PROCESSES OF BUILDING ECONOMICS MODEL

1. Meaning of Economic Model:
An economic model is an organised set of
relationships that describes the functioning of
an economic identity under a set of assumptions
from which a conclusion or a set of conclusions
is logically derived.

2.  Analysis c.b
 Prediction future
 Validity Friedman and Samuelson
 Testable
 General
 Simple
 Equations

3.  Variables
 Constant
 Parameters
 Functional relationships
 Equations

4.  Building a Micro-Static Model:
Let us construct a micro-static model to determine the price of tea in a perfectly
competitive market. Thus the fundamental relationships among the
three variables are:
Qd = f (P)
Qs = f (P)
and Qd = Qs
Assumptions:
(1) The quantity demanded is a decreasing function of price.
(2) The quantity supplied is an increasing function of price. But if price
does not exceed a minimum, there is no supply.
(3) Quantity demanded and quantities supplied are stock variables.
(4) The market is in equilibrium when excess demand is zero, i.e., Qd –
Qs = 0. In other words, the equilibrium condition is Qd = Qs.

5. Suppose we have the following values of the behavioural equations for
the market model.
Qd = 36 – 4P – (1)
Qs = – 12 + 12P – (2)
Qd = Qs – (3)
Substituting (1) and (2) in (3), we have
36-4P = -12+ 12P
– 4P- 12P = – 12- 36
-16P = – 48
P = 3
Putting the value of P in equations (1) and (2), we obtain
Qd = 36-4 x 3 = 24
Qs = -12+12 x 3 = 24
Qd = Qs = 24

7.  the quantity demanded increases to 28 tonnes and
the quantity supplied falls to 12 tonnes.
 Less supply of tea in relation to higher demand will
raise the price to Rs.3. As a result, the quantity
demanded will fall to 24 tonnes and the quantity
supplied will also rise to 24 tonnes so that the
equilibrium condition is re-established.
 On the contrary, with the rise in the price to Rs. 4 per
kg., the quantity demanded of tea will fall to 20
tonnes and the quantity supplied will increase to 36
tonnes. At the price higher than the equilibrium price,
every seller will try to sell his quantity first. For this,
he has to lower his price a little.

8. 1. To Define the Problem:
Defining the problem covers three stages. The first is to define
the problem about which the model is to be built. It may relate
to an individual household, a firm
2. To Formulate Assumptions:
3. To Collect Data:
4. To Derive Logical Deductions:
5.To Test the Model Empirically
 This is done by observations or by checking the consistency of
predictions with related facts with the help of mathematical,
statistical or econometric methods.
 6. To Accept Reject or Revise the Model:
 If the predictions of the model are correct, the model is
scientifically valid and reliable.