Empirical evidence is a set of facts to create empirical evidence.

ce. These terms all boil down to the same basic idea: using data to
established by observation and answer questions about the world and using data to test models. For example, we could test the
measurement. 2.1
New York City subway map by actually riding the subway and checking the map’s accuracy.
When conducting empirical analysis, economists refer to a model’s predictions as
Hypotheses are predictions ­hypotheses. Whenever such hypotheses are contradicted by the available data, economists
(typically generated by a model) that return to the drawing board and try to come up with a better model that yields new hypotheses. 2.2
can be tested with data.

An Economic Model
2.3
Let’s consider an example of an economic model. We’re going to study an extremely sim-
ple model to get the ball rolling. But even economic models that are far more complicated
than this example are also highly simplified descriptions of reality.
All economic models begin with assumptions. Consider the following assumption about
the returns to education: Investing in one extra year of education increases your future
wages by 10 percent. Let’s put the assumption to work to generate a model that relates a
person’s level of education to her wages.
Increasing a wage by 10 percent is the same as multiplying the wage by 1 + 0.10 = 1.10.
The returns-to-education assumption implies that someone with an extra year of education
earns 1.10 times as much as she would have earned without the extra year of education. For
example, if someone would earn $15 per hour with 13 years of education, then a 14th year
of education will cause her hourly wage to rise to 1.10 × $15, or $16.50.
Economists use assumptions to derive other implications. For example, the returns-to-­
education assumption implies that two additional years of education will increase earnings by
10 percent twice over—once for each extra year of education—producing a 21 percent total
increase.

1.10 × 1.10 = 1.21.

Consider another example. Four additional years of education will increase earnings by
10 percent four times over, implying a 46 percent total increase.

1.10 × 1.10 × 1.10 × 1.10 = (1.10)4 = 1.46.

This implies that going to college would increase a college graduate’s income by 46 p­ ercent
compared to what she would have been paid if she had ended her education after finish-
ing high school. In other words, a prediction—or hypothesis—of the model is that college
graduates will earn 46 percent more than high school graduates.
In principle, we can apply this analysis to any number of years of education. We there-
fore have a general model that relates people’s educational attainment to their income. The
model that we have derived is referred to as the returns-to-education model. It describes
the economic payoff of more education—in other words, the “return” on your educational
investment. Most economic models are much, much more complex than this. In most eco-
nomic models, it takes pages of mathematical analysis to derive the implications of the
assumptions. Nevertheless, this simple model is a good starting point for our discussion. It
illustrates two important properties of all models.
First, a model is an approximation. The model does not predict that everyone would in-
crease their future wages by exactly 10 percent if they obtained an extra year of education.
The predicted relationship between education and future wages is an average r­ elationship—
it is an approximation for what is predicted to happen for most people in most circum-
stances. The model overlooks lots of special considerations. For example, the final year of
college probably does much more to increase your wages than the ­second-to-last year of
college, because that final year earns you the official degree, which is a key item on your
resumé. Likewise, your college major importantly impacts how much you will earn after
college. Those who major in economics, for example, tend to earn more than graduates in
most other majors. Our simple model overlooks many such subtleties. Just as a flat subway
map is only an approximation of the features of a city, the returns-to-education model is
only an approximation of the mapping from years of education to wages.
Second, a model makes predictions that can be tested with data­—in this case, data on
people’s education and earnings. We are now ready to use some data to actually evaluate
the predictions of the returns-to-education model.

Section 2.1 | The Scientific Method 55

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