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Economics D10-1: A Course in Economic Modeling

Economics D10-1: A Course in Economic Modeling. Lecture 1: Introduction to Economic Models. Assumptions Economic Agents Preferences or tastes Constraints they face Information available Economic Environment Technology Market and nonmarket institutions

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Economics D10-1: A Course in Economic Modeling

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  1. Economics D10-1: A Course in Economic Modeling Lecture 1: Introduction to Economic Models

  2. Assumptions Economic Agents Preferences or tastes Constraints they face Information available Economic Environment Technology Market and nonmarket institutions Selection of endogenous and exogenous variables Logical Analysis (Math) Characterization of economic outcomes Optimizing systems Equilibrium systems Positive, Comparative Statics Analysis (Math) Testable (refutable) hypotheses Impact on endogenous variables of changes in exogenous variables Normative Analysis (Math) Evaluation of econ. outcomes Building and analyzing an economic model

  3. Assumptions: Supply equals demand at equilibrium Income increase shifts demand curve out Supply curve upward sloping Demand curve downward sloping Testable Hypotheses Higher income leads to higher equilibrium price Higher wages lead to higher equilibrium price S(pe,w) = D(pe,I) Sp>0; Sw<0; Dp<0; DI>0 Differentiating with respect to I and w yields Supply and Demand: an economic model of an equilibrium system

  4. Assumptions Firm maximizes profits ∏ = R(x) - C(x) R is twice differentiable Technology exhibits constant returns to scale: C(x) = cx Characterization of outcome Marginal revenue equals marginal cost Testable hypothesis An increase in unit costs leads to a reduction in output Assumptions x*argmax R(x)-cx x*>0 RC2  FONC: R(x*) = c SONC: R(x*)< 0 Testable Hypothesis: (dx*/dc) = 1/ R<0 Requires SOSC: R<0 Optimizing model: monopoly choice of output

  5. Assumptions Firm chooses real decision variable x to maximize real-valued payoff function F(x,a) Characterization of outcome x*= argmax F(x,a) FC2  Fx(x*,a)=0 and Fxx(x*,a)<0 More general model based upon an optimizing system

  6. Testable Hypotheses • Which of these are testable implications of an economic model? • Higher consumer income leads to higher prices • An increase in unit costs causes a monopolist to reduce output • Higher wages lead to higher prices • A profit maximizing firm operates where Marginal Revenue equals Marginal Costs • The last statement is a tautology, it cannot be false! • The first three statements are refutable they can be false.

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