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?
• 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?
2
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
3
Uses of Models
–Analysis of behaviour, facts
–Evaluation of a policy
–Analysis of impacts
–Analysis of the interrelationships
between variable
Components of a Model
– Endogenous variables
– Exogenous variables
– Parameters
– Assumptions
– Solutions
Example of a model-1
Y  0  1 X i  2 X 2  u
• 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.
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.
Representation of model
• Diagrams and equations
– linear or non-linear,
– Single or multiple equations,
– static or dynamic or strategic
Single Linear/ Non-linear
• A linear model is a model without polynomial
terms.
Y  0  1 X1  2 X 2  u
• A non-linear is a model expressed in terms of
polynomial
Y  0  1 X1  2 X  u
2
2
Multiple (simultaneous) equations
• More than one equation with the
same variables.
• Y=C+I+G ;
• C = a0 + a1(Y-T)
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)
What determined GDP growth?
GDP Growth
30
20
10
0
Benin
Burkina
Faso
Cape
Verde
Ghana
Guinea Gambia Guinea Liberia
Bissau
Mali
Niger
Nigeria Senegal
-10
-20
-30
-40
-50
-60
1985
1990
1995
2000
2005
2009
Sierra
Leone
Togo
Cote
D'ivoire
Determinants of Economic Growth and
CO2 emissions
GDP  0  1Labor  2Capital  3 FDI  4ODA  u
What determined CO2 emissions?
Carbon Dioxide Emission
0.9
0.8
0.7
0.6
1985
0.5
1990
1995
0.4
2000
2005
0.3
0.2
0.1
0
Benin
Burkina Cape
Faso
Verde
Ghana Gambia Guinea Guinea Senegal Sierra
Bissau
Leone
Togo
Mali
Niger
Liberia Nigeria
Cote
d’ivoire
What determines CO2 emissions
• What factors account for the rate of carbon
emissions into the atmosphere in a given
country????
CO2  0  1GDP  2 Industrialization  3ind.Effic.  4 Pop  u
–
–
–
–
–
–
Linear or Non-linear?
Exogenous/Independent variables
Endogenous/Dependent Variables
Parameters
Dynamic or static?
Linear non –linear
Forest Area
60
50
40
1990
30
2000
2005
20
10
0
Benin
Burkina
Faso
Cape
Verde
Ghana
Gambia Guinea
Guinea Senegal
Bissau
Sierra
Leone
Niger
Liberia
Mali
Togo
Nigeria
Cote
d’ivoire
Determinants of Deforestation
• What factors account for the rate of
deforestation?
DEF  0  1GDP  2GDP2  3 Agric _ landuse  4Urbanisation  u
• Why do we introduce a non-linear element
into the equation?????
Quiz
Identify the :
- endogenous variables
– exogenous variables
– Parameters
– Assumptions
– In the equations
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
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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
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.
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Thanks you
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
Households
(consumers)
Max U(C,L)
Wage payment, wL
Labour supply, L
Economy
(p, w, y, c, l, L)
Firms
(producers)
Max π(LS)
Payments for goods, p.y
Max U  c l 1
l  LS  1
pc  wLS  
c  0; l  0; LS  0
Supply of Goods
Max   py  wLD
y  LD

y  0; LD  0
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