ECO 306
NOUN
66 where and are parameters and u is a disturbance term. You might further hypothesize that, apart from the effects of the disturbance term, price inflation is equal to wage inflation. Under these circumstances you would say that the hypothesis that you are going to test, known as your nullhypothesis and denoted H
0
, is that is equal to 1. We also define an alternative hypothesis, denoted H
1
, which represents your conclusion if the experimental test indicates that H
0
is false. In the present case H
1,
is simply that is not equal to 1. The two hypotheses are stated using the notation
H
0
H
1
In this particular case, if we believe that price inflation is equal to wage inflation, we are trying to establish the credibility of H
0
by subjecting it to the strictest possible test and hoping that it emerges intact. In practice, however, it is more usual to setup a null hypothesis and attack it with the objective of establishing the alternative hypothesis as the correct conclusion. For example, consider the simple earnings function
…[2.42]
WhereEARNINGS is hourly earnings in dollars and S is years of schooling. On very reasonable theoretical grounds, you expect earnings to be dependent on schooling, but your theory is not strong enough to enable you to specify a particular value for You can nevertheless establish the dependence of earnings on schooling by the inverse procedure in which you take as your null hypothesis the assertion that earnings does
not depend on schooling, that is, that is 0. Your alternative hypothesis is that is not equal to 0, that is, that schooling doesaffect earnings. If you can reject the null hypothesis, you have established the relationship, at least in general terms. Using the conventional notation, your null and alternative hypotheses are H
0
H
1
, respectively. The following discussion uses the simple regression model
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