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Economic models


When economic science discovers a relationship between two or more things, then a model can be designed. Economics uses economic models to explain economic processes which are so complex in the real economy that models become useful.

A model is a simplified picture of reality that tells how some things influence other things. And various simplifying assumptions are used. For example, “other things being equal” assumption:

In constructing their generalizations, economists as well as other scientists make use of the ceteris paribus (Latin) or 'other things being equal’ assumption. That is, they assume all other variables are held constant except the one under consideration. To illustrate: If economists want to focus on “the price of product X – purchases of product X” relationship, they assume that only the price of product X varies, and all other factors which may influence the

amount of product X purchased are constant, such as the prices of other products, consumer incomes, tastes, fashion, etc.

Exactly what is an economic model?

An economic model is the same thing as an economic theory or principle or law. Economists talk about the “principle of diminishing marginal utility” and the “law of demand” and the “theory of the firm”. All these are models: statements of “what causes what” and “what would happen if…”. A model can be represe nted in three ways:

· verbally (in words)

· graphically (in graphs and diagrams)

· mathematically (equations)

There are two levels of the economic analysis:

microeconomics and macroeconomics.

Microeconomicsdeals with the problems that consumersand firms face in their economic activity. Microeconomics also studies the way that individual markets work and the detailed way that government activities such as regulations and taxes affect individual markets. Much of microeconomics focuses on trying to understand what factors affect the prices and quantities traded in individual markets.

Macroeconomicsdeals with the economy as a whole. It isconcerned with the economy of a country and regulation of the economy by the governments. In particular, it studies the overall values of output as a whole, of unemployment and of inflation.

The division is useful because what is rational for the individual firm or household is not necessary rational when considering the whole economy.

Applied economicsincludes the following: management,marketing, finance, accounting, logistics, to name just a few.

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