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Economic Theory

3. How Economists Use Theories and Models to Understand
Economic Issues
Economists see the world through a different lens than
anthropologists, biologists, classicists, or practitioners of any other

discipline. They analyze issues and problems with economic theories that
are based on particular assumptions about human behavior, that are

different than the assumptions an anthropologist or psychologist might use.
A theory is a simplified representation of how two or more variables
interact with each other. The purpose of a theory is to take a complex,
real – world issue and simplify it down to its essentials. If done well, this

enables the analyst to understand the issue and any problems around it. A
good theory is simple enough to be understood, while complex enough to
capture the key features of the object or situation being studied. Sometimes

economists use the term model instead of theory. Strictly speaking, a
theory is a more abstract representation, while a model is more applied or
empirical representation. Models are used to test theories, but for this
course we will use the terms interchangeably. For example, an architect

who is planning a major office building will often build a physical model
that sits on a tabletop to show how the entire city block will look after the
new building is constructed. Companies often build models of their new

products, which are more rough and unfinished than the final product will
be, but can still demonstrate how the new product will work.
Economists carry a set of theories in their heads like a carpenter
carries around a toolkit. When they see an economic issue or problem, they

go through the theories they know to see if they can find one that fits. Then
they use the theory to derive insights about the issue or problem. In

economics, theories are expressed as diagrams, graphs, or even as
mathematical equations. Economists do not figure out the answer to the
problem first and then draw the graph to illustrate. Rather, they use the
graph of the theory to help them figure out the answer. Although at the

introductory level, you can sometimes figure out the right answer without
applying a model, if you keep studying economics, before too long you
will run into issues and problems that you will need to graph to solve.

Model is a simplified representation of the world, not intended to be
realistic. Model is a theoretical construct, or representation of a system
using symbols, such as a flow chart, schematic, or equation.
In economics, a model is a theoretical construct representing

economic processes by a set of variables and a set of logical and/or
quantitative relationships between them. The economic model is a

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