A Cross-Section Analysis of an Economic Theory
A Cross-Section Analysis of an Economic Theory
Chapter V begins with a discussion of formal theory-data confrontations in which the sample population plays a significant role. The formalism differs from the theory-data confrontations in Chapters III and IV, but the fundamental ideas of the empirical analysis are the same. The chapter presents an example in which the formal theory-data confrontation prescribes a factor-analytic test of Milton Friedman’s Permanent Income Hypothesis. This test is then contrasted with a factor-analytic test of Friedman’s hypothesis based on ideas that Ragnar Frisch developed in his 1934 treatise on confluence analysis. In Frisch’s confluence analysis Friedman’s permanent components of income and consumption become so-called systematic variates, and Friedman’s transitory com-ponents become accidental variates. Both the systematic and the accidental variates are unobservables that live and function in the real world - here the data universe. The two tests provide an extraordinary example of how different the present-day-econometrics treatment of errors in variables and errors in equations is from the formal-econometrics treatment of inaccurate observations of variables in Frisch’s model world.
Keywords: theory-data confrontation, sample population, cross-section analysis, stratified random sampling, factor analysis, confluence analysis, permanent income, permanent consumption, systematic variates, accidental variates
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