CHAPTER 1 ECONOMIC MODELS
Economic modeling is at the heart of economic theory. Modeling provides a logical, abstract template to help organize the analyst's thoughts. The model helps the economist logically isolate and sort out complicated chains of cause and effect and influence between the numerous interacting elements in an economy. Through the use of a model, the economist can experiment, at least logically, producing different scenarios, attempting to evaluate the effect of alternative policy options, or weighing the logical integrity of arguments presented in prose. Certain types of models are extremely useful for presenting visually the essence of economic arguments. No student of economics has sat through a class for very long before a picture is drawn on a chalkboard. The visual appeal of a model clarifies the exposition. In this text, four primary models will be presented; the Aggregate Supply - Aggregate Demand (AS/AD) Model, the Loanable Funds Model, an HMCMacroSim simulation model, and the IS/LM Model. All but the Loanable Funds model are inclusive models of the national economy. The Loanable Funds Model is a model of the finance markets and is used to discuss interest rate determination theory. Types of Models There are four types of models used in economic analysis, visual models, mathematical models, empirical models, and simulation models. Their primary features and differences are discussed below. Visual Models Visual models are simply pictures of an abstract economy; graphs with lines and curves that tell an economic story. They are primarily used in textbooks and teaching, and the reader who has had any exposure to economics at all has probably seen dozens, if not hundreds of them. Some visual models are merely diagrammatic, such as those which show the flow of income through the economy from one sector to another. In other words, they employ a