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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
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
• 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.
0 1 2 2iY X X u
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.
• A non-linear is a model expressed in terms of polynomial
0 1 1 2 2Y X X u
20 1 1 2 2Y X X u
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?
Determinants of Economic Growth and CO2 emissions
0 1 2 3 4GDP Labor Capital FDI ODA u
What determined CO2 emissions?
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
2 0 1 2 3 4. .CO GDP Industrialization ind Effic Pop u
Determinants of Deforestation
• What factors account for the rate of deforestation?
• Why do we introduce a non-linear element into the equation?????
20 1 2 3 4_DEF GDP GDP Agric landuse Urbanisation u
Quiz
Identify the : - endogenous variables– exogenous variables– Parameters– Assumptions– In the equations
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Keynesian Static Model of National Income -1
Y = C + I + G ; C = a0 + a1(Y-T)
Endogenous variables - Y, C Exogenous variables - G, IParameters- a0 and a1.
C =200 + 0.8*(Y-T) T =20; G=20; I =30
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
21
Keynesian Dynamic Model of National Income
Yt= Ct + It + Gt Current consumption depends on past incomeCt =200 + 0.8*(Yt-1 -Tt-1)Tt-1 =20; Gt =20; It =30; Yt-1 = 500 Yt =200 +0.8*(500-20) +30 +20Yt = 200 +384 +30+20Yt =200+384 +50 = 634Assume Tt, It , Gt remain same for all years
Yt+1 = 200 +0.8*(634-20) +30 +20 = 741Solve this model for another 20 years.
Thanks you
23
Economy(p, w, y, c, l, L)
Firms (producers) Max π(LS)
Households (consumers)Max U(C,L)
Labour supply, L
Wage payment, wL
Supply of Goods
Payments for goods, p.y
1lcUMax1 LSlwLSpc
0;0;0 LSlc
wLDpyMax LDy
0;0 LDy
Market p and w such thatY = CLD = LSLS +l = L
Micro-Foundation to Macro VariablesGeneral Equilibrium with a representative household and firm