Economic Models as Analogies

Questions: 1.Economic models are false and so government should ignore their predictions. Explain, discuss and evaluate the accuracy of this statement? 2.Identify estimates of the price elasticity of demand for at least three different products.Provide full citations for the employed literature? Answers: 1. Not all Economic models are false. Few models help the government in regulating them towards achievement of goals as well as for framing policies. The modern economy is complex as the resources are scarce which needs to be allocated wisely so that it can be utilized properly. An economic model is a simplified description of reality, designed to yield hypotheses about economic behavior that can be tested (Bnabou Tirole, 2016). The economic models are mathematical representation of economic theories and are not based on real data and figures. The government should not totally ignore the predictions of economic models as it helps in understanding the important relationship. However, the government should also not blindly follow the models as it does not support the real data and figures. The supply and demand model of economics helps in determining the price of a commodity in the market. It is used in explaining the changes in prices of commodities such as change in price of gold either due to increase in demand or fall in supply (Gilboa et al., 2014). Few economic models also help in designing regularities that explains the structural issues persisting in the economy and its impact on the reforms. Economic models also help the government in determining the tax rate in the economy. The predictions of economic models are claimed to be wrong by some of the economists because it has no proof as science has (Hansen, 2014). However, if the predictions of economic models are adjusted with the reality then it will helps in understanding the present and the future scenario right. Economic models fail to include various concepts that are important for government to consider. It often excludes externalities such as pollution which can be harmful for the environment. The economic models fail to include the social cost which can be a earning for the government. If the government follows the model then it will fail to internalize the externalities. The models that are based on mathematical equations involves great amount of risk that can be harmful (Saltelli Funtowicz, 2014). The economic models also give different answers for different predictions. Hence, it can be concluded that few predictions of the economic models are false that the government should not follow. However, the economic models also help the government in framing economic policies, determining prices of the commodities and determining taxes. Government should not follow the predictions blindly without the support of the real data and figures. 2. Price elasticity of demand is the responsiveness of the change in total demand of the product due to change in the per unit price of the product. It helps in measuring the elasticity of the product and is expressed in percentage. The law of demand makes the price elasticity of demand to be negative always. However, the products that violate the law of demand such as Veblen and Giffen goods have positive price elasticity of demand. The demand for a product can either be relatively elastic or relatively inelastic A product have relatively inelastic demand is said to have price elasticity less than one which means that change in the quantity demanded of a product is not much affected with a change in price (Thimmapuram Kim, 2013). Examples of such products are necessary products such as food, and durable goods such as furniture. A product have relatively elastic demand is said to have price elasticity greater than one which means that change in the quantity demanded of a product is affected largely due to a change in price. Examples of such products are luxurious goods such as gold, television, refrigerator and many more. The formula to measure price elasticity of demand is given as follows: E(p) = dQ/Q dP/P where, dQ is change in the quantity and Q is the total quantity dP is the change in the price and P is the total price (Rossell, 2015). Figure: diagram of price elasticity of demand (Source: created by author) The price elasticity for the three different products are given as follows: Petrol: Petrol is a complement of car. Petrol has very less substitutes. It is one of the necessary products as car has become necessity for people now days. The alternatives or substitutes of petrol is travelling through train, bus or walking. Hence, the price elasticity of demand of petrol is said to be relatively inelastic. It is so because if the price of petrol rises then the demand is not much affected and vice versa. Hence, the price elasticity of demand of petrol is always less than one and it is also negative because it is a normal good (Lin Prince, 2013). For example, if the price of petrol rises by thirty percent then the demand for petrol will only decrease by ten percent. Therefore, the price elasticity of demand will be -0.33% Figure: price elasticity of demand of petrol (Source: as created by author) Porsche sports car- Car has many alternative brands. If the price of Porsche sports car increases then the consumers will switch over to other brands such as Jaguar or Audi. Hence, the price elasticity of demand of Porsche car is relatively elastic. This is so because even a small change in price of car will affect the demand by large amount (Rossell, 2015). For example, as the price of Porsche sports car increases by twenty percent then the demand will fall by eighty percent. Hence, the price elasticity of demand will be greater than one that is -4.0 in this case. However, the price elasticity is negative because Porsche sports car is a normal good. Figure: price elasticity of demand of Porsche (Source: as created by author) Salt- Salt is a necessity. The rise in the price of salt by large amount will not have any effect on the demand for salt as it has no alternatives. Hence, the price elasticity of demand of salt is perfectly inelastic where the value of elasticity will be equal to 0. The curve will be vertical as shown below (Nonnenmacher, 2017). Figure: price elasticity of demand of Salt (Source: as created by author) References Bnabou, R., Tirole, J. (2016). Mindful economics: The production, consumption, and value of beliefs.The Journal of Economic Perspectives,30(3), 141-164. Gilboa, I., Postlewaite, A., Samuelson, L., Schmeidler, D. (2014). Economic models as analogies.The Economic Journal,124(578), F513-F533. Hansen, L. P. (2014). Nobel lecture: Uncertainty outside and inside economic models.Journal of Political Economy,122(5), 945-987. Lin, C. Y. C., Prince, L. (2013). Gasoline price volatility and the elasticity of demand for gasoline.Energy Economics,38, 111-117. Nonnenmacher, T. (2017). ECONOMICS 100 01 Introductory Microeconomic. Rossell, J. (2015). Elasticity, demand and supply, tourism. Saltelli, A., Funtowicz, S. (2014). When all models are wrong.Issues in Science and Technology,30(2), 79-85. Thimmapuram, P. R., Kim, J. (2013). Consumers' price elasticity of demand modeling with economic effects on electricity markets using an agent-based model.IEEE Transactions on Smart Grid,4(1), 390-397.