{"id":5779,"date":"2016-07-19T18:03:45","date_gmt":"2016-07-19T18:03:45","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/macroeconomics\/?post_type=chapter&p=5779"},"modified":"2016-08-02T16:23:05","modified_gmt":"2016-08-02T16:23:05","slug":"reading-using-economic-models","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-macroeconomics\/chapter\/reading-using-economic-models\/","title":{"raw":"Reading: Using Economic Models","rendered":"Reading: Using Economic Models"},"content":{"raw":"

\"Architectural<\/a><\/h2>\r\n

Economic Models and Math<\/h2>\r\nEconomists use models as the primary tool for\u00a0explaining or making predictions about economic issues and problems. For example, an economist might try to explain what caused the Great Recession in 2008, or she might try to predict how a personal income tax cut would affect automobile purchases.\r\n\r\nEconomic models can be represented using words or using mathematics. All of the important concepts in this course can be explained without math. That said, math is a tool that can be used to explore economic concepts in very helpful ways. You know\u00a0the saying \u201cA picture is worth a thousand words\u201d? The same applies to graphs: they\u2019re a very effective means of conveying information visually\u2014without a thousand words. In addition to being a \u201cpicture,\u201d a graph is also a math-based model.\u00a0Math is one way of working with (or manipulating) economic models.\r\n\r\nWhy 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\u00a0thinking by making us\u00a0specify exactly what we\u00a0mean. You can get away with fuzzy thinking and vague approximations in your own mind, but not when you\u2019re reducing a model to algebraic equations. At the same time, math has certain disadvantages. Mathematical models lack the nuances that\u00a0can be found in narrative models. The point is that math is one tool, but it\u2019s not the only tool or even always the best tool economists can use.\r\n

Examples of Models<\/h2>\r\nAn architect who is designing\u00a0a major office building will probably\u00a0build a physical model that sits on a tabletop to show how the entire city block will look after the new building is constructed. Companies often build models of their new products that are rougher\u00a0and less finished\u00a0than the final product but can still demonstrate how the new product will work and look. Such models help people visualize\u00a0a product (or a building) in a more complete, concrete way than they could without them.\r\n\r\nSimilarly, economic models offer a way to get a complete view or picture of an economic situation and understand how economic factors fit together.\r\n\r\nA good model to start with in economics is the circular flow diagram <\/strong>(Figure 1, below). Such a diagram indicates that\u00a0the economy consists of two groups, households and firms, which\u00a0interact in two markets: the goods-and-services market\u00a0<\/strong>(also called the product market)<\/em>, in which firms sell and households buy, and the labor market<\/strong>, in which households sell labor to business firms or other employees.\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"430\"]\"The Figure 1. The Circular Flow Diagram<\/strong>[\/caption]\r\n\r\nOf course, in the real world, there are many different markets for goods and services and markets for many different types of labor. The circular flow diagram simplifies these distinctions\u00a0in order to make the picture easier to grasp. In the diagram, firms produce goods and services, which they sell to households in return for payments. The outer ring\u00a0represents the two sides of the product market (which provides\u00a0goods and services), in which households demand and firms supply. In addition, households (as workers) sell their labor to firms in return for wages, salaries, and benefits. This is shown in the inner circle, which represents the two sides of the labor market,\u00a0<\/em>in which households supply and firms demand. This version of the circular flow model is stripped down to the essentials, but it has enough features to explain how the product and labor markets work in the economy.\r\n\r\nWe could easily add details to this basic model if we wanted to introduce more real-world elements, like financial markets, governments, or\u00a0interactions with the rest of the world\u00a0(imports and exports). Economists reach for\u00a0theories in much the same way as a carpenter might grab a tool. When economists\u00a0identify\u00a0an economic issue or problem, they sift\u00a0through the available theories to see if they can find one that fits. Then they use the theory to give them\u00a0insights about the issue or problem. In economics, theories are expressed as diagrams, graphs, or even as mathematical equations. Counter to what you might expect, economists don't figure out the solution to a problem and then draw the graph. Instead, they use the graph to help them discover\u00a0the answer. At\u00a0the introductory level, you can sometimes figure out the right answer without using\u00a0a model, but if you keep studying economics, before too long you'll encounter\u00a0issues and problems whose solution will require\u00a0graphs. Both micro and macroeconomics are explained in terms of theories and models. The most well-known theories are probably those of supply and demand, but you will learn about several\u00a0others.\r\n

Economic Models and Theories Video<\/h2>\r\nAn economic\u00a0model<\/strong>\u00a0is a simplified version of reality that allows us to observe, understand, and make predictions about economic behavior. The purpose of a model\u00a0is to take a complex, real-world situation\u00a0and pare it\u00a0down to the\u00a0essentials. If designed\u00a0well, a model can give\u00a0the analyst a better understanding of the situation and any related problems.\r\n\r\nA good model\u00a0is simple enough to be understood while complex enough to capture key information. Sometimes economists use the term theory<\/em>\u00a0instead of model<\/em>. Strictly speaking, a theory is a more abstract representation, while a model is a more applied or empirical representation. Often, models are used to test theories. In this course, however, we will use the terms interchangeably.\r\n\r\nhttps:\/\/youtu.be\/lYHy2XLa4u0?t=1s\r\n

Self Check: Economic Models<\/h2>\r\nAnswer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not\u00a0<\/strong>count toward your grade in the class, and you can retake it an unlimited number of times.\r\n

You\u2019ll have more success on the Self Check if you\u2019ve completed the Reading in this section.<\/span><\/p>\r\nUse this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.\r\n\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/1546","rendered":"

\"Architectural<\/a><\/h2>\n

Economic Models and Math<\/h2>\n

Economists use models as the primary tool for\u00a0explaining or making predictions about economic issues and problems. For example, an economist might try to explain what caused the Great Recession in 2008, or she might try to predict how a personal income tax cut would affect automobile purchases.<\/p>\n

Economic models can be represented using words or using mathematics. All of the important concepts in this course can be explained without math. That said, math is a tool that can be used to explore economic concepts in very helpful ways. You know\u00a0the saying \u201cA picture is worth a thousand words\u201d? The same applies to graphs: they\u2019re a very effective means of conveying information visually\u2014without a thousand words. In addition to being a \u201cpicture,\u201d a graph is also a math-based model.\u00a0Math is one way of working with (or manipulating) economic models.<\/p>\n

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\u00a0thinking by making us\u00a0specify exactly what we\u00a0mean. You can get away with fuzzy thinking and vague approximations in your own mind, but not when you\u2019re reducing a model to algebraic equations. At the same time, math has certain disadvantages. Mathematical models lack the nuances that\u00a0can be found in narrative models. The point is that math is one tool, but it\u2019s not the only tool or even always the best tool economists can use.<\/p>\n

Examples of Models<\/h2>\n

An architect who is designing\u00a0a major office building will probably\u00a0build a physical model that sits on a tabletop to show how the entire city block will look after the new building is constructed. Companies often build models of their new products that are rougher\u00a0and less finished\u00a0than the final product but can still demonstrate how the new product will work and look. Such models help people visualize\u00a0a product (or a building) in a more complete, concrete way than they could without them.<\/p>\n

Similarly, economic models offer a way to get a complete view or picture of an economic situation and understand how economic factors fit together.<\/p>\n

A good model to start with in economics is the circular flow diagram <\/strong>(Figure 1, below). Such a diagram indicates that\u00a0the economy consists of two groups, households and firms, which\u00a0interact in two markets: the goods-and-services market\u00a0<\/strong>(also called the product market)<\/em>, in which firms sell and households buy, and the labor market<\/strong>, in which households sell labor to business firms or other employees.<\/p>\n

\"The<\/p>\n

Figure 1. The Circular Flow Diagram<\/strong><\/p>\n<\/div>\n

Of course, in the real world, there are many different markets for goods and services and markets for many different types of labor. The circular flow diagram simplifies these distinctions\u00a0in order to make the picture easier to grasp. In the diagram, firms produce goods and services, which they sell to households in return for payments. The outer ring\u00a0represents the two sides of the product market (which provides\u00a0goods and services), in which households demand and firms supply. In addition, households (as workers) sell their labor to firms in return for wages, salaries, and benefits. This is shown in the inner circle, which represents the two sides of the labor market,\u00a0<\/em>in which households supply and firms demand. This version of the circular flow model is stripped down to the essentials, but it has enough features to explain how the product and labor markets work in the economy.<\/p>\n

We could easily add details to this basic model if we wanted to introduce more real-world elements, like financial markets, governments, or\u00a0interactions with the rest of the world\u00a0(imports and exports). Economists reach for\u00a0theories in much the same way as a carpenter might grab a tool. When economists\u00a0identify\u00a0an economic issue or problem, they sift\u00a0through the available theories to see if they can find one that fits. Then they use the theory to give them\u00a0insights about the issue or problem. In economics, theories are expressed as diagrams, graphs, or even as mathematical equations. Counter to what you might expect, economists don’t figure out the solution to a problem and then draw the graph. Instead, they use the graph to help them discover\u00a0the answer. At\u00a0the introductory level, you can sometimes figure out the right answer without using\u00a0a model, but if you keep studying economics, before too long you’ll encounter\u00a0issues and problems whose solution will require\u00a0graphs. Both micro and macroeconomics are explained in terms of theories and models. The most well-known theories are probably those of supply and demand, but you will learn about several\u00a0others.<\/p>\n

Economic Models and Theories Video<\/h2>\n

An economic\u00a0model<\/strong>\u00a0is a simplified version of reality that allows us to observe, understand, and make predictions about economic behavior. The purpose of a model\u00a0is to take a complex, real-world situation\u00a0and pare it\u00a0down to the\u00a0essentials. If designed\u00a0well, a model can give\u00a0the analyst a better understanding of the situation and any related problems.<\/p>\n

A good model\u00a0is simple enough to be understood while complex enough to capture key information. Sometimes economists use the term theory<\/em>\u00a0instead of model<\/em>. Strictly speaking, a theory is a more abstract representation, while a model is a more applied or empirical representation. Often, models are used to test theories. In this course, however, we will use the terms interchangeably.<\/p>\n