Kotut c Samwel, M. Phil (Economics)
Economics is the science of scarce resource allocation to meet endless human desires. The modern economics science has two major branches i.e. Micro-economics and Macro-economics. Compared to micro-economics Macro-economics is a younger branch of economics. Until the economic depression of 1930s economics was limited to what is currently Micro-economics.
1.1 Economic Models;
Economic theory aims at the construction of models which describe the economic behavior of individual economic units;- consumers, firms, government agencies and their interactions hence creating the economic systems of a region, country or the world at large.
An economic model is a simplified representation of the real world/ situation. It includes the main features of the real situation which it represents. It implies an abstract of the reality that is achieved by a set of meaningful and consistent assumptions, which aim at simplification of the phenomenon or behavioral pattern which the model is designed to study. The series of assumptions in any particular case are chosen carefully so as to be ;-
Consistent to each other
Retain as much realism as possible
And finally attain a reasonable degree of generality.
A model can be constructed at different levels of aggregation, detailed and sophistication depending on its purpose. There are two purpose for which a model is constructed;- Analysis and prediction.
Analysis implies the explanation of the behavior of economic units. From a set of assumptions we derive certain laws which describe and explain with an adequate degree of generality the behavior of consumers and producers.
Prediction implies the possibility of forecasting the effects of changes in some magnitudes in an economy. For example a model of demand may be used to predict the effects of imposition of a tax on sales of a commodity.
The validity of a model may be judged may be judged on several criteria. This include;- its predictive power, the consistency and realism of its assumptions, the extend of information it provides, its generality (i.e. the range of cases to which it implies), and its simplicity. However economist have generally agreed that the model’s predictive performance, realism of its assumptions and the power of the model in explaining the behavior of economic agents is the most important attributes of a good economic model.
1.1(a) Steps in the construction of microeconomic models
i) Specifying the subject of study and segregating it from the rest of the system
ii) Specifying and definition of the chosen microeconomic variables.
iii) Making assumptions regarding the behavior of selected variables.
iv) Specifying the relationship between the selected variables in the form of equations, if possible
v) And lastly specifying the criteria for drawing conclusions.
The choice of relevant economic variables is a very important aspect of building economic models. So is the case with microeconomic models- the choice of relevant microeconomic variables is essential for building a purposeful microeconomic model. Microeconomic variables are generally classified as either i) Endogenous variable or dd
ii) Exogenous variable
Endogenous variables are those whose value is determined within the model. Some typical endogenous variables used in microeconomic models are consumption, Demand, supply, investment, price level etc.
These are those variables that are determined outside the model. E.g. Money supply, etc. however depending on the objective of analysis, endogenous variables are converted into exogenous variables, and exogenous variables can be endogenized.
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