1.1.1

• Models in economics

  Economics develop models and theories to help explain the multiple choices we make in our daily lives. These models are built on assumptions that help to simplify analysis, and allow us to think about links between one variable and another. However, many of the assumptions that economists make risk being criticised for not being sufficiently realistic - the real world is far more complex than most economic models suggest.
• What are assumptions?

  Assumptions are initial or prior conditions made before a micro or macroeconomic analysis is built. Sometimes assumptions are used for simplification of theoretical idea or an economic relationship.
• Ceteris paribus assumption

  To simplify analysis, economists isolate the relationship between two variables by assuming ceteris paribus - i.e. all other influencing factors are held constant.

  For example, "an increase in real income will cause an increase in demand, ceteris paribus." Here we keep constant all other factors that might lead to a change in demand for a product.
• Other assumptions

  Most of the economics that we study is based on a "neo-classical" approach. Neo-classical economists make a number of key assumptions in their analysis, including:

  • People are rational
  • People (e.g. workers, business owners etc) aim to maximise their 'utility' i.e. their 'satisfaction'. For businesses, this means aiming to maximise their profit
  • People act independently of each other when making decisions
  • The information needed to make decisions is always accurate and complete.