Economic Models and Real Numbers YouTube Lecture Handouts Part 1

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Economic Models

  • Economic theory is an abstraction from real world
  • Economic model – deliberately simplified analytical framework – just a theoretical framework
  • Mathematical model – includes set of equations

Variables, Constants and Parameters

  • Variable – magnitude can change – profit, revenue, cost, national income, consumption, investment
  • Endogenous variables – solution values we seek form the model (market clearing value of price or profit maximizing level of output)
  • Exogenous variables – variables determined by forces external to model
  • Tea and coffee (price of substitute) and price of complement (sugar) – preference and number of buyers (exogenous)
  • Analysis of market determination of wheat price (variable price is endogenous) but it is exogenous to theory of consumer expenditure
  • Constant – antithesis of variable and does not change
  • Constant with variable is known as coefficient of variable
  • Parameters – resemble exogenous variables (include in model) – like gasoline in demand of automobile included in model

Equations and Identities

  • Definitional Equations –
  • Behavioral Equation -
  • Equilibrium constant -
    • Definitional Equation – identity between two alternate expressions that have the exact same meaning profit = revenue-cost
    • Behavioral equation – variable behaves in response to changes in other variables
    • Equilibrium constant – model requires a prerequisite for attainment of equilibrium (demand = supply) – equation of market; saving = investment (equation of national income model)

Real Numbers

  • Real – rational and irrational (non repeating and non terminating like pie = 3.1415)
  • Rational numbers include integers and fractions (p/q where q not equal to 0)
  • Only real numbers are continuous