Question

What is the biggest challenge when economists try to estimate peer effects? Please explain.

Answer 1

Before getting into the biggest challenges that economists face while trying to estimate peer effect let us first understand what a peer effect is.

"Peer effect" is the consequence of a group activity(usually consisting people of the same age group) that affects an individual's behaviour, thinking ability or actions. For example- Your peer group (friends) will affect your behaviour or personality in some or the other way. The outcome may be positive or negative. Thus, this effect can be termed as peer effect.

There are number of statistical and social factors that lead to close or same outcomes between peers even if there is lack of casual peer effect. Thus, making the peer effect difficult to study.

There are three biggest challenges that economists face while trying to estimate peer effects. Namely-

1. The selection problem
2. The reflection problem and
3. Angrist mechanics

1. The selection problem- It expresses that peer groups are usually formed or originated internally and that it is empirically difficult to differentiate between peer effects and selection effects. As it is said that "Birds of a feather flock together" it becomes difficult to select individuals who already have similar traits and choices. This results in making the selection process difficult for the economists.

2. The reflection problem- It states that it becomes impossible to differentiate between the effect of peers on the individual and the effect of the individual on peers if both are determined at the same time. We can say that "if some peer group affect us there are chances that we affect them too". Let's say, if your peers affect you, do you not affect them? This usually results in making the reflection process difficult for the economists. Thus, resulting in faulty estimates.

3. Angrist mechanics- This mechanics describes that there is an automatic relationship between the measures of own ability and the ability of peers. This results or leads the economists to make biased estimates even if they adopt the method of random sampling. Say, if a peer group is collectively intelligent the individual under consideration is likely to be declared intelligent and vice versa.

Thus, these three challenges are faced by the economists while trying to estimate the peer effects.