Falsifying Economic Models

Questions: 1.Economic models are false and so government should ignore their predictions.Explain, discuss and evaluate the accuracy of this statement? 2.Provide full citations for the employed literature. Comment on the magnitudes of these estimates in relation to the standard economic determinants of the price elasticity of demand? Answers: 1. Economic models are mainly constructed on the basis of historical data, information, and statistics. Therefore, 100 percent accuracy is impossible if the outcomes of a model define randomness. Apparently, if a model has possessed cent percent accuracy as well as zero error, it will be described as a fact (Buck Lady, 2005). However, economic models have been created by the economists considering the real-world historical data that represents uncertainties, randomness, and errors. As a result of the scenario, simpler models can be misleading and false to identify the actual economic parameters. In order to create statistical modelling on economics, both reality and approximation have been considered. Depending on the leading purpose of economic models, factors and variables must be assumed to complete the model (Siliverstovs, 2017). Clearly, the hypothetical models can be perfect as far as theoretical field. Based on economic parameters and historical data, a flawless economic model cannot be formed. Understandably, each of the economic models has been constructed based on approximation. Therefore, changes in variables at a certain level can result in misleading predictions. For instance, financial risk-models can be one of the devastating models to be considered leading to the economic crisis (Freedman, 2011). During 2008 global crisis situation, misleading financial risk models had created massive economic uncertainties, to say the least. Hence, economic models are moreover false in most of the cases. Meanwhile, considering the two types of economic models such as theoretical and empirical models, the accuracy of the models can be questioned on a serious note. Each of the models has certain limitations and variables (Fingleton, 2008). Some of the models have started without explanations to be precise. Notably, most the models are created on economists experience and knowledge resources. As a result of the same, different models can deliver different types of outcome even if the set of data is constant (Buck Lady, 2005). During economic trend setting, most of the models are found as unreliable. For instance, demand-supply model of labour industry can be depended on so many variables and factors. Hence, predictions cannot be prcised by merely following the economic models based on theoretical concepts and historical data. In the current scenario, governments must change their perspective on economic models as the models can be full of flaws. Meanwhile, the governments cannot ignore all the models at once. The calibrated models should be updated according to time making sure that tiny flaws should be readjusted. Precisely, recalibrated models should be utilised in financial risks to avoid wrong predictions. Moreover, apart from logical economic models, rest of the models should be ignored by the governments to avoid unwanted financial crisis issues. Decisively, if economic models have to be utilised by the government, accurate data resources should be mandatory replacing approximation system. 2. The price elasticity of demand presents the relationship between the quantity demand and the price of the product helping in estimating the effect of change in the price on the quantity demanded of the commodity. The equation used to calculate the price elasticity of demand of a product is as follows: Percentage change in the Quantity Demanded Percentage change in the price The above equation is used to estimate the effect of change in the price on the quantity. It is also used to estimate the change in the revenue earned by the firms after and before the price change (Karlan Zinman, 2013). It is important to note that the price elasticity of demand of a product depends upon the utility derived by it. Hence, the price elasticity of demand of a product is different than any other product. The estimations of the price elasticity of three different products are presented herein below: Gold: Gold is a luxury product as well as a price sensitive product. A small change in the price of gold leads to a high change in the quantity demanded (Miller Alberini, 2016). For example, when the price of gold decreases from $45 to $40, the quantity demanded increases from 1000 units to 1250 units. Hence, the change in percentage of price is 12.5 percent, whereas the change in the percentage of quantity demanded is 25 percent. Therefore, the price elasticity of gold is 2 that make it have a highly elastic demand. A diagram has been presented for better understanding: Figure: Highly Elastic Demand Source: (Salvatore, 2011) It can be seen from the above figure that the change in the quantity demanded is more than the change in the price. Hence, gold being a luxury product has a highly elastic demand. Salt: In the case of essential goods such as salt that are used on a regular basis in daily life, the demand of the product does not change with the change in price (Rassenfosse Potterie, 2011). For example, if the price of salt increase from $1 per kg to $2 per kg, the demand will remain same. On the other hand, if the price falls, the demand for salt will remain unchanged. Therefore, the demand for necessary products is perfectly inelastic in nature. A diagram has been presented herein below for better understanding: Figure: Perfectly Inelastic Demand Source: (Salvatore, 2011) It can be seen from the above figure that the quantity demanded remains constant at Q for all level of prices at point P, P1 and P2. Though the price changes, the change in quantity demanded is zero. Hence, salt or any other necessary goods have a perfectly inelastic demand. Cigarette: In the case of cigarette, it is a product that causes addiction. Hence, a change in the price of cigarette will have a little impact on the quantity demanded of the product (Rassenfosse Potterie, 2011). For example, a rise in the price of cigarette from $4 to $5 will have a decrease in the quantity from 10 units to 9 units. Therefore, the change in the price is 25 percent, whereas the change in the quantity is 10 percent. Hence, the price elasticity of cigarette is 0.4, which makes it inelastic in nature. Figure: Highly Elastic Demand Source: (Salvatore, 2011) It can be seen from the above figure that the change in the quantity demanded is less than the change in the price of the product. Hence, cigarette is estimated to have inelastic demand because it is a product of addiction. References Buck, A. Lady, G. (2005). Falsifying economic models.Economic Modelling,22(5), 777-810. Fingleton, B. (2008). Competing models of global dynamics: Evidence from panel models with spatially correlated error components.Economic Modelling,25(3), 542-558. Freedman, D. (2011).Why Economic Models Are Always Wrong.www.scientificamerican.com. Retrieved March 2017, from https://www.scientificamerican.com/article/finance-why-economic-models-are-always-wrong/ Karlan, D. Zinman, J. (2013).Long-run price elasticities of demand for credit(1st ed.). London: Centre for Economic Policy Research. Miller, M. Alberini, A. (2016). Sensitivity of price elasticity of demand to aggregation, unobserved heterogeneity, price trends, and price endogeneity: Evidence from U.S. Data.Energy Policy,97, 235-249. Rassenfosse, G. Potterie, B. (2011). On the Price Elasticity of Demand for Patents.Oxford Bulletin Of Economics And Statistics,74(1), 58-77. Salvatore, D. (2011). Microeconomics (1st ed.). New York: McGraw Hill. Siliverstovs, B. (2017). Dissecting models' forecasting performance.Economic Modelling.