Department of Economics

Economics 145                                                                                                                 Prof. Yang

Chapter 2 Research Procedures

In Chapter 1, we covered the basic concepts of research in economics first by reviewing key terms in research and the roles of theory and data in the study of economics. We noted that the study of economics proceeds within the framework of scientific methods and we engaged in a general discussion of scientific method before moving on to a discussion of various terms and concepts within the scientific method. Clearly, learning about the scientific method and the basic concepts of the scientific method is essential to carry out research in economics. However, our discussion was general in nature and, basically, conceptual. While interesting, this kind of learning about the scientific method, and its basic concepts of research in general terms, offers little help in actually starting and successfully completing an economic research project. Thus, given the understanding of basic concepts of research, what we need to learn now are the specifics of where to start our research, and how to do it.

When students take a research methods course, they usually learn about research procedures in general terms. When they attempt to apply what they have learned in the research methods course to a real research project, they arguably find that they are not adequately prepared to start and complete a meaningful project.

This outcome is at least in part due to our way of teaching students mainly by feeding information without requiring a deeper understanding the subject. This is also partly due to the fact that undergraduate economic education is organized largely by subject-matter packages. Economics undergraduate students typically take intermediate level micro and macro economic theories, several upper division field-specific courses, depending on their interests, as well as one or two quantitative economics courses. More often than not, economics students do not have an opportunity to take a research methods course. Students in upper division field-specific economics courses seldom have the opportunity to conduct any serious and meaningful research, except for the rare occasions to do an honor’s thesis with individualized assistance from faculty members. Consequently, with or without a research methods course, undergraduate students typically do not learn the subject well enough to apply their conceptual knowledge to finding answers in the context of applied and quantitative research. There is a crying need for a practical guide to conducting applied quantitative economic research. Meeting this need is the main motivation to write this book.

The procedures and steps to follow in research are well-known, and I present below a set of standard procedures for conducting applied quantitative economic research. At each step, I will explain what you do, how you do it, and finally why you do it. But merely listing and describing each step at a time is not enough. What I am striving to accomplish is to integrate research problems, theory, and the analysis of data, and to show how and why decisions are being made throughout the research process. To assure comprehension, I will present discussions on research procedures by working with specific examples.

Research is an orderly and systematic procedure, and this procedure may be presented sequentially from the first step of problem definition through the final step of the writing-up of the final report. However, it is also essential to understand that the research process is essentially circular in the sense that each preceding and succeeding step feeds on each other.

The five major steps in any typical applied and quantitative economic research process are as follows:

1. Statement of Research Problem
2. Survey of Related Literature
3. Theoretical Model: Formulation of Hypothesis
4. Analysis of Data: Testing of Hypothesis
5. Write-up of Research Report

2.1 Statement of Research Problem

"A problem well put is half solved."** John Dewey

In starting research one obviously must first decide what problem to investigate. Clearly, therefore, a clear definition and statement of the research problem is the most important part of any research activity. When a research topic is given by your professor or supervisor there is no problem to choosing it. But the responsibility to choose research problem is yours, it becomes more daunting and difficult task. In this case, it will be first something your are interested. It is appropriate to choose a topic within a field which the student is familiar. But even if the student identifies a potential topic he or she is interested in and reasonably familiar with, it is still a difficult task to define and state the problem clearly and adequately. It takes a fair amount of mental struggle to understand the research issue thoroughly; and it takes at least an equal amount of effort to be able to write a succinct problem statement. The importance of a succinct problem statement cannot be too emphasized. Inadequate and incomplete delineation of the research problem results in wasting precious time in gathering materials, and may also result in activities not directly related to the research problem.

A research problem may be disciplinary, subject-matter, or problem-solving oriented and, indeed, combination of the three.

Finally, the requirements of a good research problem include significance, specificity, and manageability.

A. The research problem has be significant and important in the field. If not, why bother?

B. The research problem has to be specific so that it can be addressed given the constraints of time and budget. Broad and general research problems are neither meaningful nor manageable. If one wishes to study the Pacific Ocean, it is a too broad and wide topic. Research has to focus on a specific aspect of the Pacific Ocean.

C. Finally, the research problem has be "manageable" because it has to be finished within the assigned time and budget constraint.

To define the research problem adequately, however, requires substantial knowledge of the problem itself. One way of obtaining this knowledge is to read background materials. Text-books or, better, a recent review article on the topic are often useful as starting points, since they give a balanced summary of present knowledge, and also provide useful references. But as you study these books and articles by other investigators, you need to evaluate these previous works in light of your own research problem. As you read, you must always ask yourself what you are trying to find out. If you cannot state clearly what it is you want to find out, it is obvious that you are going to waste a lot of time before you settle on the specific research problem.

The problem or problem area to research depends on your interest, experience, and career goals. But once you have a research problem or problem area, a decision must be made to focus on one or two specific aspects of the problem. To accomplish this, one has to be familiar with the area; to actually know quite bit about it, fact. How does one gain enough knowledge to embark on serious research? If you are familiar with the subject matter, it is largely a matter of intuition and insight for you to come up with the specific problem. If not, you have to read background materials to gain this knowledge. Suppose, for instance, that you are interested in studying the reasons for the continual increase over time in health care expenditure in the U.S. Searching through the literature, you will find that Chapter 4, "The Economics of Health Care" in the 1993 Economic Report of the President and two symposia articles on health economics and health care reform in The Journal of Economic Perspectives (Summer 1992 and Summer 1994) provide adequate background.

As you gain knowledge on the chosen topic, it is also helpful to decide what specific research problems and issues you are interested in. Specifically, are you interested in establishing a comparison? To find a cause or an effect? With the cause-effect relationship in the health care expenditure in mind, one can choose to study the roles of third-party payment mechanism through insurance, of technology, or of government. How about measuring the magnitude of some interesting and important issue, such as measuring the welfare cost of national health care insurance? There are many more interesting questions and issues to be investigated within the general rubric of health care expenditure in the U.S.

The formulation of the statement of the problem usually requires the following two steps.

1. Overview of the problem
2. Narrowing down to specific aspect(s) of the problem

- Overview of Problem

One good way to start the problem statement is to present the problem in an overview. The reason why researchers usually start with presenting the problem in the context of an overview is to present the problem in perspective. This way, the reader is introduced to terminology, definitions, and the relationship under consideration, as well as the relationship of the topic to related questions and fields.

An example of good overview is quoted below. [See Craig S. Hakkio’s article entitled "Is Purchasing Power Parity a Useful Guide to the Dollar?" in Federal Reserve Bank of Kansas City Economic Review, Third Quarter 1992, pp. 37-51]

"Some academic and business economists use the concept of purchasing power parity to help predict the foreign exchange value of the dollar. Purchasing power parity(PPP) is a measure of the dollar’s equilibrium value - the exchange rate toward which the dollar moves over time. Because the value of the dollar is currently below its PPP value, academic and business economists

use the concept of purchasing power parity to advocates argue that the dollar is undervalued and therefore likely to rise.

Other economists acknowledge that PPP may help forecast the value of the dollar over the long run but doubt its usefulness as a short-term guide. They often cite the 1970s, when the dollar frequently strayed from its PPP value and sometimes took years to return. They also note that economic and political forces regularly buffet the dollar, keeping its value away from equilibrium. Thus, even though the dollar is currently below its PPP value, these economists maintain there is no guarantee it will rise in value in the near term.

The research problem in Hakkio’s paper is to evaluate the purchasing power parity as a guide to future direction of the US dollar. In his overview of the problem, Hakkio first defines the term "purchasing power parity" and presents two alternative views to the use of PPP as a guide to the future direction of the US dollar. According to one view, namely the purchasing power parity view, the dollar is likely to rise because current value of the dollar is below its PPP value. According to other view, however, there is no guarantee that the dollar value will rise soon, because the PPP view is known to hold only in the long run. What he skillfully accomplished in the two short paragraphs are: 1) to clearly define the problem, 2) to define the key term, and 3) to present two alternative views on the future direction of the dollar.

- Narrowing Down

After having presented an overview of the problem, the researcher usually focuses in one or two specific issues or aspects of the problem. In the case of Hakkio’s paper, however, he moves directly on to the objective statement because there is no further need to narrow it down. His objective statement and a general outline of his paper is presented in the third paragraph of his paper and is quoted below:

"This article argues that PPP is a useful guide to the dollar in the long run

and - to a lesser extent - in the short run. The first section of the article defines

the concept and discusses why most economists believe it is a useful long-run guide. The second section shows the dollar generally moves toward its PPP

value in the long run. The third section shows that in the short run the dollar generally moves towards its PPP value only when deviations from PPP are unusually large. Because today’s dollar is not unusually low relative to PPP,

the measure says little about whether the dollar will rise in the near term."

Suppose a student proposes to write a research paper with the title "Trade Deficit", "Budget Deficit", "Exchange Rate", or "U.S. Banking". One can tell immediately see that each of these subjects is too broad and general to be a meaningful research topic. How does one go about narrowing down these broad and general topics to a manageable research problem? To learn how to do that, we need to learn to reduce the topic to manageable size by limiting it by time, space, or geographically a certain aspect of the problem.

With the trade deficit as an example, one may limit it to "U.S. Trade Deficit" or, more specifically, to "U.S.-Japan Trade deficit". Similarly, it may limited to a specific time period as "Persistent U.S. Trade Deficit During 1980s". Indeed, it might be a combination of two aspects, like "U.S.-Japan Trade Deficit during the 1980s". Or one might decide to focus on one particular aspect, such as the major determinants of the U.S. trade deficit or the effect of U.S. trade deficits on the exchange value of the U.S. dollar..

With the budget deficit in mind, one might similarly limit it to "U.S. budget Deficits" or to the well known issue of the twin deficits between the "U.S. Budget Deficits and Trade Deficits". Or perhaps one might decide to limit the topic to the impact of a reduction in U.S. budget deficit on the value of the U.S. dollar..

With the U.S. banking in mind, one may ask whether or not U.S. Banking is declining". If the answer is positive, one can further examine why U.S. banking is not declining

To illustrate further, consider health care expenditure in the United States over the past several decades. We see from the data that U.S. health case expenditure has steadily increased and that it has increased faster than other categories of expenditure. One can raise a number of important and meaningful questions with respect to heath care spending vis a vis other categories of expenditures. One can ask: Why are health care expenditures in the U.S. increasing over time? Or why has health care expenditure in the U.S. increased substantially faster than other expenditure categories? With this general question in mind, one may pose a more specific question like: Why has the share of health care expenditure of total U.S. consumer expenditure increased during the 1960-95 period? To answer this question adequately, one has to examine the major determinants of health care expenditure in the U.S. Relating to this question, one might pursue the financing side of health care expenditure. To restrain this rapid growth, many health care reform proposals deal with the question of how to finance health care expenditure.

For the last illustration of narrowing down to specific aspect of the research problem, let us take up the recent surge in gasoline prices in California. One can raise a number of important and useful questions about this topic. First, why did gasoline price increase so dramatically in the first part of 1996 compared with those in the previous five years? Is it due to higher gasoline taxes or is it due to the "rigging" of gasoline price by big oil companies? Would the proposed sale of the navy petroleum reserve announced by President Clinton help lower gasoline prices or is it merely a political ploy? A second question might be: Why, in recent years, are gasoline prices in California substantially higher than in the rest of U.S.? What, if any, is the role of environmental costs in California’s recent gasoline price hike?

When you have finally defined the research problem adequately, the next task is to state the problem clearly. We often say that it is necessary to state the research problem clearly and succinctly, but completely. Success depends largely on one’s ability in organization and in technical writing. Since the writing aspect of research activity is not the primary focus of this chapter, one may refer to publications devoted to this aspect. Two good resources which many students find useful are: Technical Writing for Social Scientists by John S. Harris and Reed H. Blake (Nelson-Hall) and The Elements of Style by William Strunk Jr. and E.B. White. (Macmillan)


2.2 Review of Related Literature

"Read not to contract and confute; nor to believe and take for granted; nor to find talk and discuss; but to weigh and consider. -Francis Bacon

Almost all research topics have been studied by other researchers. Nothing under the sun is new, as one verse in the Old Testament says. As you consider some problem or research issue, you can be almost assured that somebody else has studied the problem previously. Therefore, the obvious fact is: The more one knows about what was studied earlier, the better the researcher can approach and solve the problem. What then is the purpose of this review? Obviously, it is to assist you in attacking the problem you choose to study. As you review previous research done in related areas, directly and indirectly, you will be better prepared to handle the problem.

The benefits of a review of related literature are many and a few of them are listed here:

1. It can reveal prior research similar to yours, and it can help you put your work into perspective.
2. It can lead you to related and productive issues to be studied.
3. It can suggest new methods or techniques to handle the problem.
4. It can introduce you to leading researchers in the fields and to their works.
5. It can reveal new sources of data.
6. It will show a reviewer of your work that you have done your "home work".

How should one go about preparing "Review of Related Literature". While there is no one way of doing this, following the several steps listed below will be helpful.

1. Search the Previous Research on the Topic

Before you begin a review of related literature, you first need to find out what has been done on the topic you are interested in. How does one find out what has been done on a particular topic? There are several ways to do this. An increasingly popular method to do a literature search is to tap into two popular electronic data bases. The first one is the EconLit compact disc search. This handy and economical search software consists of one compact disc and user manual. It has a complete list of all the articles and working papers listed in the Journal of Economic Literature, an official publication of the American Economic Association. To use it, however, requires access to an EconLit compact disc and a personal computer with a compact disc drive. The second electronic source is one of several search procedures available on Internet.

When using electronic search procedures, it is important to type in two or three key words to facilitate your search. If the word chosen for your search is broad and general, these search procedures will give you literately few hundreds citations and sorting through so many is not efficient. Thus, when you search previous studies directly or indirectly related to your chosen topic, type only in two or three few key words directly related to your topic.

After your electronic search procedure has produced the necessary citations, you often need to select only those citations which have a direct bearing on your topic. It is a survey of related literature, and only the researcher can make the determination of the degree of relatedness.

If you do not have access to an electronic search, you have to rely on manual search procedures through the library. You can go to library and find current and old issues of the Journal of Economic Literature. This publication lists articles published by journal and by field. It would be advisable to start from a current issue and see if one can find articles and other publications on the topic. Then go to older issues and do the same by writing down citations of all related works.

2. Make a Plan

Having identified all important previous studies which have a direct or indirect bearing on your topic, the next step of writing the review of related literature is to make a plan of how you want to organize your literature review. Without a plan, the literature survey easily becomes "Smith did this; Jones did that" by merely listing what they have done. In making a literature review plan, good advice is always to be mindful of the research problem itself. Without a clear understanding of the research issue and problem, one cannot make a plan for a good literature survey. Any serious attempt to understand the different aspects of each previous work requires substantial effort before one can see clearly how seemingly unrelated work fit together. Only then one can develop a good plan. In organizing your related literature, it is useful first to identify one or two major, or classic, studies. Then you can see the contributions of other works in relation to what was already done or not done in the major works. There may be situations where, in some cases, it is difficult to classify previous works by "major or minor" categories, because the contributions of each work are similar. In this case, it would be reasonable to review previous works by commenting only on the different aspects or focus of these works. One way or another, understanding the main research problem and the contributions of previous works is essential before one can make a plan for literature survey. Finally, it is always a good idea to see how each prior study is related to the problem you are focusing on. The importance of the related literature cannot be emphasized too much.

3. Review the Literature; Don’t reproduce it

Remember what you are doing is a review of literature. This means that you are presenting your own discussion of existing literature. Because of this, it is to avoid direct quotation. Paraphrasing or restating in your own words is the way to do it. What you are doing is evaluating prior work to shed light on your study.


3.3 The Theoretical Model

"Science is built with facts as a house is built with stones, but a collection of facts is no more science than a heap of stones is a house." -Jules Henri Poincare

"A person "can stare stupidly at phenomena; but in the absence of imagination they will not connect themselves together in any rational way". -C.S. Peirce


After the researcher has chosen a problem and has ascertained what investigations have already been done on it, the next step is to conceptualize the problem.

1. What is Conceptual Framework and Why do we need one?

The conceptual or theoretical framework is the process of conceptualizing the problem by reasoning, recognizing, and synthesizing the problem. It is an abstract process in which the researcher identifies the central versus the peripheral, or the primary versus the secondary components of the problem, and understands how these components fit together.

The economic world is incredibly complex. The economist’s task of explaining the behavior of people, institutions and their interactions is, therefore, a very difficult task. To understand why and how it works, we need, as in all other fields of science, to abstract from reality. Abstraction requires ignoring many details in order to focus on the most important elements in order to understand the functioning of a complex phenomenon. Theorizing is a combined effort of abstracting (from details) and connecting (the essential components), and is essential to provide a logical structure for organizing and analyzing the problem. As Pierce said, one can stupidly stare at the facts and data. Only with theory, one can begin to attempt to understand it. The process of arriving at a logical structure for organizing and analyzing the problem is, in fact, a deliberate simplification (abstraction) of the factual relationship to explain how those relationships work. So the theory is an explanation of the mechanism behind observed phenomena.

A couple of examples: 1) road map; 2) ocean waves on the surface as facts. Undercurrent and forces below. Focusing on waves make you dizzy with no understanding of why and how’s of pattern of ocean waves. 3) gasoline price and shift in the demand and supply.

Therefore, the first role of conceptualization is to provide a logical structure for organizing and analyzing the problem. The second role of conceptualization is to lead to a hypothesis, which in turn leads to the testing of the hypothesis. Hypotheses are the results of the conceptualization of the problem. One definition: An hypothesis is a tentative assertion that is subject to testing. "As a tentative assertion, it can take the form of a simple proposition of an expected outcome or an assertion of a relationship, or relationships, between or among forces, variables, or events". [Eldridge, p. 136]


2) How to Start and Develop the Conceptual Framework?

How does one get started on the conceptual framework? Source materials for developing the conceptual framework for your research come from existing theories. You will recall that the research process is circular in the sense that the knowledge obtained in each stage feed on each other from the problem statement, the survey of related literature, and the conceptual framework.

From the review of related literature, one must first identify existing theory or theories on the problem. Second, when there are competing theories, one has to choose a particular theory suitable to the problem. Third, and finally, one has to apply the chosen theory to solve the problem.

To illustrate how to start and develop a conceptual framework, it is best to work with a specific topic. Suppose we are interested in the relationship between transit fares in Sacramento, California and the revenue that the transit system takes in. Specifically, let our question be whether or not a hike in fares, say from a current $1.25 to $1.50, would increase revenue.

In organizing and analyzing our problem to answer that question, we will develop a conceptual framework or, as the economist calls it, build a model. From our knowledge from the micro-economics principles course, we learned that total fare collection (total revenue) is equal to the average fare times the number of rides. In an equational form, this relationship can be stated as:

Total Revenue = fare x number of rides (1)

Equation (1) helps us organize our thinking about the two key variables, namely the fare and number of rides, in the determination of the total revenue. The fare is under the control of and is set by the Sacramento Regional Transit Authority. However, the number rides depends on the fare. The problem is to know how the number of rides will be affected by proposed fare hike by the Transit Authority. Or, more broadly, the question is what determines the number of rides. The economist’s way of answering this question is to view the number of rides as depending on the consumer’s decision to choose between taking transit and alternative transportation modes. The choice of transportation mode is basically an economic decision based on the relative cost and convenience of alternative means of transportation. Once viewed this way, one can see that this is the demand for regional transit.

From the theory of demand, we know that the number of rides, or using the economist’s term, the quantity of transit rides demanded, depends first on fare and the cost of alternative mode of transportation, as well as consumer income. Formally, we can write:

Quantity of Transit Rides Demanded = f ( subway fare, taxi fare, cost of
                                                               automobile driving, income, etc.) (2)

The above equation is read as: The quantity of subway rides demanded "depends" on or "is a function of" the regional transit fare, taxi fare, cost of automobile driving, and consumer income. While there may be a host of other determining factors, Equation (2) tells us that demand for regional transit service is perceived to be determined by transit fare, costs of two alternative means of transportation, namely taxi and automobile, and consumer income. All other factors not included in the above subway demand model are obviously assumed to remain the same or that changes in these factors are assumed not to affect the quantity of transit rides demanded in any meaningful way.

The next step is then to combine the equations (1) and (2) to have the model of total revenue from fare collection. Combining equations (1) and (2) yields:

Total Subway Revenue = fare x quantity of transit ride demanded

      = fare x f (subway fare, taxi cab fare, cost of automobile driving,           consumer income, etc.)                                                               (3)

We now have a complete theoretical model of transit revenue with the key determining factors. However, one may note that the model specified above is a simplified description of the process involved when compared with real world complexities. It is obvious that important explanatory variables such as parking in downtown, the frequency and quality of service of regional transit and so forth, have been omitted. So the natural question is what is the "right" degree of abstraction. But there is no such thing as one right level of abstraction for all analytical purposes. The proper degree of abstraction obviously depends on the objective of the analysis at hand.

Once the theoretical model is specified, we need to evaluate the model qualitatively. An increase in the fare is expected to do two things. First, an increase in fare, holding constant all factors other than fare, tends to increase revenue. But second, as the theory of demand tells us, an increase in transit fare is expected to reduce the number of transit rides demanded, holding constant other factors, namely taxi cab fare, cost of owning automobile driving, and consumer income. The prediction of a negative relationship between the subway ride demanded and subway fare would make sense intuitively. But to really understand why and how an increase in the transit fare usually leads to a reduction in the transit rides demanded, one has to go beyond principles of economics and dig into microeconomics at intermediate level. There we will learn that there are income and substitution effects associated with an increase in subway fare, and that the combined income and substitution effects cause transit rides demanded to fall as a result of the increase in its fare. [See for instance, Nicholson’s Intermediate Microeconomics and its Application, Chapter 4, 1994]. Since these two effects work in opposite directions, it is not a priori clear whether the increase in fare will lead to an increase in total revenue or not. There are three possibilities: Total revenue may increase, remain the same, or decrease, all depending on the price elasticity of demand of ridership.

What does the theory of demand tells us about expected impact of an increase in cost of two alternative means of transportation? Theory tells us that an increase in taxi fare and cost of automobile driving, given the transit fare, will raise transit rides demanded because transit ride will become relatively cheaper (through the substitution effect). But how about the effect of an increase in consumer income on transit rides demanded? The theory of demand tells us that whether or not an increase in consumer income will raise or reduce transit rides demanded depends on whether consumers perceive transit rides as an inferior good or as a luxury good.

Now we realize that the theory of demand will provide answers only qualitatively. That is, the number of transit rides demanded will rise or fall, if such and such conditions are satisfied. But theory of demand will not and cannot provide quantitative answers, which is necessary to answer our initial question of whether or not a hike in transit fare would increase transit revenue. What the theory does is to conceptualize the problem to provide a logical structure for organizing and analyzing the problem, and it can predict the direction of change of a change in determining factors only qualitatively. What we need is a quantitative and empirical answer. The next section is devoted to the discussion of the formulation of an empirical model and its estimation with real-world data, as well as testing of hypotheses.

2.4 Empirical Analysis

Empirical analysis covers a wide range of activity of measurement, estimation, and verification of phenomena under consideration. Since it covers a broad range of activity, it is difficult to present discussion of general rules to follow in conducting empirical analysis. But it seems reasonable to classify various empirical analysis into two types of empirical analysis: descriptive empirical analysis and cause-effect analysis which involves estimation and the testing of hypothesis. First, we will present discussions of how to conduct a descriptive empirical analysis with an example.

2.4.1 Descriptive Empirical Analysis

A descriptive empirical analysis is based on data analysis usually consisting of descriptive statistics and other quantitative measures in analyzing a particular issue(s) or question(s). It does not involve the statistical estimation of relationship and the testing of the hypothesis, as is done in the case of analysis of an assumed cause-effect relationship.

A descriptive empirical analysis may also involve classification of categories and measurement of the extent and degree of a certain phenomenon

To illustrate how to conduct a descriptive empirical analysis, consider a well-known macroeconomic issue of the trade-off between inflation and unemployment. Some background on this issue may be useful. During the 1950s and 1960s, many empirical studies examined inflation and unemployment data for numerous countries and time periods; and in many cases finding a negative relationship between unemployment and inflation. This negative empirical relationship between unemployment and inflation is known as the Phillips curve. In the following decades, however, this relationship between unemployment and inflation failed to hold. In the latter part of the 1960s and early 1970s some economists, notably Milton Friedman and Edmund Phelps, question the logic of the Phillips curve. They argued on theoretical ground that we should not expect a stable relationship between inflation and unemployment. Rather, a stable negative relationship should exist between unanticipated inflation and the cyclical unemployment rate.

Incorporating the negative relationship between unanticipated inflation and cyclical unemployment, we may write

p - pe = -h(u - un)

where h refers to a positive number that measures the strength of the relationship between unanticipated inflation and cyclical unemployment. The latter is defined as the difference between the actual unemployment rate (u) and the natural rate of unemployment (un). The above equation states that given the expected inflation rate, unanticipated inflation will be positive when the cyclical unemployment rate is negative, negative when cyclical unemployment is positive, and zero when cyclical unemployment is zero.

With the concept of a trade-off between the unemployment rate and the inflation rate, policy makers try to gauge the amount of slack in the economy in formulating monetary policy. When the economy’s resources are not pushed beyond capacity levels, inflation tends to remain under control. But when the economy’s resources are pushed to or beyond the capacity level, then inflation is expected to surge. In assessing the capacity in the labor markets, the natural rate of unemployment (NRU) is a key concept. The natural rate of unemployment is defined as that rate of unemployment at which there is no tendency for inflation to change.

With the above background in mind, let us now consider how Stuart Weiner at the Federal Reserve Bank of Kansas examined the relationship between unemployment and inflation in recent papers. First, he defined the concept of the natural rate of unemployment and provided general background information about the relationship between inflation and unemployment, as expected. He then presented two line graphs with data on the U.S. actual unemployment rate and natural unemployment rate for the 1959-1994 period. Since both unemployment rates are measured in percentages on the vertical axis, the vertical difference between them may be considered as the cyclical unemployment rate. In the second graph, Weiner first identified the four episodes of sustained increases in inflation during the period by shaded areas, and then superimposed a line graph of the cyclical unemployment rate.

Using the second graph, he then analyzed whether or not the increases in inflation were accompanied by the actual unemployment rate going below the natural unemployment rate. Examining the graph, he found that "at no times has the actual unemployment rate gone below the natural rate without the economy ultimately experiencing a rise in inflation".

In the discussion of policy implications of his findings, he made several observations. First, he noted that the lead time between a move below the natural rate and the eventual increase in inflation varies. Second, evaluating changes in the demographics and labor market conditions, he made several comments about why he believes that the natural unemployment rate would not be declining from the then currently estimated rate of 6.25%.


2.4.2 Cause-Effect Relationship: Estimation of Function as an Equation

Regression analysis of Sacramento Regional transit demand

2.5 Reporting the Research

"Even the best scientific research is useless unless it is communicated to others" Ghebremdhin and Tweeten, 1988, p. 44

Components of the formal Research Report:

1. Introduction
2. Review of Literature
3. Theoretical Model
4. Empirical Analysis
5. Summary and Conclusions
6. Footnotes
7. Tables
8. Appendix
9. References

Back to Prof. Yang's Home Page