Relationships Among Economic Variables example essay topic

Economic theories simplify reality to allow us to understand basic economic forces and how individuals cope with the problems of scarcity. We can observe actions and their consequences. Observation and description are not sufficient for understanding and ultimately predicting actions. Theory establishes relationships between cause and effect. We use it to interpret actions 'and outcomes so we can explain the process by which the actions were undertaken and the outcomes achieved. The purpose of theory in all scientific analysis is to explain the causes of phenomena we observe.

To conduct economic analysis we frequently need to engage in abstraction. This involves making assumptions about the economic environment and human motivation that simplify the real world enough to allow us to isolate forces of cause and effect. Any theory is a simplification of actual relationships. A successful theory provides insights into the physical or social relationships it studies. Economic theories are developed to explain such important observable quantities as the production, prices and consumption of goods and services, the employment of workers, and levels of saving and investment. Economic variables are quantities that can have more than one value.

For example, the price of an item is an economic variable representing what we must give up in exchange for each unit of that item. Price is an economic variable because it can go up or down as changes occur in the economy. An economic theory of price seeks to determine the causes for changes in the price of an item. An economic model is a simplified way of expressing how some sector of the economy functions. An economic model contains assumptions that establish relationships among economic variables. We use logic, graphs, or mathematics to determine the consequences of the assumptions.

In this way we can use the model to make predictions about how a change in economic conditions result in changes in decisions affecting economic variables. Economists often use the term "model" as a synonym for theory. ECONOMIC MODELS Many economic models are developed using the deductive method through which observations are used to make assumptions about economic behaviour or productive and technological relations. Logic is then used to trace out the implications of the assumptions using a model. For example, a model of the supply of compact discs might assume that suppliers seek to maximize profits from selling that item. The economic variables affecting the profitability of selling CD players are isolated.

Logic can then be used to show how a change in one of the economic variables affects the profitability of selling more CD players. For example, if it can be shown that an increase in the price of CD players makes it profitable to sell more, the model would imply that whenever the price increases, the quantity supplied will also go up; The conclusions of the model can be tested by examining factual data to see if actual relationships are consistent with those of the underlying theory. Conclusions that are consistently supported by evidence are called economic laws or economic principles. Economic models are abstract because they don't attempt to capture all the relevant influences on behaviour. By concentrating on only one goal, even though this is not realistic, a model can more clearly unveil basic forces of cause and effect. An important qualifier in constructing economic models is hypotheses which represent the untested implications of a model.

A hypothesis is a statement of a relationship between two or more variables. An example of a testable hypothesis is: The number of CDs sold per year will increase if their price fells while all other influences on willingness and ability of consumers to buy are unchanged. To test this hypothesis we need a method of accounting for the effects of changes in all economic conditions on the value of the economic variables this model seeks to explain. And these are the steps necessary to construct an economic model: 1. Selection of economic variables among which cause-and-effect relationships are to be explained.

2. Assumptions about technology, constraints and human behaviour. 3. Analysis of the assumptions of the model for relationship among the economic variables it seeks to explain. 4. Testable hypotheses.