Uses And Limitations Of Economic Models
Introduction
Meaning and Nature
Concepts in Building Model
Dq = f(P) ; Sq = f(P) ; Hence, Dq = Sq
ITS POSTULATIONS
Dq = (e - fP) Behavioural Equation
Sq = (- g + hP) Behavioural Equation
Dq = Sq Equilibrium State
Here, e,f,g and h are constants. We are assuming some values to these equations in order to solve it. (e = 18, f = 3, g = 6 and h = 9)
Dq = 18 - 3P ............Equation 1
Sq = (- 6 + 9P) ............Equation 2
Dq = Sq ............Equation 3
If we substitute Equation 1 and 2 in 3, we get
→ 18 - 3P = (-6 + 9P)
→ (- 3P - 9P) = ( -6 - 18)
→ - 12 P = - 24
→ P = 2
By evaluating with the value P in the Equations 1 and 2, we attain
Dq = ( 18 - [3 x 2] ) = 12
Sq = (- 6 + [9 x2] ) = 12
Dq = Sq = 12
Thus the market for coffee is in equilibrium at Price (P) = 2
(w = 0.5, x = 0.67, y = 1, z = 2)
In the above tablet, Equilibrium is equal to zero in Price (x) and the Equilibrium condition is satisfied in Price (z) and the pictorial representation would be as follows:
Representation of Coffee Demand and Supply and the Point of Equilibrium.
Limitations of Economic Models
Uses of Models in Economics
Economists like scientists construct model to facilitate their understanding of the
actual world economic inconveniences. We have covered nature and meaning, concepts in
model building and construction, testing, usefulness and limitations of models.
Meaning and Nature
An economic model is the structured set of correlations that portray the implementation of an
economic individuality under a set of postulations from which a wrap up is rationally derived.
The economic individuality may be a household, a single industry, constituency, a financial
system or the globe as a whole..
An economic representation is intentionally simplified models of the actual world. It excludes
many fundamentals that function in veracity, it misrepresents reality in a number of methods.
Instead of demonstrating a real condition it elucidates the fundamental associations that are
adequate to scrutinize and explicate the key qualities of the particular situation at hand.
The correlation of a model to veracity is through its hypothesis An economic representation,
as a map, identifies the particular position and keeps it free from many complicating and
immaterial aspects found in the actual world like the real province in a map. It includes
investigation, Prophecy, Legitimacy, Testability, Generalisation, simplifications and equations.
Concepts in Building Model
An economist is required to explain the events and assumptions that are related to a problem.
For which he has to construct model which has three elements such as: A dependent variable,
Independent variables and Behavioural postulations. Formulation of conditions for the operation
of the model is the next step. The conditions are:
- Variables: A variable's quantity can be changed over a specified time period under consideration. It can have different values which are specific. For e.g.: Price is P, Demand is D and Supply is S and P, D, S are the variables. Dependant variables are those whose values changes based on the changes occurred in other values. For e.g.: Demand varies when price hikes and vice versa. Here Demand is the dependant variable of Price and Price is the independent variable.
- Constants: A constant is that does not change in value with the fluctuations of related variable. It is the co-efficient of the related variable.
- Parameters: A parameter is nothing but a constant which assumes different values in different problems. Hence it is termed parametric constant. For e.g.: ab, mn, xy.
- Functional Relationships: It means change in one variable reflects change in the relative variable. For instance, a=f(b), a is the function of b but b is not the function of a.
- Equations: Equation in general possesses three modes. They are Definitional, Behavioural and Equilibrium. A definitional equation denotes a relationship between two expressions containing the same meaning. A behavioural equation denotes how a variable behaves with regards to the change in the other variable. When a model involves the study of equilibrium, the equation that explains the attainment of equilibrium is termed as Equilibrium condition.
We shall now construct a micro static model to ascertain the price of coffee in a
perfectly competitive market. It relates to three variables, Quantity Demanded,
Quantity Supplied and Price. Let us assume these into Dq, Sq and P.
Dq = f(P) ; Sq = f(P) ; Hence, Dq = Sq
ITS POSTULATIONS
- The quantity demanded is a decreasing function of Price.
- The quantity supplied is an increasing function of Price and in the case if price do not surpass the bare minimum, there is no supply.
- Quantity demand and quantity supplied are stock variables
- The market is in equilibrium when the excess demand is Zero. Dq - Sq = 0, or Dq = Sq
Dq = (e - fP) Behavioural Equation
Sq = (- g + hP) Behavioural Equation
Dq = Sq Equilibrium State
Here, e,f,g and h are constants. We are assuming some values to these equations in order to solve it. (e = 18, f = 3, g = 6 and h = 9)
Dq = 18 - 3P ............Equation 1
Sq = (- 6 + 9P) ............Equation 2
Dq = Sq ............Equation 3
If we substitute Equation 1 and 2 in 3, we get
→ 18 - 3P = (-6 + 9P)
→ (- 3P - 9P) = ( -6 - 18)
→ - 12 P = - 24
→ P = 2
By evaluating with the value P in the Equations 1 and 2, we attain
Dq = ( 18 - [3 x 2] ) = 12
Sq = (- 6 + [9 x2] ) = 12
Dq = Sq = 12
Thus the market for coffee is in equilibrium at Price (P) = 2
Price |
18 - 3P = Dq |
- 6 + 9P = Sq |
Pw |
18 - 3x0.50 = 16.5 |
- 6 + 9x0.50 = - 1.5 |
Px |
18 - 3x0.67 = 16 |
- 6 + 9x0.67 = 0 |
Py |
18 - 3x1.00 = 15 |
- 6 + 9x1.00 = 3 |
Pz |
18 - 3x2 = 12 |
- 6 + 9x2 = 12 |
In the above tablet, Equilibrium is equal to zero in Price (x) and the Equilibrium condition is satisfied in Price (z) and the pictorial representation would be as follows:
Representation of Coffee Demand and Supply and the Point of Equilibrium.
Models presented in theories do not endow with complete vindication. These models are
practical instead of being comprehensive. Model gives quite irrelevant factors since they
are likely to eliminate factors which are difficult to quantify. It is expressed mathematically
and hence economic models lack in relevance and practicality. When it is pertained to actual
economic situation, they are discriminating, conceptual and subjective. There are four possibilities
where inaccuracy get in the economic models, as an outcome the postulations are not made precise.
They are: (i) Parameters of few may remain constant, (ii) a number of strategic variables may be
tapered by a single one, (iii) very unlike items may be analysed in terms of a single category,
(iv) certain sequences may be isolated and evaluated without regard to their associations to other series.
Uses of Models in Economics
The models are described theoretically and hence comparative analyses can be made with other theoretical
structures. With the change in the values of the postulations in the model we can ascertain the actual
economic conditions and operations. For the study of micro and macro problems, static and dynamic
structures are constructed and used. Model building has also been extended to develop plan and growth
of economics. From the perspective of methodology, the use of econometrics and computers in model
building represents an important part in progress of the incorporation of economic research process.
Based on these, fiscal policy decisions are made effortlessly.
Economic models are necessary aid to apparent assessment.
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Other topics under Basic Concepts of Economics:
- Choice As Economic Problem, Production Possibility Curve And Circular Flow of Economic Activity
- Convergent, Divergent, Continuous Cobweb,Importance ,Limitations of Economic Statics
- Economics Statics and Dynamics
- Economics Its Vital Processes And Basic Problems
- Economic Systems
- Methods Laws and Assumptions in Economic Theory
- Merits, Demerits of Socialism, Features of Mixed Economy
- Methodological Issues in Economics
- Nature and Scope of Economics
- Price Mechanism in a Mixed Economy
- Price System, Role pf Price Mechanics and Consumer Sovereignty
- Some Basic Concepts
- The Concept of Equilibrium
- The Neo-Classical Utility Analysis
- The Proportionality Rule or Consumer's Equilibrium
- Uses of Possibility Curve, The Circular Flow of Economic Activity
- Working of the General Equilibrium System