A diagram of the IS/LM model

In economics, a model is a theoretical construct that represents economic processes by a set of variables and a set of logical and quantitative relationships between them. As in other fields, models are simplified frameworks designed to illuminate complex processes. Image File history File links Islm. ... Image File history File links Islm. ... The IS curve moves to the right, causing higher interest rates and expansion in the real economy (real GDP). ... This article needs additional references or sources for verification. ... The word theory has a number of distinct meanings in different fields of knowledge, depending on their methodologies and the context of discussion. ... Process (lat. ... In computer science and mathematics, a variable (IPA pronunciation: ) (sometimes called a pronumeral) is a symbolic representation denoting a quantity or expression. ... Logic, from Classical Greek λόγος logos (meaning word, account, reason or principle), is the study of the principles and criteria of valid inference and demonstration. ... An abstract model (or conceptual model) is a theoretical construct that represents something, with a set of variables and a set of logical and quantitative relationships between them. ...

Overview

In general terms, economic models have two functions: first as a simplification of and abstraction from observed data, and second as a means of selection of data based on a paradigm of econometric study. Since the late 1960s, the word paradigm (IPA: ) has referred to a thought pattern in any scientific discipline or other epistemological context. ... Econometrics literally means economic measurement. It is the branch of economics that applies statistical methods to the empirical study of economic theories and relationships. ...

Simplification is particularly important for economics given the enormous complexity of economic processes. This complexity can be attributed to the diversity of factors that determine economic activity; these factors include: individual and cooperative decision processes, resource limitations, environmental and geographical constraints, institutional and legal requirements and purely random fluctuations. Economists therefore must make a reasoned choice of which variables and which relationships between these variables are relevant and which ways of analyzing and presenting this information are useful. Complexity in general usage is the opposite of simplicity. ... Co-operation refers to the practice of people or greater entities working in common with commonly agreed-upon goals and possibly methods, instead of working separately in competition. ... Rainforest on Fatu-Hiva, Marquesas Islands Natural resources are naturally occurring substances that are considered valuable in their relatively unmodified (natural) form. ... This article does not cite any references or sources. ... Map of the Earth Geography (from the Greek words Geo (γη) or Gaea (γαια), both meaning Earth, and graphein (γραφειν) meaning to describe or to writeor to map) is the study of the earth and its features, inhabitants, and phenomena. ... A constraint is a limitation of possibilities. ... Institutions are structures and mechanisms of social order and cooperation governing the behavior of two or more individuals. ... Lady Justice or Justitia is a personification of the moral force that underlies the legal system (particularly in Western art). ... Random redirects here. ...

Selection is important because the nature of an economic model will often determine what facts will be looked at, and how they will be compiled. For example inflation is a general economic concept, but to measure inflation requires a model of behavior, so that an economist can differentiate between real changes in price, and changes in price which are to be attributed to inflation.

In addition to their professional academic interest, the use of models include: Academia is a collective term for the scientific and cultural community engaged in higher education and research, taken as a whole. ...

• Forecasting economic activity in a way in which conclusions are logically related to assumptions;
• Proposing economic policy to modify future economic activity;
• Presenting reasoned arguments to politically justify economic policy at the national level, to explain and influence company strategy at the level of the firm, or to provide intelligent advice for household economic decisions at the level of households.
• Planning and allocation, in the case of centrally planned economies, and on a smaller scale in logistics and management of businesses.
• In finance predictive models have been used since the 1980s for trading (investment, and speculation), for example emerging market bonds were often traded based on economic models predicting the growth of the developing nation issuing them. Since the 1990s many long-term risk management models have incorporated economic relationships between simulated variables in an attempt to detect high-exposure future scenarios (often through a Monte Carlo method).

Obviously any kind of reasoning about anything uses representations by variables and logical relationships. A model however establishes an argumentative framework for applying logic and mathematics that can be independently discussed and tested and that can be applied in various instances. Policies and arguments that rely on economic models have a clear basis for soundness, namely the validity of the supporting model. Look up forecast in Wiktionary, the free dictionary. ... Look up assumption in Wiktionary, the free dictionary. ... Economic policy refers to the actions that governments take in the economic field. ... Corporate redirects here. ... A plan is a proposed or intended method of getting from one set of circumstances to another. ... Look up Allocation in Wiktionary, the free dictionary. ... This box:      A planned economy is an economic system in which a single agency makes all decisions about the production and allocation of goods and services. ... Look up Logistics in Wiktionary, the free dictionary. ... Look up Management in Wiktionary, the free dictionary. ... Wall Street, Manhattan is the location of the New York Stock Exchange and is often used as a symbol for the world of business. ... Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. ... This article does not cite any references or sources. ... Look up Trade in Wiktionary, the free dictionary Trade centers on the exchange of goods and/or services. ... Invest redirects here. ... Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. ... In finance, a bond is a debt security, in which the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ... A developing country is a country with low average income compared to the world average. ... For the band, see 1990s (band). ... Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources. ... Monte Carlo methods are a widely used class of computational algorithms for simulating the behavior of various physical and mathematical systems, and for other computations. ... In logic, an argument is a set of statements, consisting of a number of premises, a number of inferences, and a conclusion, which is said to have the following property: if the premises are true, then the conclusion must be true, or highly likely to be true. ... Euclid, Greek mathematician, 3rd century BC, as imagined by by Raphael in this detail from The School of Athens. ...

Economic models in current use have no pretensions of being theories of everything economic; any such pretensions would immediately be thwarted by computational infeasibility and the paucity of theories for most types of economic behavior. Therefore conclusions drawn from models will be approximate representations of economic facts. However, properly constructed models can remove extraneous information and isolate useful approximations of key relationships. In this way more can be understood about the relationships in question than by trying to understand the entire economic process. Look up computation in Wiktionary, the free dictionary. ... It has been suggested that this article or section be merged with estimation. ...

The details of model construction vary with type of model and its application, but a generic process can be identified. Generally any modelling process has two steps: generating a model, then checking the model for accuracy (sometimes called diagnostics). The diagnostic step is important because a model is only useful to the extent that it accurately mirrors the relationships that it purports to describe. Creating and diagnosing a model is frequently an iterative process in which the model is modified (and hopefully improved) with each iteration of diagnosis and respecification. Once a satisfactory model is found, it should be double checked by applying it to a different data set.

Types of models

Broadly speaking economic models are stochastic or non-stochastic; discrete or continuous choice. In the mathematics of probability, a stochastic process is a random function. ...

• Stochastic models are formulated using stochastic processes. They model economically observable values over time. Most of econometrics is based on statistics to formulate and test hypotheses about these processes or estimate parameters for them. A widely used class of econometric models popularized by Tinbergen and later Wold are autoregressive models, in which the stochastic process satisfies some relation between current and past values. Examples of these are autoregressive moving average models and related ones such as autoregressive conditional heteroskedasticity (ARCH) and GARCH models for the modelling of heteroskedasticity.

• Non-stochastic mathematical models may be purely qualitative (for example, models involved in some aspect of social choice theory) or quantitative (involving rationalization of financial variables, for example with hyperbolic coordinates, and/or specific forms of functional relationships between variables). In some cases economic predictions of a model merely assert the direction of movement of economic variables, and so the functional relationships are used only in a qualitative sense: for example, if the price of an item increases, then the demand for that item will decrease. For such models, economists often use two-dimensional graphs instead of functions.

• Qualitative models - Although almost all economic models involve some form of mathematical or quantitative analysis, qualitative models are occasionally used. One example is qualitative scenario planning in which possible future events are played out. Another example is non-numerical decision tree analysis. Qualitative models often suffer from lack of precision.

At a more practical level, quantitative modelling is applied to many areas of economics and several methodologies have evolved more or less independently of each other. As a result, no overall model taxonomy is naturally available. We can nonetheless provide a few examples which illustrate some particularly relevant points of model construction. In the mathematics of probability, a stochastic process is a random function. ... Econometrics literally means economic measurement. It is a combination of mathematical economics and statistics. ... A graph of a Normal bell curve showing statistics used in educational assessment and comparing various grading methods. ... A hypothesis (= assumption in ancient Greek) is a proposed explanation for a phenomenon. ... Jan Tinbergen Jan Tinbergen (The Hague, April 12, 1903 – June 9, 1994 The Hague), Dutch economist, was awarded the first Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 1969, which he shared with Ragnar Frisch for having developed and applied dynamic models for the analysis... Herman O. A Wold is a Swedish econometrician and statistician who discovered Wolds theorem leading to the Wold decomposition of time series as well as the Cramer-Wold theorem together with Harald Cramer. ... In statistics, autoregressive moving average (ARMA) models are typically applied to time series data. ... In statistics, autoregressive moving average (ARMA) models, sometimes called Box-Jenkins models after George Box and G. M. Jenkins, are typically applied to time series data. ... In econometrics, an autoregressive conditional heteroskedasticity (ARCH) model considers the variance of the current error term to be a function of the variances of the previous time periods error terms. ... In econometrics, an autoregressive conditional heteroskedasticity (ARCH) model considers the variance of the current error term to be a function of the variances of the previous time periods error terms. ... In statistics, a sequence or a vector of random variables is heteroskedastic if the random variables in the sequence or vector may have different variances. ... Social choice theory studies how individual preferences are aggregated to form a collective choice, such as, for example in voting systems. ... In mathematics, hyperbolic coordinates are a useful method of locating points in Quadrant I of the Cartesian plane {(x,y) : x > 0, y > 0} = Q. Hyperbolic coordinates take values in HP = {(u,v) : u ∈ R, v > 0 }. For (x,y) in Q take u = −1/2 log(y... Graph of example function, The mathematical concept of a function expresses the intuitive idea of deterministic dependence between two quantities, one of which is viewed as primary (the independent variable, argument of the function, or its input) and the other as secondary (the value of the function, or output). A... In economics and business, the price is the assigned numerical monetary value of a good, service or asset. ... The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). ... Scenario planning or Scenario thinking is a strategic planning method that some organizations use to make flexible long-term plans. ... Look up taxonomy in Wiktionary, the free dictionary. ...

• An accounting model is one based on the premise that for every credit there is a debit. More symbolically, an accounting model expresses some principle of conservation in the form

algebraic sum of inflows = sinks - sources

This principle is certainly true for money and it is the basis for national income accounting. Accounting models are true by convention, that is any experimental failure to confirm them, would be attributed to fraud, arithmetic error or an extraneous injection (or destruction) of cash which we would interpret as showing the experiment was conducted improperly.

• Optimality and constrained optimization models - Other examples of quantitative models are based on principles such as profit or utility maximization. An example of such a model is given by the comparative statics of taxation on the profit-maximizing firm. The profit of a firm is given by

where p(x) is the price that a product commands in the market if it is supplied at the rate x, xp(x) is the revenue obtained from selling the product, C(x) is the cost of bringing the product to market at the rate x, and t is the tax that the firm must pay per unit of the product sold.

The profit maximization assumption states that a firm will produce at the output rate x if that rate maximizes the firm's profit. Using differential calculus we can obtain conditions on x under which this holds. The first order maximization condition for x is

Regarding x is an implicitly defined function of t by this equation (see implicit function theorem), one concludes that the derivative of x with respect to t has the same sign as

which is negative if the second order conditions for a local maximum are satisfied.

Thus the profit maximization model predicts something about the effect of taxation on output, namely that output decreases with increased taxation. If the predictions of the model fail, we conclude that the profit maximization hypothesis was false; this should lead to alternate theories of the firm, for example based on bounded rationality.

Borrowing a notion apparently first used in economics by Paul Samuelson, this model of taxation and the predicted dependency of output on the tax rate, illustrates an operationally meaningful theorem; that is one which requires some economically meaningful assumption which is falsifiable under certain conditions.

• Aggregate models. Macroeconomics needs to deal with aggregate quantities such as output, the price level, the interest rate and so on. Now real output is actually a vector of goods and services, such as cars, passenger airplanes, computers, food items, secretarial services, home repair services etc. Similarly price is the vector of individual prices of goods and services. Models in which the vector nature of the quantities is maintained are used in practice, for example Leontief input-output models are of this kind. However, for the most part, these models are computationally much harder to deal with and harder to use as tools for qualitative analysis. For this reason, macroeconomic models usually lump together different variables into a single quantity such as output or price. Moreover, quantitative relationships between these aggregate variables are often parts of important macroeconomic theories. This process of aggregation and functional dependency between various aggregates usually is interpreted statistically and validated by econometrics. For instance, one ingredient of the Keynesian model is a functional relationship between consumption and national income: C = C(Y). This relationship plays an important role in Keynesian analysis.

It has been suggested that Accounting scholarship be merged into this article or section. ... Credit as a financial term, used in such terms as credit card, refers to the granting of a loan and the creation of debt. ... link title Debit is an accounting and bookkeeping term that comes from the Latin word debere which means to owe. ... This article needs additional references or sources for verification. ... Measures of national income and output are used in economics to estimate the value of goods and services produced in an economy. ... This article or section does not adequately cite its references or sources. ... In the scientific method, an experiment (Latin: ex-+-periri, of (or from) trying), is a set of actions concerning phenomena. ... This article or section does not cite any references or sources. ... In economics, utility is a measure of the relative happiness or satisfaction (gratification) gained. ... This article is about utility in economics and in game theory. ... Comparative statics is the comparison of two different equilibrium states, before and after a change in one of the variables. ... Look up Market in Wiktionary, the free dictionary. ... Differential calculus is the theory of and computations with differentials; see also derivative and calculus. ... In multivariable calculus, a branch of mathematics, the implicit function theorem is a tool which allows relations to be converted to functions. ... For a non-technical overview of the subject, see Calculus. ... A graph illustrating local min/max and global min/max points In mathematics, a point x* is a local maximum of a function f if there exists some &#949; > 0 such that f(x*) &#8805; f(x) for all x with |x-x*| < &#949;. Stated less formally, a local maximum... Many models of human behavior in the social sciences assume that humans can be reasonably approximated or described as rational entities, especially as conceived by rational choice theory. ... Paul Anthony Samuelson Paul A. Samuelson (born May 15, 1915, in Gary, Indiana) is an American economist known for his work in many fields of economics. ... In science and the philosophy of science, falsifiability is the logical property of empirical statements, related to contingency and defeasibility, that they must admit of logical counterexamples. ... Circulation in macroeconomics Macroeconomics is a branch of Economics that deals with the performance, structure, and behavior of the economy as a whole. ... The price level is a measurement of the average level of prices in an economy. ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... A vector going from A to B. In physics and in vector calculus, a spatial vector, or simply vector, is a concept characterized by a magnitude and a direction. ... Good (accounting) - Wikipedia /**/ @import /skins-1. ... Wikibooks has more about this subject: Marketing In economics and marketing, a service is the non-material equivalent of a good. ... The NASA Columbia Supercomputer. ... In economics and business, the price is the assigned numerical monetary value of a good, service or asset. ... Wassily Leontief (August 5, 1905, Munich, Germany – February 5, 1999, New York)[1], was an economist notable for his research on how changes in one economic sector may have an effect on other sectors. ... The Input-output model of economics uses a matrix representation of a nations (or a regions) economy to predict the effect of changes in one industry on others and by consumers, government, and foreign suppliers on the economy. ... The term qualitative research has at least three meanings: Qualitative research is an umbrella term used, especially in the social sciences, to describe various research methods or approaches. ... Econometrics literally means economic measurement. It is a combination of mathematical economics and statistics. ... This article includes a list of works cited or a list of external links, but its sources remain unclear because it lacks in-text citations. ...

Pitfalls

Restrictive, unrealistic assumptions

Economic models can be such powerful tools in understanding some economic relationships, that it is easy to ignore their limitations. Take, for example, perfect-competition equilibrium market models. These models are based on perfect information, an identical product, and inability of individual agents to significantly affect total output or demand. When these assumptions are met, the resulting static equilibrium conditions will be Pareto-optimal. One can interpret optimality as an ideal situation in which each agent can do no better. When these assumptions fail, for instance under imperfect information or product differentiation, the model cannot be used to draw these conclusions (nor can the propositions be shown false; alternative methods, such as experimental economics are required). Price of market balance In economics, economic equilibrium is simply a state of the world where economic forces are balanced and in the abscence of external shocks the (equilibrium) values of economic variables will not change. ... Pareto efficiency, or Pareto optimality, is a central concept in game theory with broad applications in economics, engineering and the social sciences. ... A central concept in science and the scientific method is that all evidence must be empirical, or empirically based, that is, dependent on evidence or consequences that are observable by the senses. ... Experimental economics is the use of experimental methods to evaluate theoretical predictions of economic behaviour. ...

An economic model that has been established to have validity in explaining a relationship under one set of assumptions is useless if the assumptions are not valid. Model assumptions include not only those that can be expressed as predicates on model parameters but others with more qualitative or asymptotic form. This basic concept is however surprisingly often ignored. A common example is the application of Keynesian economics to government fiscal policy. The simple Keynesian model postulates (among other things) that output is a function of aggregate demand. Government spending is one component of aggregate demand, so Keynes' model is often applied to conclude that increasing government spending will have the same positive effect on output as private investment (see the article by Paul Samuelson, Simple Mathematics of Income Determination). This application of the model is correct in the short run, but the model does not take into account the results of this policy change, which may affect business cycles, interest and tax rates, private investment, and other factors which could in the long run either reduce or increase output as a result of the change in fiscal policy. This example highlights one of the difficulties of applying economic models, which is correctly inferring short term and long term effects of economic policy. This article includes a list of works cited or a list of external links, but its sources remain unclear because it lacks in-text citations. ... Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. ... In economics, aggregate demand is the total demand for goods and services in the economy (Y) during a specific time period. ... Invest redirects here. ... // [edit] Introduction [edit] Definition If we were to take snapshots of an economy at different points in time, no two photos would look alike. ... For other senses of this word, see interest (disambiguation). ... Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. ...

Omitted details

A great danger inherent in the simplification required to fit the entire economy into a model is omitting critical elements. Some economists believe that making the model as simple as possible is an art form, but the details left out are often contentious. For instance: The Bath, a painting by Mary Cassatt (1844-1926). ...

• Market models often exclude externalities such as unpunished pollution. Such models are the basis for many environmentalist attacks on mainstream economists. It is said that if the social costs of externalities were included in the models their conclusions would be very different, and models are often accused of leaving out these terms because of economist's pro-free market bias.
• In turn, environmental economics has been accused of omitting key financial considerations from its models. For example the returns to solar power investments are sometimes modelled without a discount factor, so that the present utility of solar energy delivered in a century's time is precisely equal to gas-power station energy today.
• Financial models can be oversimplified by relying on historically unprecedented arbitrage-free markets, probably underestimating the chance of crises, and under-pricing or under-planning for risk.
• Models of consumption either assume that humans are immortal or that teenagers plan their life around an optimal retirement supported by the next generation. (These conclusions are probably harmless, except possibly to the credibility of the modelling profession.)

In economics, an externality is a cost or benefit from an economic transaction that parties external to the transaction receive. ... It has been suggested that Pollutant be merged into this article or section. ... Bold textHello ... The dismal science is another, often derogatory, name for economics devised by the Victorian historian Thomas Carlyle. ... A free market is an idealized market, where all economic decisions and actions by individuals regarding transfer of money, goods, and services are voluntary, and are therefore devoid of coercion and theft (some definitions of coercion are inclusive of theft). Colloquially and loosely, a free market economy is an economy... Environmental economics is a subfield of economics concerned with environmental issues (other usages of the term are not uncommon). ... Solar power describes a number of methods of harnessing energy from the light of the sun. ... In finance, discounting is the process of finding the current value of an amount of cash at some future date, and along with compounding cash form the basis of time value of money calculations. ... In economics, utility is a measure of the relative happiness or satisfaction (gratification) gained. ... In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ... The far red light has no effect on the average speed of the gravitropic reaction in wheat coleoptiles, but it changes kurtosis from platykurtic to leptokurtic (-0. ... Lets talk about risk control strategies, anyone with more information and willing to share, please do so. ... In economics, consumption refers to the final use of goods and services to provide utility. ... This article is about living for infinite period of time. ... The overlapping generations model, abbreviated to OLG Model, is an economic model in which agents live a finite length of time, but long enough to live at least one period with the next generations of agents. ...

Are economic models falsifiable?

The sharp distinction between falsifiable economic models and those that are not is by no means a universally accepted one. Indeed one can argue that the ceteris paribus (all else being equal) qualification that accompanies any claim in economics is nothing more than an all-purpose escape clause (See N. de Marchi and M. Blaug.) The all else being equal claim allows holding all variables constant except the few that the model is attempting to reason about. This allows the separation and clarification of the specific relationship. However, in reality all else is never equal, so economic models are guaranteed to not be perfect. The goal of the model is that the isolated and simplified relationship has some predictive power that can be tested. Ignoring the fact that the ceteris paribus assumption is being made is another big failure often made when a model is applied. At the minimum an attempt must be made to look at the various factors that may not be equal and take those into account. In science and the philosophy of science, falsifiability is the logical property of empirical statements, related to contingency and defeasibility, that they must admit of logical counterexamples. ... The New York Times reported on Einsteins confirmed prediction. ...

History

One of the major problems addressed by economic models has been understanding economic growth. An early attempt to provide a technique to approach this came from the French physiocratic school in the Eighteenth century. Among these economists, François Quesnay should be noted, particularly for his development and use of tables he called Tableaux économiques. These tables have in fact been interpreted in more modern terminology as a Leontiev model, see the Phillips reference below. The Physiocrats were a group of thinkers who believed in an economic theory which considered that the wealth of nations was derived solely from agriculture. ... François Quesnay. ...

All through the 18th century (that is, well before the founding of modern political economy, conventionally marked by Adam Smith's 1776 Wealth of Nations) simple probabilistic models were used to understand the economics of insurance. This was a natural extrapolation of the theory of gambling, and played an important role both in the development of probability theory itself and in the development of actuarial science. Many of the giants of 18th century mathematics contributed to this field. Around 1730, De Moivre addressed some of these problems in the 3rd edition of the Doctrine of Chances. Even earlier (1709), Nicolas Bernoulli studies problems related to savings and interest in the Ars Conjectandi. In 1730, Daniel Bernoulli studied "moral probability" in his book Mensura Sortis, where he introduced what would today be called "logarithmic utility of money" and applied it to gambling and insurance problems, including a solution of the paradoxical Saint Petersburg problem. All of these developments were summarized by Laplace in his Analytical Theory of Probability (1812). Clearly, by the time David Ricardo came along he had a lot of well-established math to draw from. An Inquiry into the Nature and Causes of the Wealth of Nations is the magnum opus of Adam Smith, published in 1776. ... Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. ... The term gambling has had many different meanings depending on the cultural and historical context in which it is used. ... Probability theory is the branch of mathematics concerned with analysis of random phenomena. ... 2003 US mortality (life) table, Table 1, Page 1 Actuarial science applies mathematical and statistical methods to finance and insurance, particularly to the assessment of risk. ... Euclid, Greek mathematician, 3rd century BC, as imagined by by Raphael in this detail from The School of Athens. ... Abraham de Moivre (May 26, 1667 - November 27, 1754), was a French mathematician famous for de Moivres formula, which links complex numbers and trigonometry, and for his work on the normal distribution and probability theory. ... The Doctrine of Chances is a book on probability theory by 18th-century French mathematician Abraham de Moivre, published in 1733. ... Nicolaus Bernoulli (* October 21, 1687 in Basel, † November 29, 1759 in Basel), sometimes also written Nicolas or Nikolas, was a Swiss mathematician; he was the nephew of Jacob and Johann Bernoulli. ... Daniel Bernoulli Daniel Bernoulli (Groningen, February 8, 1700 – Basel, March 17, 1782) was a Dutch-born mathematician who spent much of his life in Basel, Switzerland. ... In probability theory and decision theory the St. ... Pierre-Simon Laplace Pierre-Simon Laplace (March 23, 1749 &#8211; March 5, 1827) was a French mathematician and astronomer, the discoverer of the Laplace transform and Laplaces equation. ... David Ricardo (18th April, 1772–11th September, 1823), a political economist, is often credited with systematizing economics, and was one of the most influential of the classical economists, along with Thomas Malthus and Adam Smith. ...

Tests of macroeconomic predictions

In the late 1980s a research institute compared the twelve top macroeconomic models available at the time. They asked the designers of these models what would happen to the economy under a variety of quantitatively specified shocks, and compared the diversity in the answers (allowing the models to control for all the variability in the real world; this was a test of model vs. model, not a test against the actual outcome). Although the designers were allowed to simplify the world and start from a stable, known baseline (e.g NAIRU unemployment) the various models gave dramatically different answers. For instance, in calculating the impact of a monetary loosening on output some models estimated a 3% change in GDP after one year, and one gave almost no change, with the rest spread between. This article does not cite any references or sources. ... The Brookings Institution is one of the oldest and best known think tanks in the United States. ... The term NAIRU is an acronym for Non-Accelerating Inflation Rate of Unemployment. ... Moneys is an agreement within a community, to use something as a medium of exchange, which acts as an intermediary market good. ...

Partly as a result of such experiments, modern central bankers no longer have as much confidence that it is possible to ‘fine-tune’ the economy as they had in the 1960s and early 1970s. Modern policy makers tend to use a less activist approach, explicitly because they lack confidence that their models will actually predict where the economy is going, or the effect of any shock upon it. The new, more humble, approach sees danger in dramatic policy changes based on model predictions, because of several practical and theoretical limitations in current macroeconomic models; in addition to the theoretical pitfalls, (listed above) some problems specific to aggregate modelling are: The 1960s decade refers to the years from January 1, 1960 to December 31, 1969, inclusive. ... The 1970s decade refers to the years from 1970 to 1979. ... A diagram of the IS/LM model In economics, a model is a theoretical construct that represents economic processes by a set of variables and a set of logical and quantitative relationships between them. ...

• Limitations in model construction caused by difficulties in understanding the underlying mechanisms of the real economy. (Hence the profusion of separate models.)
• The law of Unintended consequences, on elements of the real economy not yet included in the model.
• The time lag in both receiving data and the reaction of economic variables to policy makers attempts to ‘steer’ them (mostly through monetary policy) in the direction that central bankers want them to move. Milton Friedman has vigorously argued that these lags are so long and unpredictably variable that effective management of the macroeconomy is impossible.
• The difficulty in correctly specifying all of the parameters (through econometric measurements) even if the structural model and data were perfect.
• The fact that all the model's relationships and coefficients are stochastic, so that the error term becomes very large quickly, and the available snapshot of the input parameters is already out of date.
• Modern economic models incorporate the reaction of the public & market to the policy maker's actions (through game theory), and this feedback is included in modern models (following the rational expectations revolution and Robert Lucas's critique of the optimal control concept of precise macroeconomic management). If the response to the decision maker's actions (and their credibility) must be included in the model then it becomes much harder to influence some of the variables simulated.

This article or section does not cite any references or sources. ... In time series analysis, the lag operator or backshift operator operates on an element of a time series to produce the previous element. ... Moneys is an agreement within a community, to use something as a medium of exchange, which acts as an intermediary market good. ... Milton Friedman (July 31, 1912 – November 16, 2006) was a prominent American economist and public intellectual. ... Econometrics literally means economic measurement. It is the branch of economics that applies statistical methods to the empirical study of economic theories and relationships. ... Game theory is often described as a branch of applied mathematics and economics that studies situations where multiple players make decisions in an attempt to maximize their returns. ... Rational expectations is a theory in economics originally proposed by John F. Muth (1961) and later developed by Robert E. Lucas Jr. ... Robert Lucas (April 1, 1781 &#8211; February 7, 1853) was the 12th governor of Ohio from 1832 to 1836. ... Optimal control theory is a mathematical field that is concerned with control policies that can be deduced using optimization algorithms. ... In game theory and economics, dynamic inconsistency, or time inconsistency is situation in a dynamic game, where a players best plan for some future period will not be optimal when that future period arrives; The plan is inconsistent over time. ...

Comparison with models in other sciences

The comparison of economic forecasting to weather forecasting using (much more sophisticated) simulations shows the present state of economic modelling in an unflattering light. Although meteorological simulations are capable of only about five days reliability, this is all they claim to predict; the medium and long term macroeconomic models presently available often have similar predictive power to 1930s weather forecasters looking five days ahead. Meteorology is the scientific study of the atmosphere that focuses on weather processes and forecasting. ... Face The 1930s (years from 1930–1939) were described as an abrupt shift to more radical and conservative lifestyles, as countries were struggling to find a solution to the Great Depression, also known in Europe as the World Depression. ...

The effects of deterministic chaos on economic models

Economic and meteorological simulations may share a fundamental limit to their predictive powers: chaos. Although the modern mathematical work on chaotic systems began in the 1970s the danger of chaos had been identified and defined in Econometrica as early as 1958: A plot of the Lorenz attractor for values r = 28, σ = 10, b = 8/3 In mathematics and physics, chaos theory describes the behavior of certain nonlinear dynamical systems that under certain conditions exhibit dynamics that are sensitive to initial conditions (popularly referred to as the butterfly effect). ... In mathematics and physics, chaos theory deals with the behavior of certain nonlinear dynamical systems that (under certain conditions) exhibit the phenomenon known as chaos, most famously characterised by sensitivity to initial conditions (see butterfly effect). ... The 1970s decade refers to the years from 1970 to 1979. ... Econometrica is a prestigious academic journal of economics, publishing articles in not only econometrics but in many areas of economics. ... Year 1958 (MCMLVIII) was a common year starting on Wednesday (link will display full calendar) of the Gregorian calendar. ...

"Good theorising consists to a large extent in avoiding assumptions....(with the property that)....a small change in what is posited will seriously affect the conclusions."

(William Baumol, Econometrica, 26 see: Economics on the Edge of Chaos).

It is straightforward to design an economic models susceptible to butterfly effects of initial-condition sensitivity. See, for instance: Review of chaotic models from 2003 William Baumol (born February 26, 1922) is a Princeton University economics professor (although he is also affiliated with NYU) who has written extensively about labor market and other economic factors that affect the economy. ... Point attractors in 2D phase space. ...

However, the econometric research program to identify which variables are chaotic (if any) has largely concluded that aggregate macroeconomic variables probably do not behave chaotically. This would mean that refinements to the models could ultimately produce reliable long-term forecasts. However the validity of this conclusion has generated two challenges: Econometrics literally means economic measurement. It is the branch of economics that applies statistical methods to the empirical study of economic theories and relationships. ...

• In 2004 Philip Mirowski challenged this view and those who hold it, saying that chaos in economics is suffering from a biased "crusade" against it by neo-classical economics in order to preserve their mathematical models.
• The variables in finance may well be subject to chaos. Also in 2004, the University of Cantebury study Economics on the Edge of Chaos concludes that after noise is removed from S&P 500 returns, evidence of deterministic chaos is found.

shelby was here 2004 (MMIV) was a leap year starting on Thursday of the Gregorian calendar. ... Philip Mirowski is a historian and philosopher of economic thought at the University of Notre Dame. ... Neoclassical economics is the grouping of a number of schools of thought in economics. ... Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. ... shelby was here 2004 (MMIV) was a leap year starting on Thursday of the Gregorian calendar. ... The S&P 500 is an index containing the stocks of 500 Large-Cap corporations, most of which are American. ...

The critique of hubris in modelling

A key strand of free market economic thinking is that the market's "invisible hand" guides an economy to prosperity more efficiently than central planning using an economic model. One reason is the claim that many of the true forces shaping the economy can never be captured in a single plan. This is an argument which can not be made through a conventional (mathematical) economic model, because it says that there are critical systemic-elements that will always be omitted from any top-down analysis of the economy. (Including such an effect within a model would lead to a paradox, if the theory that the effect cannot be anticipated by a planner were true.) A free market is an idealized market, where all economic decisions and actions by individuals regarding transfer of money, goods, and services are voluntary, and are therefore devoid of coercion and theft (some definitions of coercion are inclusive of theft). Colloquially and loosely, a free market economy is an economy... A planned economy is an economic system in which economic decisions are made by centralized planners, who determine what sorts of goods and services to produce, and how they are to be priced and allocated. ... Look up paradox in Wiktionary, the free dictionary. ...

Examples of economic models

• Economic Modeling Specialists, Inc. - economic impact model
• Keynesian cross
• IS/LM model
• Black-Scholes option pricing model
• Leontief's input-output model
• Heckscher-Ohlin model
• Policy Insight [1] Economic Geography Model

This article includes a list of works cited or a list of external links, but its sources remain unclear because it lacks in-text citations. ... The IS curve moves to the right, causing higher interest rates and expansion in the real economy (real GDP). ... The Black-Scholes model, often simply called Black-Scholes, is a model of the varying price over time of financial instruments, and in particular stocks. ... Wassily Leontief (August 5, 1905, Munich, Germany – February 5, 1999, New York)[1], was an economist notable for his research on how changes in one economic sector may have an effect on other sectors. ... The Input-output model of economics uses a matrix representation of a nations (or a regions) economy to predict the effect of changes in one industry on others and by consumers, government, and foreign suppliers on the economy. ... The Heckscher-Ohlin model (H-O model) is a general equilibrium mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. ...

See also

• Economics
• Computational Economics
• Agent-Based Computational Economics
• Model (macroeconomics)
• List of economics topics
• List of economic models
• List of financial models
• List of statistical models
• List of other socioeconomic models

This article needs additional references or sources for verification. ... Computational economics is a form of economics which relies on mathematical methods, including mathematical economics and econometrics. ... Agent-based computational economics (ACE) is the computational study of economic processes modeled as dynamic systems of interacting agents. ... A model in macroeconomics is designed to simulate the operation of a national or international economy in terms of factors including the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general behavior of prices. ... This aims to be a complete list of the articles on economics. ...

References

• W. Baumol and A. Binder, Economics: Principles and Policy 2ed., Harcourt Brace Jovanovich, Inc. 1982.
• Bruce Caldwell, Beyond Positivism Revised edition, Routledge, 1991.
• R. Frigg and S. Hartmann, Models in Science. Entry in the Stanford Encyclopedia of Philosophy.
• R. Holcombe, Economic Models and Methodology, Greenwood Press, 1989. Defines model by analogy with maps, an idea borrowed from Baumol and Blinder. Discusses deduction within models, and logical derivation of one model from another. Chapter 9 compares the neoclassical school and the Austrian school, in particular in relation to falsifiability.
• Oskar Lange The Scope and Method of Economics, Review of Economic Studies, 1945. One of the earliest studies on methodology of economics, analysing the postulate of rationality.
• N. B. de Marchi and M. Blaug., Appraising Economic Theories, Edward Elgar, 1991. A series of essays and papers analysing questions about how (and whether) models and theories in economics are empirically verified and the current status of positivism in economics.
• M. Morishima, The Economic Theory of Modern Society, Cambridge University Press, 1976. A thorough discussion of many quantitative models used in modern economic theory. Also a careful discussion of aggregation.
• A. Phillips, The Tableau Économique of a Simple Leontiev Model, Quarterly Journal of Economics, 69, 1955 pp 137-44.
• Paul Samuelson, Foundations of Economic Analysis, 1947, Enclarged ed., 1983, Harvard Univiversity Press. This is a classic book carefully discussing comparative statics in microeconomics, though some dynamics is studied as well as some macroeconomic theory. This should not be confused with Samuelsons' popular textbook.
• Paul Samuelson, "The Simple Mathematics of Income Determination," in: Income, Employment and Public Policy; essays in honor of Alvin Hansen, W. W. Norton, 1948
• J. Tinbergen, Statistical Testing of Business Cycle Theories, League of Nations, 1939
• H . Wold, A Study in the Analysis of Stationary Time Series, Almqvist and Wicksell, 1938
• H. Wold and L. Jureen, Demand Analysis A Study in Econometrics, 1953

The Austrian School, also known as the Vienna School or the Psychological School, is a school of economic thought that advocates adherence to strict methodological individualism. ... Paul Anthony Samuelson Paul A. Samuelson (born May 15, 1915, in Gary, Indiana) is an American economist known for his work in many fields of economics. ... Foundations of Economic Analysis is a book by Paul A. Samuelson published in 1947 (Enlarged ed. ...

External links

• H. Varian How to build a model in your spare time The author makes several unexpected suggestions: Look for a model in the real world, not in journals. Look at the literature later, not sooner.
• Elmer G. Wiens: Classical & Keynesian AD-AS Model - An on-line, interactive model of the Canadian Economy.