Economic Models
A model is simply a framework that is designed to show complex economic processes.
Learning Objective

Recognize the uses and limitations of economic models
Key Points
 Many models use mathematical techniques in order to investigate, theorize, and fit theories into economic situations.
 Economic models have two functions: 1) to simplify and abstract from observed data, and 2) to serve as a means of selection of data based on a paradigm of econometric study.
 Creating a model has two basic steps: 1) generate the model, and 2) checking the model for accuracy  also known as diagnostics.
 Examples of the uses of economic models include: professional academic interest, forecasting economic activity, proposing economic policy, presenting reasoned arguments to politically justify economic policy, as well as economic planning and allocation.
Terms

deductive
Based on inferences from general principles.

diagnostics
The process of determining the state of or capability of a component to perform its function(s).

qualitative
Based on descriptions or distinctions rather than on some quantity.
Full Text
Economic Models
In economics, a model is defined as a theoretical construct that represents economic processes through a set of variables and a set of logical or quantitative relationships between the two. A model is simply a framework that is designed to show complex economic processes. Most models use mathematical techniques in order to investigate, theorize, and fit theories into economic situations.
Uses of an Economic Model
Economists use models in order to study and portray situations. The focus of a model is to gain a better understanding of how things work, to observe patterns, and to predict the results of stimuli . Models are based on theory and follow the rules of deductive logic.
Economic model diagram
In economics, models are used in order to study and portray situations and gain a better understand of how things work.
Economic models have two functions: 1) to simplify and abstract from observed data, and 2) to serve as a means of selection of data based on a paradigm of econometric study. Economic processes are known to be enormously complex, so simplification to gain a clearer understanding is critical. Selecting the correct data is also very important because the nature of the model will determine what economic facts are studied and how they will be compiled.
Examples of the uses of economic models include: professional academic interest, forecasting economic activity, proposing economic policy, presenting reasoned arguments to politically justify economic policy, as well as economic planning and allocation.
Constructing a Model
The construction and use of a model will vary according to the specific situation. However, creating a model does have two basic steps: 1) generate the model, and 2) checking the model for accuracy  also known as diagnostics. The diagnostic step is important because a model is only useful if the data and analysis is accurate.
Limitations of a Model
Due to the complexity of economic models, there are obviously limitations that come into account. First, all of the data provided must be complete and accurate in order for the analysis to be successful. Also, once the data is entered, it must be analyzed correctly. In most cases, economic models use mathematical or quantitative analysis. Within this realm of observation, accuracy is very important. During the construction of a model, the information will be checked and updated as needed to ensure accuracy. Some economic models also use qualitative analysis. However, this kind of analysis is known for lacking precision. Furthermore, models are fundamentally only as good as their founding assumptions.
The use of economic models is important in order to further study and understand economic processes. Steps must be taken throughout the construction of the model to ensure that the data provided and analyzed is correct.
Key Term Reference
 assumption
 Appears in these related concepts: Cost Flow Assumptions, Observable Culture, and Assumptions
 quantitative
 Appears in these related concepts: Preparing the Research Report, Overview of the IMRAD Model, and Math Review
 simplify
 Appears in these related concepts: Clearing the Market at Equilibrium Price and Quantity, Price Leadership, and How to Compare Economies Throughout History
 variable
 Appears in these related concepts: What is a Linear Function?, Fundamentals of Statistics, and Introduction to Variables
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