ea ures o conom1c s

Assumptions and simplifications: every model needs them in order to

be useful.

Testability: good models generate testable predictions, which can be

verified or disproven using data.

Economic variables: something measurable that can have different

values, such as the income.

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 s
Economists develop economic models to analyze real-world issues.

Building an economic model often follows these steps:

1. Decide on the assumptions to use in developing the model.

2. Formulate a testable hypothesis.
3. Use economic data to test the hypothesis.
4. Revise the model if it fails to explain the economic data well.
5. Retain the revised model to help answer similar economic
questions in the future.

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• • •
 s
Economists develop economic models to analyze real-world issues.

Building an economic model often follows these steps:

1. Decide on the assumptions to use in developing the model.

2. Formulate a testable hypothesis.
3. Use economic data to test the hypothesis.
4. Revise the model if it fails to explain the economic data well.
5. Retain the revised model to help answer similar economic
questions in the future.

l)r Renu Verma Verma's screen

• • •
 xampes o s
Economic models offer a way to get a complete view or picture
of an economic situation and understand how economic factors
fit together.
A good model to start with in economics is the circular flow
diagram. Such a diagram indicates that the economy consists
of two groups, households and firms, which interact in two
markets: the goods-and-services market (also called
the product market), in which firms sell and households buy,
and the labor market, in which households sell labor to
business firms or other employees.

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• • •
 Why would an economist use math when there are other ways
of representing models, such as with text or narrative? Why
would you use your fist to bang a nail, if you had a hammer?
Math has certain advantages over text. It disciplines
our thinking by making us specify exactly what we mean. You
can get away with fuzzy thinking and vague approximations in
your own mind, but not when you're reducing a model to
algebraic equations. At the same time, math has certain
disadvantages. Mathematical models lack the nuances that can
be found in narrative models. The point is that math is one tool,
but it's not the only tool or even always the best tool economists
can use to work with economic models.

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• • •
 The use of algebra is a specific way that economics express
and explore economic models. Where graphs require you to
"eyeball" a model, algebra can give you more precise answers
to questions. For example, if a business puts their product on
sale for 10% off the regular price, how much more will
consumers buy? Similarly, using the algebraic formula for a line
allows economists to find precise points on a graphs that help in
interpreting how much of a good should be sold, or at what
price.

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 conom1c
An economic model is a simplified version of reality that allows us to
observe, understand, and make predictions about economic behavior.
The purpose of a model is to take a complex, real-world situation and
pare it down to the essentials. If designed well, a model can give the
analyst a better understanding of the situation and any related
problems.
A good model is simple enough to be understood while complex
enough to capture key information. Sometimes economists use the
term theory instead of model. Strictly speaking, a theory is a more
abstract representation, while a model is a more applied or empirical
representation

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• • •
ypes o conom1es
Centrally planned economies result when governments decide
what to produce, how to produce it, and who received the goods and
services.

Market economies result when the decisions of households and

firms determine what is produced, how it is produced, and who
receives the goods and services.

Market: A group of buyers and sellers of a good or service and the

institution or arrangement by which they come together to trade

• • •
 ece,ve erv1ces.

The way we are most familiar with in the United States is that people
with higher incomes obtain more goods and services.

Changes in tax and welfare policies change the distribution of

income; though people often disagree about the extent to which this
"redistribution" is desirable.

• ••
A firm might have several different methods for producing its goods
and services.

Example: A music producer can make a song sound good by

• Hiring a great singer, and using standard production techniques; or
• Hiring a mediocre singer, and using Auto-Tune to correct the
inaccuracies.

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The Economic Problem That Every Society Must Solve

What goods and services will be produced?

How will the goods and services be produced?
Who will receive the goods and services produced?

• • •
The Economic Problem That Every Society Must Solve

What goods and services will be produced?

How will the goods and services be produced?
Who will receive the goods and services produced?

• • •
 1croeconom1cs an acroeconom1cs
Microeconomics is the study of
• how households and firms make choices,
• how they interact in markets, and
• how the government attempts to influence their choices

Macroeconomics is the study of the economy as a whole, including

topics such as inflation, unemployment, and economic growth.

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Microeconomics is the study of

• how households and firms make choices,
• how they interact in markets, and
• how the government attempts to influence their choices

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