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Uses And Limitations Of Economic Models

Economic Models
Introduction

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.
Building a Micro Static Model

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
Now let us construct static market model. As per the above postulations, there are two behavioural condition and one equilibrium condition. Then,

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

(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

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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