Economic Modelling

Abstract

Economic modelling encompasses a multitude of related activities; it includes the specification, estimation and validation of single-and multiple-equation models for policy analysis and forecasting. A model in this context is broadly defined as a system of interdependent quantitative relations. Various types of relationships are considered: behavioural, which constitute attempts to describe certain aspects of economic agents’ behaviour; technical, an example of which is a production function; and identities. The following simple, stochastic and dynamic, macroeconomic model can be used to illustrate this and to introduce some standard terminology:

$$Y = C + \bar G + X - M$$

(1.1)

$$Y = A{K^a}{\bar L^{1 - a}}{u_1}$$

(1.2)

$$C = {m_0} + {m_1}{y^d} - 1 + {u_2}$$

(1.3)

$$I = {b_0} + {b_1}\Delta Y + {b_2}\bar r + {u_3}$$

(1.4)

$${Y^d} = Y - \bar T$$

(1.5)

$$M = {c_0} + {c_1}{Y_{ - 1}} + {u_4}$$

(1.6)

$$K = {K_{ - 1}} + I$$

(1.7)

where Y = income or output, C = consumption, I = investment, G = government expenditure, X = exports, M = imports, K = fixed productive capital, L = labour, Y^d = disposable income, T = tax revenue, AY = Y − Y₋₁, r = interest rate, and u_i = disturbance term.