2.6 WHAT IS AN ECONOMIC MODEL

• An economic model is a simplified representation of reality, used to understand specific aspects of how the world works.
• A good model makes accurate predictions about the real world by focusing on the key relationships between economic variables.
• Main Ingredients of an Economic Model:

  • Description: Identifies the individuals or entities involved, along with the economic variables of interest.
  • Assumptions: Simplifications about the behavior of individuals and the relationships between the variables. These assumptions are necessary to build a manageable model.
  • Outcomes: The predictions made by the model based on its assumptions. These can be tested using data to see if they hold true.
• Other Things Equal Assumption:

  • The "other things equal" assumption (ceteris paribus) is used to focus on the relationship between two variables while assuming that all other factors remain constant.
  • This simplifies analysis but may overlook complex real-world interactions.
• • The outcome or solution to an economic model is called the equilibrium. This represents a state where no one has an incentive to change their behavior, given the assumptions of the model.
• Models are useful for simplifying reality, but they must strike a balance between too much simplicity (which may omit important factors) and too much complexity (which can make the model hard to understand).