Question

What is meant by the nature of the economic model and what are the roles of mathematics in economic model?

Answer 1

Nature of the economic model

An economic model is an organized set of relationships that describes the functioning of an economic identity under a set of assumptions from which a conclusion derived. The economic identity may be a household, a single industry, an economy or the world as a whole.

An economic model is a set of economic relationships which is generally expressed through a set of mathematical equations. Each equation involves at least one variable which also appears in at least one other relationship which is part of the model which says the importance of Mathematics in an Economic Model.

An economic model is a simplified representation of the real world. It leaves out many elements that operate in reality, and it falsifies reality in a number of respects.

Instead of representing a real situation, it explains the essential relationships that are sufficient to analyze and explain the main features of the particular situation. The relation of a model to reality is through its assumptions. But assumptions do not exactly represent reality.

Rather, they are reasonable abstractions from reality which means that certain aspects of reality are contained in the assumptions that are relevant to the model. If the assumptions of a model are realistic, the conclusion that is drawn can be shown to apply to the real world situation. Thus a model does not describe the true economic world since by its nature it is constructed as an abstraction from the truth.

An economic model for example, a map, pinpoints the particular situation and keeps it free from many complicating and irrelevant factors found in the real world like the real territory in a map. It can be said that the major use of models is in theoretical economic analysis.

Roles of mathematics in economic model

Mathematics is necessary for economics for two big reasons, clarity of argument and quantitative prediction.

The reason why economists adopted mathematics as the language to create their models is that it is very hard to be imprecise with mathematics. Sure, it can be hard for a layman or even fellow economists to understand, but when you use mathematics as a language to model economic phenomena, it forces you to be very explicit about your assumptions and how you prove your results.

The second big reason is that we want to be able to show quantitatively causal links and forecast the effects of policies and other economic phenomena. Using the tools of mathematics, we can take economic intuition and insight and rigorously develop a model that both establishes under what conditions we might observe x causing y but also to what degree x can affect y. Economists often also use what are called fixed point theorems to prove the existence of equilibrium in an economy. Without mathematics, all we could do is claim x causes y and not be able to show how it occurs except through vague wording.