01 KWCh_02_Models_in_Economics_Some_Important_Examples

01 KWCh_02_Models_in_Economics_Some_Important_Examples -...

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>> Economic Models: Trade-offs and Trade Section 1: Models in Economics: Some Important Examples chapter 2 A model is any simplified representation of reality that is used to better understand real-life situations. But how do we create a simplified representation of an economic situation? One possibility—an economist’s equivalent of a wind tunnel—is to find or create a real but simplified economy. For example, economists interested in the economic role of money have studied the system of exchange that developed in World War II prison camps, in which cigarettes became a universally accepted form of payment even among prisoners who didn’t smoke. Another possibility is to simulate the workings of the economy on a computer. For example, when changes in tax law are proposed, government officials use tax models large computer programs—to assess how the proposed changes would affect different types of people. A model is a simplified representation of a real situation that is used to better understand real-life situations.
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The importance of models is that they allow economists to focus on the effects of only one change at a time. That is, they allow us to hold everything else constant and study how one change affects the overall economic outcome. So the other things equal assumption , which means that all other relevant factors remain unchanged, is an important assumption when building economic models. But you can’t always find or create a small-scale version of the whole economy, and a computer program is only as good as the data it uses. (Programmers have a say- ing: garbage in, garbage out.) For many purposes, the most effective form of eco- nomic modeling is the construction of “thought experiments”: simplified, hypothetical versions of real-life situations. In Chapter 1 we illustrated the concept of equilibrium with the example of how customers at a supermarket would rearrange themselves when a new cash register opens. Though we didn’t say it, this was an example of a simple model—an imaginary supermarket, in which many details were ignored (what are the customers buying? never mind), that could be used to answer a “what if” question: what if another cash register were opened? As the cash register story showed, it is often possible to describe and analyze a useful economic model in plain English. However, because much of economics involves changes in quantities—in the price of a product, the number of units pro- duced, or the number of workers employed in its production—economists often find that using some mathematics helps clarify an issue. In particular, a numerical example, a simple equation, or—especially—a graph can be key to understanding an economic concept. Whatever form it takes, a good economic model can be a tremendous aid to understanding. The best way to make this point is to consider some simple but important economic models and what they tell us. First, we will look at the pro- duction possibility frontier
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