Based on the article below state the main points presented. It is fine to use bu

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Based on the article below state the main points presented. It is fine to use bullets and to use the authors words without rephrasing

The economy is a complex web of interdependent elements, and understanding any part is a significant accomplishment. The price of tea in the USA is determined by many factors, including individual preferences (or tastes), labor costs, weather conditions, and the price of tea in China, among others. Preferences, labor costs, weather, etc., are in turn connected to other factors, including the price of coffee, which in turn can affect the price of tea. All the parts can be moving simultaneously, making it hard to see what is causing what. To write effectively about economics, you have to understand how economists think about such complicated phenomena. In general, to make their task easier, economists focus on and try to isolate simple causal connections, often between two variables ceteris paribus, or “other things being equal.” “Other things being equal,” what is the effect of a change in labor costs on the price of tea? “Other things being equal,” how does a change in the price of coffee affect the price of tea? This kind of analysis allows economists to say something very precise about well-defined relationships and to run rigorous tests to measure the strength and direction of their connections.

ECONOMIC MODELS Economic analysis is characterized by the use of models, simplified representations of how economic phenomena work. Supply and demand, cost/benefit analysis, and comparative advantage are examples of basic economic models. A model is a theory rendered in precise, usually mathematical, terms. Economic models specify relationships between two kinds of variables: exogenous variables and endogenous variables (Gregory N. Mankiw, 1997). Exogenous variables are inputs to the model, factors that influence what happens but are themselves determined “outside” the model. They are givens, fixed values that are assumed not to change over the period of analysis. Endogenous variables are outputs of the model, determined “within.” Usually, a mathematical function is used to represent the relationship between exogenous and endogenous variables. For example, we can model the market for ice cream in terms of three functions: The quantity of ice cream demanded depends (negatively) on the price of ice cream and (positively) on income (Y): Qd = D(PI, Y) The quantity of ice cream supplied depends (negatively) on the price of milk (because ice cream is made from milk) and on the price of ice cream: Qs = S(PI, PM) In equilibrium, the quantity of ice cream supplied equals the quantity demanded: Qd = Qs. In this model, the price of milk and the level of income are exogenous variables; the price of ice cream and the quantity of ice cream exchanged are endogenous variables. Applying basic models allows one to make predictions about the real world economy, both forward-looking predictions about, say, future interest rates and backward-looking predictions about, say, the savings rate during the Depression. Models also provide guidance about where to look for and how to look at data, and they provide a structure on which the rest of the paper can hang.

HYPOTHESIS TESTING A model’s predictions about the future or the past are essentially empirical hypotheses: claims, supported by facts, about how some economic phenomenon works. Most economists, aspiring to be good social scientists, would like to test their hypotheses under laboratory conditions. But this is not ordinarily possible. Instead, we take sample data from the real world, by looking at census reports, balance sheets and the like, and we use statistical methods to test the predictive power of our models and the hypotheses they generate. Most economic data come in, or can be easily transformed into, numerical terms. Prices and quantities are numbers, and economists also attach numerical measurements to factors such as standards of living that do not usually come in quantified form. But a long list of numbers is just that until a relationship among them can be specified that imparts some order. By building and using models, economists are able to focus on simple, sometimes subtle, relationships in the data and explain the causal links involved. Finding the pattern in the data allows one to say something about how the economy works. A set of well-known models can greatly simplify the task of organizing and communicating your ideas. But the real test of a model is how well it helps us understand the workings of the economy.

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ECONOMIC MODELS

HYPOTHESIS TESTING

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