. The earliest year in the data set is the first observation, and the most
recent year available is the last observation. When econometric methods are used to analyze time series data,
the data should be stored in chronological order.
The variable avgmin refers to the average minimum wage for the year, avgcov is the average coverage rate
(the percentage of workers covered by the minimum wage law), prunemp is the unemployment rate, and prgnp
is the gross national product, in millions of 1954 dollars. We will use these data later in a time series analysis
of the effect of the minimum wage on employment. The subject of minimum wage effects on employment
remains a very important topic, and, with some effort, such older time series data sets could be updated to
produce a more current analysis.

1-3c Pooled (or Repeated) Cross Sections

Some data sets have both cross-sectional and time series features. For example, suppose that two cross-sectional
household surveys are taken in the United States, one in 1985 and one in 1990. In 1985, a random!sample of
households is surveyed for variables such as income, savings, family size, and so on. In 1990, a new random
sample of households is taken using the same survey questions. To increase our sample size, we can form a
pooled cross section, also called a repeated cross section, by combining the two years.
Pooling cross sections from different years is often an effective way of analyzing the effects of a new
government policy. The idea is to collect data from the years before and after a key policy change. As an
example, consider the following data set on housing prices taken in 2018 and 2020, before and after a reduction
in property taxes in 2019. Suppose we have data on 250 houses for 1993 and on 270 houses for 1995. One
way to store such a data set is given in Table 1.4.
Observations 1 through 250 correspond to the houses sold in 2018, and observations 251 through 520
correspond to the 270 houses sold in 2020. Although the order in which we store the data turns out not to be
crucial, keeping track of the year for each observation is usually very important. This is why we enter year
as a separate variable.

Table 1.3 Minimum Wage, Unemployment, and Related Data for Puerto Rico
obsno year avgmin avgcov prunemp prgnp
1 1950 0.20 20.1 15.4 878.7
2 1951 0.21 20.7 16.0 925.0
3 1952 0.23 22.6 14.8 1015.9
. . . . . .
. . . . . .
. . . . . .
37 1986 3.35 58.1 18.9 4281.6
38 1987 3.35 58.2 16.8 4496.7

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 Chapter 1 The Nature of Econometrics and Economic Data 9

Table 1.4 Pooled Cross Sections: Two Years of Housing Prices

obsno year hprice proptax sqrft bdrms bthrms
1 2018 185,500 42 1600 3 2.0
2 2018 167,300 36 1440 3 2.5
3 2018 234,000 38 2000 4 2.5
. . . . . . .
. . . . . . .
. . . . . . .
250 2018 343,600 41 2600 4 3.0
251 2020 186,000 16 1250 2 1.0
252 2020 282,400 20 2200 4 2.0
253 2020 197,500 15 1540 3 2.0
. . . . . . .
. . . . . . .
. . . . . . .
520 2020 168,000 16 1100 2 1.5

A pooled cross section is analyzed much like a standard cross section, except that we often need to account
for secular differences in the variables across the time. In fact, in addition to increasing the sample size, the
point of a pooled cross-sectional analysis is often to see how a key relationship has changed over time.
Pooled (repeated) cross sections play an important role for policy analysis, where we can collect
information on two groups, one subjected to an intervention and the other not. We can obtain samples on
the two groups both before and after the intervention occurs, but we cannot follow the same units over
time. For example, we might obtain employment status, and other information, on individuals across two
states where one state increases its minimum wage. Often such survey sampling obtains random samples
in the separate time periods, in which case very few, if any, individuals would appear in the data set in
both years.

1-3d Panel or Longitudinal Data

A panel data (or longitudinal data) set consists of a time series for each cross-sectional member in the data set.
As an example, suppose we have wage, education, and employment history for a set of individuals followed
over a 10-year period. Or we might collect information, such as investment and financial data, about the same
set of firms over a five-year time period. Panel data can also be collected on geographical units. For example,
we can collect data for the same set of counties in the United States on immigration flows, tax rates, wage
rates, government expenditures, and so on, for the years 2010, 2015, and 2020.
The key feature of panel data that distinguishes them from a pooled cross section is that the same cross-
sectional units (individuals, firms, or counties in the preceding examples) are followed over a given time period.
The data in Table 1.4 are not considered a panel data set because the houses sold are likely to be different in
1993 and 1995; if there are any duplicates, the number is likely to be so small as to be unimportant. In contrast,
Table 1.5 contains a two-year panel data set on crime and related statistics for 150 cities in the United States.
There are several interesting features in Table 1.5. First, each city has been given a number from 1!through
150. Which city we decide to call city 1, city 2, and so on, is irrelevant. As with a pure cross section, the order-
ing in the cross section of a panel data set does not matter. We could use the city name in place of a number,
but it is often useful to have both.
A second point is that the two years of data for city 1 fill the first two rows or observations, observations
3 and 4 correspond to city 2, and so on. Because each of the 150 cities has two rows of data, any econometrics
package will view this as 300 observations. This data set can be treated as a pooled cross section, where the

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 10 Chapter 1 The Nature of Econometrics and Economic Data

Table 1.5 A Two-Year Panel Data Set on City Crime Statistics

obsno city year murders population unem police
1 1 2016 5 350,000 8.7 440
2 1 2020 8 359,200 7.2 471
3 2 2016 2 64,300 5.4 75
4 2 2020 1 65,100 5.5 75
. . . . . . .
. . . . . . .
. . . . . . .
297 149 2016 10 260,700 9.6 286
298 149 2020 6 245,000 9.8 334
299 150 2016 25 543,000 4.3 520
300 150 2020 32 546,200 5.2 493

same cities happen to show up in each year. But, as we will see in Chapters 13 and 14, we can also use the
panel structure to analyze questions that cannot be answered by simply viewing this as a pooled cross section.
In organizing the observations in Table 1.5, we place the two years of data for each city adjacent to one
another, with the first year coming before the second in all cases. For just about every practical purpose, this
is the preferred way for ordering panel data sets. Contrast this organization with the way the pooled cross
sections are stored in Table 1.4. In short, the reason for ordering panel data as in Table 1.5 is that we will need
to perform data transformations for each city across the two years.
Because panel data require replication of the same units over time, panel data sets, especially those on
individuals, households, and firms, are more difficult to obtain than pooled cross sections. Not surprisingly,
observing the same units over time leads to several advantages over cross-sectional data or even pooled
cross-sectional data. The benefit that we will focus on in this text is that having multiple observations on the
same units allows us to control for certain unobserved characteristics of individuals, firms, and so on. As we
will see, the use of more than one observation can facilitate causal inference in situations where inferring
causality would be very difficult if only a single cross section were available. A second advantage of panel
data is that they often allow us to study the importance of lags in behavior or the result of decision making.
This information can be significant because many economic policies can be expected to have an impact only
after some time has passed.
Most books at the undergraduate level do not contain a discussion of econometric methods for panel data.
However, economists now recognize that some questions are difficult, if not impossible, to answer satisfacto-
rily without panel data. As you will see, we can make considerable progress with simple panel data analysis,
a method that is not much more difficult than dealing with a standard cross-sectional data set.

1-3e A Comment on Data Structures

Part 1 of this text is concerned with the analysis of cross-sectional data, because this poses the fewest concep-
tual and technical difficulties. At the same time, it illustrates most of the key themes of econometric analysis.
We will use the methods and insights from cross-sectional analysis in the remainder of the text.
Although the econometric analysis of time series uses many of the same tools as cross-sectional analy-
sis, it is more complicated because of the trending, highly persistent nature of many economic time series.
Examples that have been traditionally used to illustrate the manner in which econometric methods can be
applied to time series data are now widely believed to be flawed. It makes little sense to use such examples
initially, because this practice will only reinforce poor econometric practice. Therefore, we will postpone the
treatment of time series econometrics until Part 2, when the important issues concerning trends, persistence,
dynamics, and seasonality will be introduced.

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 Chapter 1 The Nature of Econometrics and Economic Data 11

In Part 3, we will treat pooled cross sections and panel data explicitly. The analysis of independently
pooled cross sections and simple panel data analysis are fairly straightforward extensions of pure cross-
sectional analysis. Nevertheless, we will wait until Chapter 13 to deal with these topics.

1-4 Causality, Ceteris Paribus, and Counterfactual

Reasoning
In most tests of economic theory, and certainly for evaluating public policy, the economist’s goal is to infer
that one variable (such as education) has a causal effect on another variable (such as worker productivity).
Simply finding an association between two or more variables might be suggestive, but unless causality can
be established, it is rarely compelling.
The notion of ceteris paribus—which means “other (relevant) factors being equal”—plays an important
role in causal analysis. This idea has been implicit in some of our earlier discussion, particularly Examples!1.1
and 1.2, but thus far we have not explicitly mentioned it.
You probably remember from introductory economics that most economic questions are ceteris paribus
by nature. For example, in analyzing consumer demand, we are interested in knowing the effect of changing
the price of a good on its quantity demanded, while holding all other factors—such as income, prices of other
goods, and individual tastes—fixed. If other factors are not held fixed, then we cannot know the causal effect
of a price change on quantity demanded.
Holding other factors fixed is critical for policy analysis as well. In the job training example (Example
1.2), we might be interested in the effect of another week of job training on wages, with all other components
being equal (in particular, education and experience). If we succeed in holding all other relevant factors fixed
and then find a link between job training and wages, we can conclude that job training has a causal effect on
worker productivity. Although this may seem pretty simple, even at this early stage it should be clear that,
except in very special cases, it will not be possible to literally hold all else equal. The key question in most
empirical studies is: Have enough other factors been held fixed to make a case for causality? Rarely is an
econometric study evaluated without raising this issue.
In most serious applications, the number of factors that can affect the variable of interest—such as crim-
inal activity or wages—is immense, and the isolation of any particular variable may seem like a hopeless
effort. However, we will eventually see that, when carefully applied, econometric methods can simulate a
ceteris paribus experiment.
The notion of ceteris paribus also can be described through counterfactual reasoning, which has become
an organizing theme in analyzing various interventions, such as policy changes. The idea is to imagine an
economic unit, such as an individual or a firm, in two or more different states of the world. For example,
consider studying the impact of a job training program on workers’ earnings. For each worker in the relevant
population, we can imagine what his or her subsequent earnings would be under two states of the world: hav-
ing participated in the job training program and having not participated. By considering these counterfactual
outcomes (also called potential outcomes), we easily “hold other factors fixed” because the counterfactual
thought experiment applies to each individual separately. We can then think of causality as meaning that the
outcome—in this case, labor earnings—in the two states of the world differs for at least some indiviuals. The
fact that we will eventually observe each worker in only one state of the world raises important problems of
estimation, but that is a separate issue from the issue of what we mean by causality. We formally introduce an
apparatus for discussing counterfactual outcomes in Chapter 2.
At this point, we cannot yet explain how econometric methods can be used to estimate ceteris paribus
effects, so we will consider some problems that can arise in trying to infer causality in economics. We do not
use any equations in this discussion. Instead, in each example, we will discuss what other factors we would like
to hold fixed, and sprinkle in some counterfactual reasoning. For each example, inferring causality becomes
relatively easy if we could conduct an appropriate experiment. Thus, it is useful to describe how such an exper-
iment might be structured, and to observe that, in most cases, obtaining experimental data is impractical. It is
also helpful to think about why the available data fail to have the important features of an experimental data set.

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 12 Chapter 1 The Nature of Econometrics and Economic Data

We rely, for now, on your intuitive understanding of such terms as random, independence, and correla-
tion, all of which should be familiar from an introductory probability and statistics course. (These concepts
are reviewed in Math Refresher B.) We begin with an example that illustrates some of these important issues.

Example 1.3 Effects of Fertilizer on Crop Yield

Some early econometric studies [for example, Griliches (1957)] considered the effects of new fertilizers on
crop yields. Suppose the crop under consideration is soybeans. Because fertilizer amount is only one factor
affecting yields—some others include rainfall, quality of land, and presence of parasites—this issue must be
posed as a ceteris paribus question. One way to determine the causal effect of fertilizer amount on soybean
yield is to conduct an experiment, which might include the following steps. Choose several one-acre plots
of land. Apply different amounts of fertilizer to each plot and subsequently measure the yields; this gives
us a cross-sectional data set. Then, use statistical methods (to be introduced in Chapter 2) to measure the
association between yields and fertilizer amounts.
As described earlier, this may not seem like a very good experiment because we have said nothing
about choosing plots of land that are identical in all respects except for the amount of fertilizer. In fact,
choosing plots of land with this feature is not feasible: some of the factors, such as land quality, cannot
even be fully observed. How do we know the results of this experiment can be used to measure the ceteris
paribus effect of fertilizer? The answer depends on the specifics of how fertilizer amounts are chosen. If
the levels of fertilizer are assigned to plots independently of other plot features that affect yield—that is,
other characteristics of plots are completely ignored when deciding on fertilizer amounts—then we are in
business. We will justify this statement in Chapter 2.

The next example is more representative of the difficulties that arise when inferring causality in applied
economics.

Example 1.4 Measuring the Return to Education

Labor economists and policy makers have long been interested in the “return to education.” Somewhat
informally, the question is posed as follows: If a person is chosen from the population and given another
year of education, by how much will his or her wage increase? As with the previous examples, this is a
ceteris paribus question, which implies that all other factors are held fixed while another year of education
is given to the person. Notice the element of counterfactual reasoning here: we can imagine the wage of
each individual varying with different levels of education, that is, in different states of the world. Eventually,
we obtain data on each worker in only one state of the world: the education level they actually wound up
with, through perhaps a complicated process of intellectual ability, motivation for learning, parental input,
and societal influences.
We can imagine a social planner designing an experiment to get at this issue, much as the agricultural
researcher can design an experiment to estimate fertilizer effects. Assume, for the moment, that the social
planner has the ability to assign any level of education to any person. How would this planner emulate the
fertilizer experiment in Example 1.3? The planner would choose a group of people and randomly assign
each person an amount of education; some people are given an eighth-grade education, some are given a
high school education, some are given two years of college, and so on. Subsequently, the planner measures
wages for this group of people (where we assume that each person works in a job). The people here are like
the plots in the fertilizer example, where education plays the role of fertilizer and wage rate plays the role
of soybean yield. As with Example 1.3, if levels of education are assigned independently of other charac-
teristics that affect productivity (such as experience and innate ability), then an analysis that ignores these
other factors will yield useful results. Again, it will take some effort in Chapter 2 to justify this claim; for
now, we state it without support.

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 Chapter 1 The Nature of Econometrics and Economic Data 13

Unlike the fertilizer-yield example, the experiment described in Example 1.4 is unfeasible. The ethical
issues, not to mention the economic costs, associated with randomly determining education levels for a group
of individuals are obvious. As a logistical matter, we could not give someone only an eighth-grade education
if he or she already has a college degree.
Even though experimental data cannot be obtained for measuring the return to education, we can certainly
collect nonexperimental data on education levels and wages for a large group by sampling randomly from the
population of working people. Such data are available from a variety of surveys used in labor economics, but
these data sets have a feature that makes it difficult to estimate the ceteris paribus return to education. People
choose their own levels of education; therefore, education levels are probably not determined independently
of all other factors affecting wage. This problem is a feature shared by most nonexperimental data sets.
One factor that affects wage is experience in the workforce. Because pursuing more education generally
requires postponing entering the workforce, those with more education usually have less experience. Thus,
in a nonexperimental data set on wages and education, education is likely to be negatively associated with
a key variable that also affects wage. It is also believed that people with more innate ability often choose
higher levels of education. Because higher ability leads to higher wages, we again have a correlation between
education and a critical factor that affects wage.
The omitted factors of experience and ability in the wage example have analogs in the fertilizer example.
Experience is generally easy to measure and therefore is similar to a variable such as rainfall. Ability, on
the other hand, is nebulous and difficult to quantify; it is similar to land quality in the fertilizer example. As
we will see throughout this text, accounting for other observed factors, such as experience, when estimating
the!ceteris paribus effect of another variable, such as education, is relatively straightforward. We will also find
that accounting for inherently unobservable factors, such as ability, is much more problematic. It is fair to say
that many of the advances in econometric methods have tried to deal with unobserved factors in econometric
models.
One final parallel can be drawn between Examples 1.3 and 1.4. Suppose that in the fertilizer example, the
fertilizer amounts were not entirely determined at random. Instead, the assistant who chose the fertilizer levels
thought it would be better to put more fertilizer on the higher-quality plots of land. (Agricultural researchers
should have a rough idea about which plots of land are of better quality, even though they may not be able to
fully quantify the differences.) This situation is completely analogous to the level of schooling being related
to unobserved ability in Example 1.4. Because better land leads to higher yields, and more fertilizer was used
on the better plots, any observed relationship between yield and fertilizer might be spurious.
Difficulty in inferring causality can also arise when studying data at fairly high levels of aggregation, as
the next example on city crime rates shows.

Example 1.5 The Effect of Law Enforcement on City Crime Levels

The issue of how best to prevent crime has been, and will probably continue to be, with us for some time.
One especially important question in this regard is: Does the presence of more police officers on the street
deter crime?
The ceteris paribus question is easy to state: If a city is randomly chosen and given, say, ten additional
police officers, by how much would its crime rates fall? Closely related to this thought experiment is explic-
itly setting up counterfactual outcomes: For a given city, what would its crime rate be under varying sizes
of the police force? Another way to state the question is: If two cities are the same in all respects, except
that city A has ten more police officers than city B, by how much would the two cities’ crime rates differ?
It would be virtually impossible to find pairs of communities identical in all respects except for the size
of their police force. Fortunately, econometric analysis does not require this. What we do need to know is
whether the data we can collect on community crime levels and the size of the police force can be viewed
as experimental. We can certainly imagine a true experiment involving a large collection of cities where we
dictate how many police officers each city will use for the upcoming year.
Continues

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 14 Chapter 1 The Nature of Econometrics and Economic Data

Although policies can be used to affect the size of police forces, we clearly cannot tell each city how
many police officers it can hire. If, as is likely, a city’s decision on how many police officers to hire is
correlated with other city factors that affect crime, then the data must be viewed as nonexperimental. In fact,
one way to view this problem is to see that a city’s choice of police force size and the amount of crime are
simultaneously determined. We will explicitly address such problems in Chapter 16.

The first three examples we have discussed have dealt with cross-sectional data at various levels of
aggregation (e.g., at the individual or city levels). The same hurdles arise when inferring causality in time
series problems.

Example 1.6 The Effect of the Minimum Wage on Unemployment

An important, and perhaps contentious, policy issue concerns the effect of the minimum wage on unemploy-
ment rates for various groups of workers. Although this problem can be studied in a variety of data settings
(cross-sectional, time series, or panel data), time series data are often used to look at aggregate effects.
An example of a time series data set on unemployment rates and minimum wages was given in Table 1.3.
Standard supply and demand analysis implies that, as the minimum wage is increased above the mar-
ket clearing wage, we slide up the demand curve for labor and total employment decreases. (Labor supply
exceeds labor demand.) To quantify this effect, we can study the relationship between employment and the
minimum wage over time. In addition to some special difficulties that can arise in dealing with time series
data, there are possible problems with inferring causality. The minimum wage in the United States is not
determined in a vacuum. Various economic and political forces impinge on the final minimum wage for any
given year. (The minimum wage, once determined, is usually in place for several years, unless it is indexed
for inflation.) Thus, it is probable that the amount of the minimum wage is related to other factors that have
an effect on employment levels.
We can imagine the U.S. government conducting an experiment to determine the employment effects of
the minimum wage (as opposed to worrying about the welfare of low-wage workers). The minimum wage
could be randomly set by the government each year, and then the employment outcomes could be tabulated.
The resulting experimental time series data could then be analyzed using fairly simple econometric methods.
But this scenario hardly describes how minimum wages are set.
If we can control enough other factors relating to employment, then we can still hope to estimate the
ceteris paribus effect of the minimum wage on employment. In this sense, the problem is very similar to
the previous cross-sectional examples.

Even when economic theories are not most naturally described in terms of causality, they often have
predictions that can be tested using econometric methods. The following example demonstrates this approach.

Example 1.7 The Expectations Hypothesis

The expectations hypothesis from financial economics states that, given all information available to investors
at the time of investing, the expected return on any two investments is the same. For example, consider two
possible investments with a three-month investment horizon, purchased at the same time: (1) Buy a three-
month T-bill with a face value of $10,000, for a price below $10,000; in three months, you receive $10,000.
(2) Buy a six-month T-bill (at a price below $10,000) and, in three months, sell it as a three-month T-bill.
Each investment requires roughly the same amount of initial capital, but there is an important difference.
For the first investment, you know exactly what the return is at the time of purchase because you know the
initial price of the three-month T-bill, along with its face value. This is not true for the second investment:
although you know the price of a six-month T-bill when you purchase it, you do not know the price you

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 Chapter 1 The Nature of Econometrics and Economic Data 15

can sell it for in three months. Therefore, there is uncertainty in this investment for someone who has a
three-month investment horizon.
The actual returns on these two investments will usually be different. According to the expectations
hypothesis, the expected return from the second investment, given all information at the time of investment,
should equal the return from purchasing a three-month T-bill. This theory turns out to be fairly easy to test,
as we will see in Chapter 11.

Summary
In this introductory chapter, we have discussed the purpose and scope of econometric analysis. Econometrics is
used in all applied economics fields to test economic theories, to inform government and private policy makers,
and to predict economic time series. Sometimes, an econometric model is derived from a formal economic
model, but in other cases, econometric models are based on informal economic reasoning and intuition. The
goals of any econometric analysis are to estimate the parameters in the model and to test hypotheses about
these parameters; the values and signs of the parameters determine the validity of an economic theory and
the effects of certain policies.
Cross-sectional, time series, pooled cross-sectional, and panel data are the most common types of data
structures that are used in applied econometrics. Data sets involving a time dimension, such as time series
and panel data, require special treatment because of the correlation across time of most economic time series.
Other issues, such as trends and seasonality, arise in the analysis of time series data but not cross-sectional data.
In Section 1-4, we discussed the notions of causality, ceteris paribus, and counterfactuals. In most cases,
hypotheses in the social sciences are ceteris paribus in nature: all other relevant factors must be fixed when
studying the relationship between two variables. As we discussed, one way to think of the ceteris paribus
requirement is to undertake a thought experiment where the same economic unit operates in different states
of the world, such as different policy regimes. Because of the nonexperimental nature of most data collected
in the social sciences, uncovering causal relationships is very challenging.

Key Terms
Causal Effect Economic Model Pooled Cross Section
Ceteris Paribus Empirical Analysis Potential Outcomes
Counterfactual Outcomes Experimental Data Random Sampling
Counterfactual Reasoning Longitudinal Data Repeated Cross Section
Cross-Sectional Data Set Nonexperimental Data Retrospective Data
Data Frequency Observational Data Time Series Data
Econometric Model Panel Data

Problems
1 Suppose that you are asked to conduct a study to determine whether smaller class sizes lead to
improved student performance of fourth graders.
(i) If you could conduct any experiment you want, what would you do? Be specific.
(ii) More realistically, suppose you can collect observational data on several thousand fourth
graders in a given state. You can obtain the size of their fourth-grade class and a standardized
test score taken at the end of fourth grade. Why might you expect a negative correlation
between class size and test score?
(iii) Would a negative correlation necessarily show that smaller class sizes cause better
performance? Explain.

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 16 Chapter 1 The Nature of Econometrics and Economic Data

2 A justification for job training programs is that they improve worker productivity. Suppose that you
are asked to evaluate whether more job training makes workers more productive. However, rather
than having data on individual workers, you have access to data on manufacturing firms in Ohio. In
particular, for each firm, you have information on hours of job training per worker (training) and
number of nondefective items produced per worker hour (output).
(i) Carefully state the ceteris paribus thought experiment underlying this policy question.
(ii) Does it seem likely that a firm’s decision to train its workers will be independent of
worker characteristics? What are some of those measurable and unmeasurable worker
characteristics?
(iii) Name a factor other than worker characteristics that can affect worker productivity.
(iv) If you find a positive correlation between output and training, would you have convincingly
established that job training makes workers more productive? Explain.
3 Suppose at your university you are asked to find the relationship between weekly hours spent study-
ing (study) and weekly hours spent working (work). Does it make sense to characterize the problem
as inferring whether study “causes” work or work “causes” study? Explain.
4 States (and provinces) that have control over taxation sometimes reduce taxes in an attempt to spur
economic growth. Suppose that you are hired by a state to estimate the effect of corporate tax rates
on, say, the growth in per capita gross state product (GSP).
(i) What kind of data would you need to collect to undertake a statistical analysis?
(ii) Is it feasible to do a controlled experiment? What would be required?
(iii) Is a correlation analysis between GSP growth and tax rates likely to be convincing? Explain.

Computer Exercises
C1 Use the data in WAGE1 for this exercise.
(i) Find the average education level in the sample. What are the lowest and highest years of
education?
(ii) Find the average hourly wage in the sample. Does it seem high or low?
(iii) The wage data are reported in 1976 dollars. Using the Internet or a printed source, find the
Consumer Price Index (CPI) for the years 1976 and 2022.
(iv) Use the CPI values from part (iii) to find the average hourly wage in 2022 dollars. Now does
the average hourly wage seem reasonable?
(v) How many women are in the sample? How many men?
C2 Use the data in BWGHT to answer this question.
(i) How many women are in the sample, and how many report smoking during pregnancy?
(ii) What is the average number of cigarettes smoked per day? Is the average a good measure of
the “typical” woman in this case? Explain.
(iii) Among women who smoked during pregnancy, what is the average number of cigarettes
smoked per day? How does this compare with your answer from part (ii), and why?
(iv) Find the average of fatheduc in the sample. Why are only 1,192 observations used to
compute this average?
(v) Report the average family income and its standard deviation in dollars.
C3 The data in MEAP01 are for the state of Michigan in the year 2001. Use these data to answer the
following questions.
(i) Find the largest and smallest values of math4. Does the range make sense? Explain.
(ii) How many schools have a perfect pass rate on the math test? What percentage is this of the
total sample?
(iii) How many schools have math pass rates of exactly 50%?
(iv) Compare the average pass rates for the math and reading scores. Which test is harder to pass?

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 Chapter 1 The Nature of Econometrics and Economic Data 17

(v) Find the correlation between math4 and read4. What do you conclude?
(vi) The variable exppp is expenditure per pupil. Find the average of exppp along with its
standard deviation. Would you say there is wide variation in per pupil spending?
(vii) Suppose School A spends $6,000 per student and School B spends $5,500 per student.
By what percentage does School A’s spending exceed School B’s? Compare this to 100 ·
[log(6,000) " log(5,500)], which is the approximation percentage difference based on the
difference in the natural logs. (See Section A.4 in Math Refresher A.)
C4 The data in JTRAIN2 come from a job training experiment conducted for low-income men during
1976–1977; see Lalonde (1986).
(i) Use the indicator variable train to determine the fraction of men receiving job training.
(ii) The variable re78 is earnings from 1978, measured in thousands of 1982 dollars. Find the
averages of re78 for the sample of men receiving job training and the sample not receiving
job training. Is the difference economically large?
(iii) The variable unem78 is an indicator of whether a man was unemployed or not in 1978. What
fraction of the men who received job training were unemployed? What about for men who
did not receive job training? Comment on the difference.
(iv) From parts (ii) and (iii), does it appear that the job training program was effective? What
would make our conclusions more convincing?
C5 The data in FERTIL2 were collected on women living in the Republic of Botswana in 1988. The
variable children refers to the number of living children. The variable electric is a binary indicator
equal to one if the woman’s home has electricity, and zero if not.
(i) Find the smallest and largest values of children in the sample. What is the average of
children?
(ii) What percentage of women have electricity in the home?
(iii) Compute the average of children for those without electricity and do the same for those with
electricity. Comment on what you find.
(iv) From part (iii), can you infer that having electricity “causes” women to have fewer children?
Explain.
C6 Use the data in COUNTYMURDERS to answer this question. Use only the year 1996. The variable
murders is the number of murders reported in the county. The variable execs is the number of exe-
cutions that took place of people sentenced to death in the given county. Most states in the United
States have the death penalty, but several do not.
(i) How many counties are there in the data set? Of these, how many have zero murders? What
percentage of counties have zero executions? (Remember, use only the 1996 data.)
(ii) What is the largest number of murders? What is the largest number of executions? Compute
the average number of executions and explain why it is so small.
(iii) Compute the correlation coefficient between murders and execs and describe what you find.
(iv) You should have computed a positive correlation in part (iii). Do you think that more
executions cause more murders to occur? What might explain the positive correlation?
C7 The data set in ALCOHOL contains information on a sample of men in the United States. Two key
variables are self-reported employment status and alcohol abuse (along with many other variables).
The variables employ and abuse are both binary, or indicator, variables: they take on only the values
zero and one.
(i) What percentage of the men in the sample report abusing alcohol? What is the employment
rate?
(ii) Consider the group of men who abuse alcohol. What is the employment rate?
(iii) What is the employment rate for the group of men who do not abuse alcohol?
(iv) Discuss the difference in your answers to parts (ii) and (iii). Does this allow you to conclude
that alcohol abuse causes unemployment?

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 18 Chapter 1 The Nature of Econometrics and Economic Data

C8 The data in ECONMATH were obtained on students from a large university course in introductory
microeconomics. For this problem, we are interested in two variables: score, which is the final course
score, and econhs, which is a binary variable indicating whether a student took an economics course
in high school.
(i) How many students are in the sample? How many students report taking an economics
course in high school?
(ii) Find the average of score for those students who did take a high school economics class.
How does it compare with the average of score for those who did not?
(iii) Do the findings in part (ii) necessarily tell you anything about the causal effect of taking high
school economics on college course performance? Explain.
(iv) If you want to obtain a good causal estimate of the effect of taking a high school economics
course using the difference in averages, what experiment would you run?
C9 The data set in LOANAPP contains information on a sample of mortgage applications in the Boston,
Massachusetts area; the data were originally compiled by the Federal Reserve Bank of Boston. The
race variable, denoted white, is recorded as binary, equaling one if the mortgage applicant is classified
as White and zero otherwise. The variable approve is also binary, equaling one if the loan application
was approved, and zero otherwise.
(i) What proportion of the applicants in the sample are recorded as being White?
(ii) For the group of non-White applicants, what is the proportion of loans approved?
(iii) What is the loan approval rate for White applicants?
(iv) Report the difference between (iii) and (ii) in percentage point terms. Does this analysis
allow you to convincingly conclude that there is racial bias in mortgage application
approvals? Explain.

Copyright 2025 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

900161_ch01_hr_001-[Link] 18 2/8/2024 8:06:32 AM