What Are Economic Models?

Sam Ouliaris of IMF has this nice description of the enigma of economics — its models.

The idea behind model ironically is to simplify economics:

An economic model is a simplified description of reality, designed to yield hypotheses about economic behavior that can be tested. An important feature of an economic model is that it is necessarily subjective in design because there are no objective measures of economic outcomes. Different economists will make different judgments about what is needed to explain their interpretations of reality.

Two kinds of models:

There are two broad classes of economic models—theoretical and empirical. Theoretical models seek to derive verifiable implications about economic behavior under the assumption that agents maximize specific objectives subject to constraints that are well defined in the model (for example, an agent’s budget). They provide qualitative answers to specific questions—such as the implications of asymmetric information (when one side to a transaction knows more than the other) or how best to handle market failures.

In contrast, empirical models aim to verify the qualitative predictions of theoretical models and convert these predictions to precise, numerical outcomes. For example, a theoretical model of an agent’s consumption behavior would generally suggest a positive relationship between expenditure and income. The empirical adaptation of the theoretical model would attempt to assign a numerical value to the average amount expenditure increases when income increases. 

He explains in brief how economists make models. what is a good and a bad model…

At the end of the day, one must remember model is a model and never the actual thing. And each model is based on certain economists’ experience and so on. So one set of data and you could get very different results  as models are different.

I would suggest that to help people understand this, each paper should explain in English what the model is about and its limitations. Instead most papers burden start upfront with equations without much explanation for basics of the model. This makes it difficult to understand the basis of the models and its limitations..

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2 Responses to “What Are Economic Models?”

  1. keta meera sahebu Says:

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  2. Vijaykumar.p Says:

    I want to do model

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