An Overview of Economic Models & Uses

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  • 0:01 Why Model?
  • 1:24 Models for Microeconomists
  • 3:03 When Models Fail
  • 4:27 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.

For this lesson on economic models, you won't need any plastic cement or craft knives. That said, a lot of very useful detail can still be captured and portrayed in economic models, as this lesson demonstrates.

Why Model?

When you were a little kid, chances are you had models of some sort. Granted, you may not have called them models, but from doll houses to action figures, from pony farms and building blocks, a lot of what you considered play was really using a shrunken and simplified version of the world as you saw it. And to help you play, you used toys; often themselves easily manipulated versions of a much larger actual entity. In short, you've been using models all your life.

Economic models also are shrunken down versions of the world. In short, an economic model is simply a way of analyzing data, both theoretical and observed. It allows economists to make generalizations and predictions about how parts of the economy, or indeed whole economies, will respond to various changes.

In this lesson, we're going to focus mainly on models used by microeconomists, but there are models for literally every type of economist. As such, rather than focusing on massive, economy-wide models that macroeconomists use, such as Keynesian or Classical models, we get to use much smaller models. And the best part is that you are probably already pretty familiar with some of them.

Models for Microeconomists

Remember, a model just shows how different changes to an economy should work - in other words, they show a direction of movement. This means that charts and graphs are great visualizations for models. In fact, the most important chart for an economist, and certainly a microeconomist, is a supply and demand graph. Now if you're new to the study of economics, you probably want to say 'gee, it just seems to be common sense that supply and demand have an inverse relationship. I don't need these models.' Well, you can't have that attitude if you want to excel in the field. You must use these models!

Sure, it's easy when you're only accounting for one variable, say an increase in demand. But what about an increase in taxes with a price ceiling? By the way, a price ceiling is just a control that prevents companies from raising prices more than a certain amount. In that case, you might want a model to visualize this all. That's what the supply and demand model lets us do.

But that's not to say that supply and demand is the only model useful for microeconomists. Remember, microeconomics is especially interested in helping companies make better decisions. As a result, something like the production possibilities curve is a great model to help firms figure out how to allocate resources. It is definitely a generalization but can help managers determine the best way to use resources. Remember, scarcity is a problem across economics, and for individuals and firms to prosper, they have to use their scarce resources effectively.

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