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modeling

When economists make a number of simplified assumptions about how the economy, or some part of it, behaves, and then see what this implies in various different scenarios. Milton Friedman argued that economic models should not be judged on the basis of the validity of their assumptions, but on the accuracy of their predictions. An expert billiards player, he said, may not know the laws of physics, but acts as if he knows such laws. So his behavior could be predicted accurately with a model that assumes he knows the laws of physics. Likewise, the behavior of people making economic decisions may be accurately predicted by a model that assumes their goal is, say, profit Maximization, even if they are not actually conscious of this being their goal. The more complex the thing being modeled, the harder it is to get right. Economic forecasting has a poor overall track record. The more micro¬economic the thing being modeled, the more likely it is that a model can be designed that will deliver accurate predictions.

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