Methodology of Economic Model Building

Question: Discuss about the Methodology of Economic Model Building. Answer: Introduction: An economic model is explained as a hypothetical construct that highlights economic policies by a range of logical collaboration as well as the association that it shares with a set of variables. According to reports, the Bureau of Labour Statistics published its individual composition on the future that predicted the next ten years in jobs. However, BLS was not successful to anticipate the surprises of the real world. The economic models are considered to be less capable to make estimates despite the fact that they act as a great tool to stimulate. Economic models are mostly disordered as they share their shortcomings with weather forecasting. Weather is disordered as it is tremendously sensitive to initial circumstances in the prediction calculation (Lotze?Campen et al., 2014). Economic models also suppose that there is a point at which rationality prevents certain efforts. The furthermost flaw that is associated with an economic model is that it is classified as a social science. The predictions that are made by the economic models are fumed by the strengths of the theories that help to get hold of the randomness of appropriate data. As a result, the government should always ignore the predictions made by the economic models. The economic models are mostly based on assumptions and as a result, they are not able to provide a clear and transparent explanation that is related to reality. The incredibility of the models dwells in massive allegation about economic forecast. Economics has been dominated by a scholarly orthodoxy that describes that economic cycles are driven by players in real economy (Boland, 2014). A government uses the economic models to provide an underlying structure of the economy as well as to examine perturbations on the margins through approximate behavioural equations. The relationship between efficient market hypothesis and rational expectations hypothesis acts as the major blemishes in the economic models. The economic actors in the mark et acts rationally but they act as per the mental models that are prearranged by economists. When it comes to assigning blame for the present economic doldrums, the traders are to be blamed due to their complicated mathematical financial risks model. The economic models are overwhelmed by calibration issues and as a result, the models continue to turn out bad predictions. The models are tremendously sensitive to initial circumstance assumptions that are easily influenced by those assumptions. The economic models are often used as a source of projection rather than a measurement to check consistency (Gray, 2015). Price elasticity of demand is used to illustrate the responsiveness of the quantity demanded of a commodity or service to a change in price. Price elasticity is mostly negative however; economists tend to avoid the sign even though this can lead to vagueness. However, the commodities that do not match to the law of demand such as Veblen and Giffen goods have a positive PED (Pacula Lundberg, 2014). The term price elasticity is mostly used to discuss sensitivity of price. It can be illustrated as follows: The receptivity of demand to changes in price for a particular good is measured by the price elasticity of demand. If the PED is less than one, the demand for a commodity is said to be inelastic. However, if PED is more than one the demand for a commodity is said to be elastic. The three diverse commodities that are highlighted include pizza, tobacco and gasoline (Miller Alberini, 2016). If the price of pizza is initially $20.50 however, the quantity demanded for an hour is 9 pizzas. On the other hand, if the price of pizza falls to $19.50 the quantity demanded increases to 11 pizzas for an hour. In other words, if the price of pizza falls by $1, the quantity demanded will increase by 2 pizzas per hour. The price elasticity of demand for pizza is 4. In other words, a small change in price will lead to an enormous change in demand. The elasticity of demand measures the change in demand for a product, alongside the change with economic factor. In order to have elastic demand, the demand for the commodity requires to be greater than 1. On the other hand, in the case of gasoline the price elasticity of demand is comparatively inelastic. In other words, despite the change in price the demand for gasoline will stay stable as gasoline has fewer substitutes (Lin Prince, 2013). The price volatility of gasoline influences the price elasticity of demand for customers. Volatility in prices reduces the demand for gasoline in the instant run. The customers appears to have loss elastic demand in response to changes in the price of gasoline when the volatility of gasoline price is high or medium. The price elasticity of demand for tobacco is less than 1 that is it has inelastic demand. With the increase in the price of tobacco, the demand for tobacco decreases. In other words, a 10 percent rise in the price for tobacco will decrease the demand for tobacco by 4 percent. References Boland, L. A. (2014). The Methodology of Economic Model Building (Routledge Revivals): Methodology After Samuelson. Routledge. Gray, J. (2015). False dawn: The delusions of global capitalism. Granta Books. Lin, C. Y. C., Prince, L. (2013). Gasoline price volatility and the elasticity of demand for gasoline. Energy Economics, 38, 111-117. Lotze?Campen, H., Lampe, M., Kyle, P., Fujimori, S., Havlik, P., Meijl, H., ... Valin, H. (2014). Impacts of increased bioenergy demand on global food markets: an AgMIP economic model intercomparison. Agricultural Economics, 45(1), 103-116. Miller, M., Alberini, A. (2016). Sensitivity of price elasticity of demand to aggregation, unobserved heterogeneity, price trends, and price endogeneity: Evidence from US Data. Energy Policy, 97, 235-249. Pacula, R. L., Lundberg, R. (2014). Why changes in price matter when thinking about marijuana policy: A review of the literature on the elasticity of demand. Public health reviews, 35(2), 1.