Econ Unit 2 Part 2

Introduction to Economic Modeling

• Economic modeling is a foundational aspect of economics dealing with predictions and assumptions.

• It starts with a set of assumptions that describe key characteristics of the phenomena to be modeled.

Variables in Economic Models

• Models often include independent variables (x) and dependent variables (y).

  • Example: Technological change (x-axis) affects economic growth (y-axis).

  • Technological change is the independent variable; economic growth is the dependent variable.

• Assumptions must be outlined for these variables, leading to simplifications in the model.

Complexity in Economic Models

• Economic models can be simplified to grasp fundamental relationships before adding complexity.

• Interaction between different parties often leads to equilibrium, which can be disrupted by various factors.

  • Examples of interactions: Firms and consumers, firms and workers, and government involvement.

Presentation of Models

• Assumption - abstract from reality to focus on the key determinants of an outcome.

• Economic models can be expressed mathematically, verbally, or graphically, often incorporating elements of all three.

• A good model must be clear, useful, and primarily focused on generating accurate predictions.

The Nature of Economic Models

• Models may seem counterintuitive at times, requiring significant assumptions to simplify predictions.

• Good economic modeling focuses on achieving accurate forecasts; other areas of economics may delve into deeper analysis.

Abstraction in Economic Models

• Economic models, like maps, abstract from reality to provide useful insights.

  • A good map shows essential features without overwhelming details.

  • Bad models may overgeneralize or misrepresent critical elements, akin to poorly drawn maps.

The Heart of economic modeling

• Economic modeling is fundamentally about optimization within constraints.

• How do firms decide on the right quantity and selling price ,given their costs?

  Optimize - Maximize profits

  Choose - considering their inputs ( quantity )

  Constraints - raw materials, labor, capital, and technology.

• Consumers aim to maximize utility based on preferences and income.

The Concept of Equilibrium

• Equilibrium is where all parties in a model are optimizing together.

• Reflects a state of stability where economic interactions balance out.

• Following economic shocks, conditions may return to equilibrium or stabilize at a new one.

• The balancing point in this economic model

Current Focus: Firms and Profit Optimization

• The primary focus for this unit is on understanding how firms optimize profit.

• Constraints in profit optimization include capital, labor, technology, and market circumstances.

• Upcoming discussions will explore the role of technology and input costs like wages and materials in optimization.