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Economic models

Economic models are a way of taking complicated ideas and events and breaking them down into their most important characteristics. We use models in economics so that we can focus our attention on a few things instead of getting bogged down a lot of details. In this video, learn more about the role that models play in economics, and the importance of the assumptions that underlie those models.

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  • leafers seedling style avatar for user heartwood71
    Is Kahn Academy a free resource?
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  • mr pants teal style avatar for user Elhison Raphael B. Cortez
    Can someone simplify this?
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    • male robot donald style avatar for user Christoph Raitzig
      The point of this video is that you cannot perfectly predict what everybody does in the economy and therefore simplified models are used.
      Some people are willing to pay more than others for something or wont do something although it would be good for them. You can't know every person and know what they're up to. Therefore you cannot fully predict the economy.
      Instead you can look what people do on average: If the price for something goes down, more people tend to buy it and vice versa. If the government does this and that, that probably has that effect and so on. You can't predict what every single person will do, but you can get a sense for things by coming up with a simplified model.
      Other sciences also use models. You can't predict how every molecule moves, but you can make models that tell you about the average velocity of a molecule and so on.
      (61 votes)
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    What experiments would "feel fairly unethical to our modern moral ethos" and why does Khan ask it that way? -
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  • blobby green style avatar for user asj16598
    I have a few questions related to Solow model. I was hoping someone could answer
    What are the four basic results of Solow model and what is the major draw back of this model?
    Discuss the validity of the following statement, Unlike Solow's model, Romers model concludes that changes in saving rate do not affect the sustained per capita output growth rate
    what is the leading economy in the world today? Economist will use two related measures to answer this question, GPD and GPD per capita
    Discuss which measure is more important from person's point of view and which better reflects the standard of living? china is experiencing tremendous growth since 1978 and its projected growth is three times more than US growth rate. if china continues to grow at current growth pace it will have larger GDP than US in 2018. Will China be able to close the gap between US in real GDP per capita? what factors can contribute to that? what government policy to promote growth should be used?
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  • sneak peak green style avatar for user G. Tarun
    Is economics even a science like the natural sciences? Isn't it fundamentally a social science that makes assumptions about human nature and builds models on those assumptions, and uses them to draw conclusions and make predictions about the real world? Isn't economics different from the natural sciences? And isn't it closer to, say, sociology, anthropology, and political science?
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  • aqualine ultimate style avatar for user SoccerPro1013
    What exactly do economics models mean? and what do chemistry and biology have to do with economics?
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    • winston default style avatar for user Stew Studios
      Macroeconomics studies the aggregate world, and as a direct result, it has to study the decisions of millions and millions of people at once. The problem is that the real world is really weird. People make odd decisions all the time. Because of that, it's really hard to precisely measure economies as a whole, even impossible. That's where economic systems come in.

      Economic systems are simply sets of rules that simplify the economy to make it easier to measure. They are assumptions that make it easier to measure the economy. For example, the Production Possibility Frontier (PPF) makes the assumption that, when measuring two variables, all other variables remain equal. That's obviously not how the real world works, but it's approximately correct. Through that approximate data, we can draw conclusions about the real economy. Economic systems help economists measure the unmeasurable.

      As to your second question, they were simply using chemistry and biology as examples of what a system is. Those two fields are also complicated, so sometimes scientists will make simplifying assumptions to reach conclusions, just like economics.
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    How will bitcoin (blockchain) alter the study of economics?
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  • piceratops ultimate style avatar for user Marie
    At Sal says, "... but economics straddles between a social science and the sciences like chemistry or physics, because you can't run experiments in the same way and we often make simplifying assumptions." This statement surprised me because I thought economics was a social science, not a science. Could anyone explain to me why economics would be considered science?
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  • blobby green style avatar for user ibrahimaahed1112
    What is the concept of supply and demand
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  • sneak peak green style avatar for user G. Tarun
    Is the point of making assumptions in creating models to facilitate simplicity? Why make unrealistic assumptions when making a model? Wouldn't that dilute that accuracy of that model—how accurately it describes the world?
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Video transcript

- When you think about what the field of economics is about, it is quite daunting. An economy is made up of millions or even billions of actors organized in incredibly complex ways. Write down, this is complex real-world and each of the actors, human beings or organizations, these are incredibly complex. A human brain. I can't predict what you're going to do the next second much less what you're going to do the next day or the next year and imagine trying to make insights about what millions or billions of people will do but the field of economics has borrowed an idea from other fields. So for example, in chemistry, chemists have tried to understand at a high level, well, how do molecules in a container behave? Let's say molecules of gas. Well, you could imagine if you have a container here with trillions upon trillions of molecules, this is incredibly complex but by making some simplifying assumptions about the type of interactions these particles will have or don't have, they can come up with models like the ideal gas law which you might be familiar with or not from your chemistry class that relates the pressure to the volume to the number of particles you have to the actual temperature and so this right over here where you're taking something that's hairy and complex and making simplifying assumptions to help you understand it, this thing right over here is a model and this is in other fields as well. Sometimes, it's not an equation. Sometimes, it might be a simpler organism. For example, in biology, human beings are incredibly complex organisms and not only are they incredibly complex but certain forms of experimentation would also feel fairly unethical to our modern moral ethos and so what do biologists do? Well, they make simplifying assumptions or they pare down, they say, okay, we can't do that study on human beings but maybe we can simplify the problem by looking at simpler organisms. Maybe you can look at an individual cell right over here. Maybe you can look at things like fruit flies which are famous in the study of genetics. Maybe you can even look at fairly complex organisms. Even a mouse is a very complex thing but it's still simpler than a human being and at least to our modern ethics, we're willing to do certain things to mice that we aren't willing to do to human beings and so that's why in a biological context, you will hear people talk about things like a mouse model where they will test a drug on a mouse or try to understand how something happens in a mouse and then say, well, that's a pretty good indication that might be happening to human beings. In fact, when they do drug trials in medicine, they often will do it on mice first and when they have good confidence that it works there and that it's fairly safe, only then will they start to do the experiments on human beings. Well, economists are doing the same thing. Even before the advent of computers and computer models, economists make simplifying assumptions, assumptions like all of the actors in an economy are rational which we already know is not exactly true. I'm not always rational and I definitely know people who aren't always rational. They're simplifying assumptions that all of the people in an economy have the same access to information or that they all even have perfect information which we also know isn't necessarily true in a real economy. So depending on the model, there are going to be these simplifying assumptions that take this large, complex real-world thing and try to break it down into simple equations or lines or charts. We have models early on in our economic study. We will see things like the production possibility frontier where it assumes that you're only trading off between two things and everything else is equal, this notion of ceteris, ceteris paribus which means all things equal. In a real-world, you're not gonna be able to say, hey, let's just pick between these two things and then hold everything else equal. There's hundreds or thousands or millions of variables are operating but if you wanna make a model, maybe we can make these assumptions. Same thing with famous price equilibria that we're going to study later on where you have supply and demand and then you have these notions of equilibrium prices and quantities. These also make similar types of assumptions about rational actors and perfect information and these economic models can be very useful and that's why most of your study in a first year economics course is of these models. Now, with that said, you should also take them with a grain of salt and you shouldn't just accept them as the absolute description of reality. In fact, that's when economic models can get dangerous. You always have to be conscientious of what are those assumptions you made? In fact, Nobel Prizes have been won in economics by revisiting some simplifying assumptions and coming up with new models. The other difficulty about economics is it's hard to test it in as absolute a way definitely as something like chemistry or physics but even in biology where you're dealing with similarly complex systems, a human body and an economy, these are both extremely complex systems. If I wanna see in medicine whether a certain medication works, I can do a clinical trial. I could take hundreds or thousands of people and give maybe half of them the drug and I could try to control for a bunch of different variables but in economics, you can't take a thousand different economies that look very similar in what you think matters and then apply some type of economic prescription to half of them and then see what happens, to see whether your model is exactly true or whether your prescription for what makes an economy grow faster actually works and so the big takeaway, models are valuable across the various sciences including in economics but economics straddles between a social science and the sciences like chemistry or physics because you can't run experiments in the same way and we often make simplifying assumptions that even though we know aren't exactly true, they're the only way that we're able to make sense of an incredibly complex real-world.