Theory and Models

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Theory and Models
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Why Understand Economics?

• Automakers, and the Strong Dollar of 1986
• 1986 1 gt 240 yen
• 1988 1 gt 120 yen
• 1994 1 gt 100 yen
• 1995 1 gt 100 yen
• 1996 1 gt 116 yen
• 1997 1 gt 134 yen

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Why Understand Economics?

• Big Three U.S. Automakers, and the Strong Dollar
  of 1986
• 1986 1 gt 240 yen
• 1988 1 gt 120 yen
• 1994 1 gt 100 yen
• 1995 1 gt 100 yen
• 1996 1 gt 116 yen
• 1997 1 gt 134 yen

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Why Understand Economics?

• One Third of the Iran Population was Born
  Between 1361 to 1969
• Baby Boomers
• 1395 36 to 54 years old
• How will this aging of our population affect our
  economy in the future?

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Theory and Models

• Economics is a social science that makes use of
  similar methodology used by the hard sciences
  (biology, physics, etc.)
• The hard sciences refer to this method as the
  scientific method, in economics we will refer
  to this method as the economic method

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The Scientific Method

• Step 1 The observation of phenomena,
• Step 2 The formulation of a hypothesis
• concerning the phenomena,
• Step 3 Experimentation to demonstrate
• the truth or falseness of the
• hypothesis,
• Step 4 Develop a conclusion that validates
• or modifies the hypothesis.

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The Economic Method1

• Step 1 Identify and state the problem
• Step 2 Apply the relevant economic model
• Step 3 Identify the solutions
• Step 4 Evaluate the solutions
• Step 5 Select and implement a
• solution

1Adaped from Mabry and Ulbrich, Introduction to
Economic Principles, 1989.
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Theory and Models

• Models
• Simplified representations of the real world
  that we use to help us understand, explain, and
  predict economic events in the real world.

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Theory and Models

• No model captures every little detail and
  inter-relationship that exists
• Models are abstractions from reality

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Theory and Models

• A Good Model should capture only the essential
  relationships that are sufficient to analyze a
  particular problem, or answer a particular
  question.
• A Model is the guideline we follow to analyze
  economic problems and predict outcomes.

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Theory and Models

• Questions
• How do consumers respond when the price of a
  commodity changes?
• What choices do they have?
• What choices do they make?

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Theory and Models

• Dove season opens soon, and we want some shotgun
  shells.
• How we will respond to a price of 10000 Toman
  per box of 25 shells?
• There are probably thousands of determinants
  affecting how each consumer will respond to this
  high price.

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Theory and Models

• Many of these determinants were left out of the
  model we used to answer the questions above.
• Our class model probably included
• The price of the specific commodity
• The income of the consumer
• The price of substitutes for the commodity

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Theory and Models

• These 3 determinants do a good job of explaining
  the behavior of consumers with respect to a price
  change. Later we will learn that there are in
  excess of 10 determinants that affect consumer
  demand.

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Theory and Models

• An economic model is nothing more than a set of
  definitions, assumptions, and hypotheses that are
  put together in a manner that expresses the
  relationships of certain observed events in a
  meaningful way.

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The Consumption-Production Model

• In Equilibrium
• PRICE
• CONSUMPTION PRODUCTION
• INVENTORIES

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In Disequilibrium

• P
• C lt Pr
• Iv
• How should a manager respond in this case?

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In Disequilibrium

• What if production process is at full capacity?
• What if production process is at less than full
  capacity?

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In Disequilibrium

• P
• C gt Pr
• Iv
• How should a manager respond in this case?

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In Disequilibrium

• What if production process is at full capacity?
• What if production process is at less than full
  capacity?

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Short Run vs. Long Run?

• Short Run1 a period of time that is not long
  enough to allow change to certain economic
  conditions that a decision maker may face.
• Long Run1 a period of time long enough for all
  important information and choices to be available
  to a decision maker

1Mabry and Ulbrich, Introduction to Economic
Principles, 1989
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References

• N.c.State university-College of Agriculture and
  Life science Dr. herman_sampson