Methodology in Economics

1. Methodology in Economics

2. Modeling • Modeling – simplified (abstract) representation of relationships of agents and variables that exist in reality. • Structure of model • Identify economic agents and objective • Identify decision variables and given variables • Specify relations of variables • Outcomes • Decision rules • Equilibrium conditions

3. Modeling • Determined in the model – values they take are determined in the model (e.g., quantity demanded) • Endogenous variables • Decision variables • Dependent variables • Given or assumed in the model – values they take are given or assumed (e.g., income of households) • Exogenous variables • Independent variables

4. Modeling • Representation of relationships of variables in a model • Table form presentation of data • Graphical form • Functional form • Individual equations or systems • Specific functional forms (e.g., linear, quadratic, logarithmic, exponential) • Specific parameters

5. Tables of Related Variables Table A.1 Advertising and Sales at Len & Harry’s

6. Graphs of Related Variables

7. Graphs - Curves

8. Slopes and Intercepts

9. Shifts in the Graphs

10. Shifts in Lines and Curves

11. Solving Equations Y = 40 + 3X • If X = 4, solve for Y Y = 40 + 3(4) = 40 + 12 Y = 52 • If Y = 64, solve for X 64 = 40 + 3X 3X = 64 – 40 = 24 X = 24/3 X = 8

12. Solving Equations Equation 1 Qd = 500 – 50P Equation 2 Qs = 50 + 25P Solve for Qd, Qs, and P • Equate the two equations, i.e., Qd=Qs 500 – 50P = 50 + 25P • 1 equation 1 unknown, solve for P 500 - 50 = 50P + 25P 75P = 450 P = 450/75 P = 6 • Substitute P=6 in either equation 1 or 2 Qd = 500 – 50(6) = 500 - 300 = 200 Qs = 50 + 25(6) = 50 + 150 = 200

13. Applied Modeling Process • Specification – edogenous-exogenous variables and their functional form • Estimation of parameters • Validation • Theoretical consistency of estimates • Signs • Magnitudes • Statistical properties of estimates • Fit • Significance • Forecasting performance of model