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Introduction to Economic Modeling

Introduction to Economic Modeling. D. K. Twerefou. Major Economic and CC Questions. Why rate of growth of income are different over time and in different countries? How do households and firms make their consumption and investment decisions?

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Introduction to Economic Modeling

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  1. Introduction to Economic Modeling D. K. Twerefou

  2. Major Economic and CC Questions • Why rate of growth of income are different over time and in different countries? • How do households and firms make their consumption and investment decisions? • What factors affect household decision to adapt or not adapt to climate change • What is the relationship between land value and climatic variable? • What is the relationship between plant growth and changes in climatic variable?

  3. What is an Economic Model? • An abstract map of an economy • Way of systematic thinking on • how the value of one variable determines the value of another variable. • How one set of variables determine another set of variables • Language that economists speak

  4. Uses of Models • Analysis of behaviour, facts • Evaluation of a policy • Analysis of impacts • Analysis of the interrelationships between variable

  5. Components of a Model • Endogenous variables • Exogenous variables • Parameters • Assumptions • Solutions

  6. Example of a model-1 • Endogenous Variable -variables determined within a given model -Y -endogenous - determined by given values of X. • Exogenous Variable - X1 and X2 - exogenous determined outside the model. • Parameters- constants whose values are fixed in a given model. Eg. B0 ,B1 and B2 are parameters.

  7. Example of a model-2 • Models are abstract representation of reality, there is the need to make some assumptions about the behaviour of the model. • Why? necessary to ensure that model is concise and yield meaningful analysis.

  8. Representation of model • Diagrams and equations • linear or non-linear, • Single or multiple equations, • static or dynamic or strategic

  9. Single Linear/ Non-linear • A linear model is a model without polynomial terms. • A non-linear is a model expressed in terms of polynomial

  10. Multiple (simultaneous) equations • More than one equation with the same variables. • Y = C + I + G ; • C = a0 + a1(Y-T)

  11. Static or Dynamic • Static model -Explains the behavior of a phenomenon/activity within a specific point in time. • A dynamic model - explains the behaviour of a phenomenon over a some period of time. - model deforestation using a dynamic model. - deforestation occurs over a period of time • Yt= Ct + It + Gt • Current consumption depends on past income • Ct =200 + 0.8*(Yt-1 -Tt-1)

  12. What determined GDP growth?

  13. Determinants of Economic Growth and CO2 emissions

  14. What determined CO2 emissions?

  15. What determines CO2 emissions • What factors account for the rate of carbon emissions into the atmosphere in a given country???? • Linear or Non-linear? • Exogenous/Independent variables • Endogenous/Dependent Variables • Parameters • Dynamic or static? • Linear non –linear

  16. Determinants of Deforestation • What factors account for the rate of deforestation? • Why do we introduce a non-linear element into the equation?????

  17. Quiz Identify the : - endogenous variables • exogenous variables • Parameters • Assumptions • In the equations

  18. Keynesian Static Model of National Income -1 Y = C + I + G ; C = a0 + a1(Y-T) Endogenous variables - Y, C Exogenous variables - G, I Parameters- a0 and a1. C =200 + 0.8*(Y-T) T =20; G=20; I =30

  19. Keynesian Static Model of National Income -2 • Solving the model: Y = (a0 - a1T+I+G)/(1-a1) • Y =200 +0.8*(Y-T) +I +G • Y-0.8Y = 200 -0.8*(20) +30+20 • 0.2 Y =200-16 +50 • Y =234/0.2 = 5*(234) = 1170 • C = 200+0.8*(1170-20) = 1120 • Checking the validity of the solution: • Y =1170 =1120+20+30 = C + I + G • MULTIPLIER = (1/(1-0.8))=5

  20. Keynesian Dynamic Model of National Income Yt= Ct + It + Gt Current consumption depends on past income Ct =200 + 0.8*(Yt-1 -Tt-1) Tt-1 =20; Gt =20; It =30; Yt-1 = 500 Yt =200 +0.8*(500-20) +30 +20 Yt = 200 +384 +30+20 Yt =200+384 +50 = 634 Assume Tt, It , Gt remain same for all years Yt+1 = 200 +0.8*(634-20) +30 +20 = 741 Solve this model for another 20 years.

  21. Thanks you

  22. Micro-Foundation to Macro Variables General Equilibrium with a representative household and firm Market p and w such that Y = C LD = LS LS +l = L Wage payment, wL Labour supply, L Economy (p, w, y, c, l, L) Households (consumers) Max U(C,L) Firms (producers) Max π(LS) Payments for goods, p.y Supply of Goods

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