A model is useful because it simplifies, but that is also its weakness.
Where models fall short
They simplify
A model keeps a few factors and leaves out the rest.
They assume
Ceteris paribus and rational choice rarely hold in real life.
People surprise us
Habits, emotions and herd behaviour change what people do.
No lab
Economies cannot be rerun, and data arrive late and get revised.
The points to remember
- Always ask which assumption a model makes.
- A model is a guide, not a forecast.
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When the evidence disagrees, economists change the model.
Models change when evidence disagrees
| Idea | What happened |
|---|---|
| Phillips curve: lower unemployment means higher inflation | In the 1970s both rose together (stagflation), so economists changed the model |
| People always act rationally | Behavioural economics showed they often do not, so models now allow for biases |
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