Economic Modeling 101: Everything You Need To Know About Economic Models

You’ve undoubtedly heard about economic modeling if you’re in the business world. It is a big part of every larger company since it’s often the foundation for significant business moves or decisions.

From collecting and analyzing job postings data to launching new products or services, economic modeling can be a part of every business aspect. Its two main properties, simulating and forecasting, equip businesses with thorough knowledge and detailed information necessary for running a company and making plans for the future.

Keep reading to learn more about economic modeling and how it can help your business.

What are economic models?

Economic models represent the basis for economic modeling. An economic model is a framework for simplifying complex processes related to the hypotheses of economic behavior.

These models help test different economic outcomes by using theoretical constructs, often based on mathematics and logic. The constructs they use typically represent various economic processes.

They provide a simplified description of reality, and they achieve that by using sets of variables and relationships between them.

What are the classes of economic models?

It’s vital to know the two main classes of economic models to understand them better – theoretical and empirical. Let’s see what they are.

Theoretical economic models

The main goal of theoretical economic models is to derive verifiable implications related to economic behavior. In most cases, they achieve that by maximizing the objectives and constraints defined in a particular model.

Theoretical economic models offer qualitative answers to all kinds of economic questions, including the budget, how to handle market failures, and details concerning the implications of asymmetric information.

Empirical economic models

Empirical models are slightly different. Their primary goal is to verify the predictions by theoretical models and find ways to turn them into accurate outcomes.

For instance, a theoretical model of someone’s consumption behavior can explain the relationship between income and expenditure. However, empirical models assign an accurate numerical value to this behavior.

What are the properties of economic models?

Each valuable and well-established economic model contains unique characteristics. Here are the primary economic models’ properties.

  1. Parsimony

Parsimonious economic models leave little to no freedom to researchers as they rely on few assumptions.

Parsimony is one of the main properties because it leaves no room for researchers to manipulate a particular model and cause it to over-fit. Over-fitting happens when a model works flawlessly but fails to deliver precise predictions.

  1. Tractability

Tractable economic models aren’t complicated and are simple to analyze. You can even solve completely tractable models with the most straightforward calculations without software assistance.

However, neither humans nor computers can solve intractable economic models because they include too many variables.

  1. Conceptual insightfulness

Conceptually insightful economic models can reveal critical properties of economic systems and behaviors. Whether those systems make predictions or clarify abstract ideas, these models can uncover the main properties.

  1. Generalizability

You can use generalizable economic models for various situations. For example, you can create these models to measure and analyze risk aversion in all cases and settings.

  1. Falsifiability

Falsifiable economic models can make accurate predictions. As such, we can say that falsifiability and prediction are synonymous. If a particular economic model is falsifiable, it can make reliable and precise predictions.

  1. Empirical consistency

Empirically consistent models can show consistency with the available data. That means models with high empirical consistency can make solid and numerous empirically verified predictions.

  1. Predictive precision

Finally, models with predictive precision can make precise predictions. Precise and predictive economic models can help forecasters predict future events and consequences before they occur.

What is the purpose of economic modeling?

As mentioned above, there are two primary purposes of economic modeling – simulating and forecasting.

  1. Simulating

By relying on numerous economic models, economic modeling works great for simulations. That means researchers can simulate possible economic scenarios by using this modeling to introduce different variables into the simulation.

  1. Forecasting

Even though economic modeling is less accurate in forecasting, you can still use it to make rough plans and get an idea about future changes in the economy.

However, you will always face uncertainties when forecasting future events since nothing related to the future can be entirely accurate. No one can predict the future, but this modeling type can provide a peek into it to support your business decisions.

Conclusion

Economic modeling can provide you and your business with valuable insights relating to economics. It’s now more important than ever to follow every market trend and tread carefully around making new decisions.

If you wish to be more informed about how successful your business decisions are from the aspect of economics, economic models can supply you with everything you need. We’ve only touched the surface of this modeling here, so be sure to dig deeper into the matter to empower your business.

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