Principles of Economics/Economic Modeling

Use of Models

Economists use models to analyze an economy with high-accuracy. A model is a theoretical framework that attempts to describe certain aspects of a real-world economic problem. The framework is usually based on mathematics, and most models make several assumptions about how people behave and how the modeled economy operates. Models allow economists to simplify complex problems to the point where they can be analyzed so that useful observations or predictions can be made.

Importantly, models are not intended to perfectly represent reality (see Assumptions Economists Make). Experimental results have often found that some of the most basic assumptions of economics do not hold true for large percentages of the population. On one hand, a model based on incorrect assumptions should be closely scrutinized to ensure those assumptions aren't returning results that don't hold in the real world. On the other hand, a model that is extremely accurate at making correct predictions about economic problems is useful whether or not its assumptions are fully correct.

Methodology

Economics is a social science. Many aspects of the scientific method are incorporated into how economists do their work. Hypotheses are developed from observations. Data is used to test hypotheses. A proven hypothesis is used to make predictions. Economics is not exactly like a "hard science", though. Most economic hypotheses are tested using observational data, not controlled experiments. Behavioral and experimental economics are emerging subfields which attempt to use controlled experiments to test economic theories, but many theories do not lend themselves well to controlled experiments.

Economists both develop theory and apply theory to economic problems. A theoretical economist creates a model to explain an economic problem. An applied economist uses data to explain an economic problem. Many economists both develop theory and solve applied problems, and applied economists use aspects of existing theory when formulating their hypotheses, developing predictions, or determining cause-and-effect relationships.