## Tuesday, November 18, 2014

### how to understand an economic model

So I finally Googled how to understand an economic model, something I really need to understand.

It was the article of the week at Reddit that drove me to it. I didn't read the linked article, just the comments on it at Reddit. Integralds lays out an overview of growth theory, of the development of growth theory, what standerby calls a "timeline of thought". It's easy reading, just a summary of developments. But it's impressive.

I didn't even click on any of the links. It wouldnt do me any good. Every time they start laying out a model my brain becomes impenetrable. Said to myself I need to know how to understand an economic model. Next thing I knew, it was Googled.

The fourth item in the Google results -- and the first one I hadn't been to before -- was The Craft of Economic Modeling, Part 1 (PDF, 149 pages) by Clopper Almon. Here's two bits of it, from the intro:
Simply put, an economic model is a set of equations which describe how the economy or some part of it functions. In my view, a model should incorporate and test our understanding of how the economy works. Its equations should make sense. And it should be possible to test how adequate our understanding is by running it over the past and seeing how well it can reproduce history. By changing some of its assumptions and rerunning history with the changed assumptions, it is possible to analyze the effects of policies. Finally, it should be useful not only for policy analysis but also for forecasting. By studying the errors of the forecast, the builder of the model may hope to improve his or her understanding of the economy.

Some of the equations in our models have constants which describe the behavior of firms, consumers, or other economic agents. These constants, often called "parameters", must somehow be estimated. The most frequently used way is by choosing them so that the equation describes accurately the behavior of those agents in the past. Thus, estimating the parameters is just a way to sum up the lessons of the past to forecast the future or examine how the past itself might have been different had different decisions been made. A large part of this book is about how to do that...

Yeah, I have to read this. I know, 149 pages. Usually if the page count is more than a single digit I start to worry. But I have to read this.

Oh yeah, one more thing:
The computer software, the G regression package, version 7.3, (referred to as G7) and the Build model builder, are comprehensive, easy-to-use programs that run under Windows XP and Windows 7 or 8. They are designed for work with time-series data. Public domain versions accompany the book or are available via Internet (www.inforum.umd.edu), where thousands of economic time series are also available as data banks for G7. Assembling equations into a model requires the use of the Borland C++ compiler, which is also available for free download...

Oh, my.