Economic models are simplified descriptions of reality used by economists to help them understand real life economies. An economic model includes several economic variables and describes the nature of the logical relationships between these variables.
Economic models include variables and require that assumptions be made. A variable is just the value of an economic quantity, such as the rate of interest or the price of a good. The assumptions often involve holding some variables constant and only allowing one or two variables of interest to change. The relationships between the variables can be expressed graphically, mathematically or verbally.
Economic models fulfill two functions. The first is to describe some aspect of the reality of an economic phenomena. The second is to assist economists in understanding the economy. In order to fulfill both of these functions, economic models are simplified versions of reality, with many real life variables removed. This makes models easier to understand, but it may also be less descriptive of the economic reality.
There are two basic types of economic models: qualitative and quantitative. Qualitative models are usually expressed in words, while quantitative models are expressed in mathematics or a graphical format. Other categories of economic models include accounting, aggregate and optimizing models.
- graph image by Roman Sigaev from Fotolia.com