Economic model
A diagram of the IS/LM model
In economics, a model is a theoretical con-
struct that represents economic processes by
a set of variables and a set of logical and/or
quantitative relationships between them. The
economic model is a simplified framework
designed to illustrate complex processes, of-
ten but not always using mathematical tech-
niques. Frequently, economic models use
structural parameters. Structural parameters
are underlying parameters in a model or
class of models.[1] A model may have various
parameters and
those parameters may
change to create various properties.[2]
Overview
In general terms, economic models have two
functions: first as a simplification of and ab-
straction from observed data, and second as
a means of selection of data based on a
paradigm of econometric study.
Simplification is particularly important for
economics given the enormous complexity of
economic processes. This complexity can be
attributed to the diversity of factors that de-
termine economic activity; these factors in-
clude: individual and cooperative decision
processes, resource limitations, environment-
al 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 vari-
ables are relevant and which ways of analyz-
ing and presenting this
information are
useful.
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 in-
flation 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:
• Forecasting economic activity in a way in
which conclusions are logically related to
assumptions;
• Proposing economic policy to modify
future