Economic Model Building

Economic Model Building

In economics, a model is a mathematical framework defining the complex economic processes using a set of variables. It basically show quantitative or logical relationships between economic variables such as price and quantity, labor and capital and so forth. They are typically built to explain or predict how a complex economic systemworks and in particular how certain things in the economy would change due changes in exogenous variables (Mankiw, 2014) An example of economic system could be the market for maize flour and the models seeks to explain how the price would change due to changes taxation. These models are used in economics to serve tow main purposes; first to simplify the complex economic process and secondly to select economic data based on econometric study paradigm.

Building an economic model begins by identifying the interest of the system the models seeks to explain (Mankiw, 2014). It is usually used to explain just a subset of the economic system rather than everything in the system. It reduces the economic system into simple variables and the relationship between these variables. Variables are classified into independent/endogenous and dependent/exogenous variables where changes in dependent variables lead to changes in independent variables. In economic model, dependent variables such as tax rate are varied to determine changes in independent/ endogenous variables such the price of maize flour. An example is the price of floor (independent usually denoted y) and tax rate (dependent variable denoted x).

An example of economic model explaining the consumption can be stated as c =a+md where is c = consumer spending; a = autonomous consumption, m = marginal propensity to consume and d = disposable income.  In this model, c=a if disposable income is zero. In this model, the interest of an economist is not on how the level of exogenous variables (a, m and d) are determined, but rather how they influence the level of endogenous/independent variable c.


Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.