Royal University of Phnom Penh

Institution of Foreign Language

Department of International Studies

Chapter1: What Models Do

Contents:
1. Introduction
2. A variety of Models
3. Models as Fables Class: E4.4
4. Models as Experiments Group 1:
5. Unrealistic Assumptions a. LIM LEANGSENG
b. VA VICHETH
6. On Math and Models c. THONG KIMSA
7. Simplicity versus Complexity d. SEU PUTHINEAT
8. Simplicity, Realism, and Reality e. PECH KEONETRA
1. Introduction
❖ Axel Leijonhufvud published in 1973, “Life ❖ What model do?
among Econ”. ➢ Model is the essential tool to
❖ “Econ tribe” is the obsession with what called understand the working of society.
“molds” - a reference to the stylized ➢ Model is useful because it captures
mathematical models that are economists’ an aspect of reality in a given
tool of the trade. context.
❖ Economic requires the learning of models in
which person has the ability to develop new
models or use existing one in conjunction
with new evidence to shed light on some
aspect of social reality.
2. A variety of Models A. Supply & Demand Model

● Economists traditionally preoccupied with

how markets work.
● Economists build models to capture
aspects of social interactions in the market
for Goods and Service.
● Economists use models to shed light on
the functioning of other institutions.

❖ What is economic model?

→ It is used by economists to simplify the reality
of how the economy works and design to solve
real world problems.
❖ What are economic models?
A. The Supply & Demand Model ● Depend on Price Elasticity
“A perfectly competitive market with a large
number of consumers and producers.” ● Pareto Efficiency
B. The Prisoner’s Dilemma Model
C. Coordination Model Ex: A rise in production cost increases market
price and reduce quantities demanded and
supplied.
B. Prisoner’s Dilemma Model C. Coordination Model
Ex: Two Cafe shops must decide on a big Ex: a firm decides to invest in ship building,
advertising budget that allow them to steal invest or not.
other’s customer. ● If it produces in larges scale, profit, but the
inputs need low-cost Steel
Cafe Shop A Don’t Advertise ● If there is a steel factory nearby, invest, if
Cafe Shop B advertise no, not invest
● Steel producers think if there is a
Don’t 150$ A: 200$ shipbuilding nearby, they’ll make money
advertise B: 100$ Two outcomes:
-Good: both invest, -Bad: both not invest
Advertise A: 100$ Cancel Out, Coordination model illustrates the failure when
B: 200$ 120$ people are unable to reach a mutually benefit
agreement/ coordinate their actions.
Individual might not cooperate even if it is in their ★ Conclusion:
best interests to do so because both parties Models tell us what the possible outcomes are,
choose to protect themselves at the expense of but it depends on the critical features
another. Different settings require,
Different Models.
3. Model as fable
❖ What is fable? ➢ They offer a useful analogy.
➢ The context in which the story unfolds ❖ The differences:
is sketched in spare terms, and the ➢ Model always tell a story and fable is
behaviour of the characters is driven by used as the relation to economic and
stylized motives such as greed and physic models
jealousy. ➢ Economic models are more like
❖ Similarity between Model and Fable parables and require lots of care and
➢ They are simple and are set in abstract interpretation in drawing out the policy
environment. implication, unlike fables, in which the
➢ The story line revolve around clear moral is clear.
cause and effect.
➢ They are short and simple.
4. Models as Experiments ❖ Scientist refer as “Internal Vs External
Validity ”
❖ Can economic model can even close as lab
experiment?
❖ Such as “Field Research”: generate
❖ What is Lab Experiment? knowledge that is model free. But not right.

➢ Means used by scientist to find “truth” ➢ Columbia distribution of private-school

about how the world works or particular vouchers for education attainment. Not
hypothesis is true. guarantee that outcome is same for other
countries like US, Africa.
❖ Uskali Maki explains that economic
practice similars methods as lab ❖ The difference between real experiments
experiments. and thought experiments (model) is less
than we thought.
❖ The different between them:
➢ Both need extrapolation when/where
➢ Lab experiment: manipulates physical applied. It require good judgement,
environment, and takes place in real world. evidences, and structured reasoning
➢ Models manipulate the assumption that go
into it, and existing in our mind only.
5. Unrealistic Assumption ❖ When Assumption is Critical?
❖ Economic Models assembled out of many
unrealistic assumption. ➢ Assumption that realistic direction would
produce a substantive difference in the
❖ What is the best way to think about this conclusion produced by the model
lack of realism?
➢ Milton Friedmen: “unrealistic assumption ❖ Most of economic model are not critical.
were a necessary part of theorizing”
➢ Paul Pflederer: “need to apply realism filter
to critical assumption before a model
➢ Example: the effects of imposing price
considered useful”.
control on the cigarettes industry. In
➢ Groucho Marx: “Prediction always involves
competitive market, price control => supply
the future”
reduction. In Monopoly Market, price
control does not affected supply.
● Example: data on traffic accidents, most
accidents occur between 5:00 to 7:00 PM.
❖ Ultimately, we cannot avoid unrealism in
➢ Reasonable Explanation: Most people
assumptions.
leave works.
➢ Another Theory: Because of John’s Fault.
He has superhuman brain that generate
invisible waves.
6. Math and Model
● Math ensures that the elements of a model, the assumption, behavioral mechanism are stated
clearly and transparent
● Math ensures the internal of a model-simply put, that the conclusions follow the assumption
● Math plays instrumental role in economic model
○ In principle, models do not require math
○ The correlation between two variable can not easily identify consistency through math
7. Simplicity versus Complexity
Complex Model Simple Model
Reasons to choose complex model Criticisms of complex models
1. Increase in computing power and decrease of its 1. Assumptions and behavioral relations built into the
costs to facilitate computation larger models comes from first-level theorizing
(smaller models)
2. The use of “big data” (from the internet or social 2. Large-scale and theory-free models can:
media) to generate patterns and regularities - Only deliver the predictions,
- Not the fundamental operations
3. The capacity to take into account of all the complexity 3. Evaluation of the effectiveness of complex models
of the world depends on
Example: - Reasonableness of the causal mechanism
Analysis of international trade agreements - Whether it applies to smaller models
8. Simplicity, Realism and Reality
Which economic model should we use?

It depends:
- Too complex model can lead us away from the purpose
- Too simple model is too simple to reflect the reality

Therefore, it is important to identify the relevant matters and include it in the model.

Economic models should be

- Relevant
- Simple to teach us about the world

“We can understand the world only by

simplifying it.”