Model Building - UNC-Wilmington Cameron School of Business...

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UNC-Wilmington ECN 321 Cameron School of Business Dr. Chris Dumas Dept. of Economics and Finance Model Building The process of building models to explain the world around us is common to all sciences. This handout outlines the process of building economic models. Understanding the process of model building is crucial to upper-level decision makers. Even if you do not plan to build models yourself, the ability to analyze, critique and discuss alternative models with model-builders is a highly valuable management skill. "In the Beginning . . ." -- Observation and Theories All sciences begin with observation and measurement of the world around us. Descriptive Economics is the study of raw economic data with the goal of observing, measuring and summarizing economic facts and phenomena. Descriptive economics doesn't try to explain what is going on in the economy, it simply tries to accurately measure and summarize it, to "take a picture" of the economy so that other economists can try to explain it. Observed, measured facts are called data . For example, the U.S. government uses surveys to collect data on consumer expenditures. These surveys collect data on the types of goods and services purchased by consumers, the prices of the goods and services, and the annual incomes of the consumers doing the purchasing. Suppose a descriptive economist provides us with a sample of these data, the quantities of products X and Y purchased per week by consumers: X Y X Y 1.3 9.2 4.8 6.5 2.5 8.5 5.6 5.1 3.5 6.2 1.9 6.8 4.7 6.2 4.6 5.9 5.2 4.1 2.3 7.8 6.3 5.0 4.6 5.1 2.7 7.0 3.1 6.1 3.1 6.4 1.5 12.5 1.9 5.0 2.8 6.6 Looking at the data, a question that next comes to mind is, "Okay, now what?" A bunch of data is, well, just a bunch of data. Why did we gather the data? Typically, the reason why we gather data is that we want to know what might be "going on" in the data. Of course, many things could be going on in the data. For example, an increase in purchases of X might decrease the number of units of product Y purchased by consumers. Or, an
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increase in purchases of X might increase purchases of Y, if, say, X and Y are used together (like Walkman portable radios and batteries). But hold on a minute, maybe it's the case that purchases of product Y affect purchases of X, rather than the other way around. If so, the effect might grow stronger and stronger as more Y is purchased, or the effect might get weaker and weaker, or stronger and then weaker, Etc., etc., etc. Notice that each of these things is a possible pattern, or relationship, that we may (or may not) find in the data. A Theory is a pattern believed to be present in data. Clearly, there are many possible theories associated with a given data set, one theory for each possible pattern in the data. Luckily, rather than trying to find all possible patterns in the data, we're usually interested in trying to determine whether a particular pattern is in the data. Why? Well, because usually someone comes to us and says, "Hey, I wonder
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This note was uploaded on 10/22/2009 for the course ECN 321 taught by Professor Dumas during the Fall '08 term at University of North Carolina Wilmington.

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Model Building - UNC-Wilmington Cameron School of Business...

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