Consider two models for estimating, in advance of an election, the shares of votes that will go to rival candidates. According to one model, pollsters’ surveys of a randomly chosen set of registered voters before an election can be used to forecast the percentage of votes that each candidate will receive. This first model relies on the assumption that unpaid survey respondents will give truthful responses about how they will vote and that they will actually cast a ballot in the election. The other model uses prices of financial assets (legally binding IOUs) issued by the Iowa Electronic Markets, operated by the University of Iowa, to predict electoral outcomes. The final payments received by owners of these assets, which can be bought or sold during the weeks and days preceding an election, depending on the shares of votes the candidates actually end up receiving. This second model assumes that owners of these assets wish to earn the highest possible returns, and it indicates that the market prices of these assets provide an indication of the percentage of votes that each candidate will actually receive on the day of the election.

(a) Which of these two models for forecasting electoral results is more firmly based on the rationality assumption of economics?

(b) How would an economist evaluate which is the better model for forecasting electoral outcomes?

Step by step solution

01

Step 1. Definition of Economics.

Economics is the study of wants and the use of scarce resources with alternative uses to fulfill the wants.

02

Part (a). The correct model.

The second model by Iowa Electronics will give better electoral results based on the rationality assumption of economics. This is because poor forecast will lead to losses which is not adapted in the first model which considers that unpaid respondents will give truthful responses. The second model can be tested with empirical data and other economic tools.

03

Part (b). Evaluation of the correct model.

The correct model is evaluated by comparing the electoral results with the outcomes of the two models. The model which matches the outcome of the electoral result is the better model.

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