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What is an Economic Model? - Definition & Example

What is an Economic Model? - Definition & Example
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  • 0:00 Economic Models & Uses
  • 1:00 Classical Economic Model
  • 2:00 The Production…
  • 2:44 Other Economic Models
  • 2:59 Limitations of…
  • 3:20 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

Economic models are used by economists to communicate current economic conditions - causes and effects on the future of the economy. This lesson will present economic models, definitions, and examples to help bring clarity to the issue.

Economic Models

An economic model is a hypothetical construct that embodies economic procedures using a set of variables in logical and/or quantitative correlations. It is a simplistic method using mathematical and other techniques created to show complicated processes. An economic model can have many constraints, which may change to generate different property.

Uses of Economic Models

There are five main reasons that economic models are used. These are:

  1. To predict economic activities in which conclusions are drawn based on assumptions
  2. To prescribe new economic guidelines that will change future economic behaviors
  3. To provide logical defense to justify economic policies at three levels: national/political, organizational, and household
  4. For planning and allocating resources and planning logistics and business leadership
  5. To assist with trading and investment speculation

Classical Economic Model

The law of demand and the law of supply are represented in one very commonly used economic model: the classical model. The law of demand states, with all other factors remaining unchanged, the quantity of a product or service that is demanded will increase when the price has decreased. The law of supply states, with all other factors remaining unchanged, an increase in price will result in an increase in the quantity of the product or service that is supplied to the market.

This is a graphical representation of the classical economic model:

Demand and Supply

The graphic shows that as the price changes from $4 to $3, the quantity demanded of the product changes from 18 to 28. It also shows that as the price increases from $1 to $5, the quantity that the supplier is willing to offer to the market increases from 10 to 60. Equilibrium price and quantity occurs when the quantity supplied by the producer and the quantity demanded by the market is equal.

The Production Possibility Frontier Model

Another important economic model is the production possibility frontier (PPF): a curve that depicts maximum productivity likelihood for two or more products, with a specific set of inputs, such as technology, labor, or capital. The main assumption of the PPF is that all inputs are utilized with utmost efficiency.

Production Possibility Frontier

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