Building a Set of Simple Models

Within limits, which I describe in this presentation, I have constructed several variations of a simple stock and flow model that depict four fundamental principles regarding the behavior of economic systems:

• the production of economic goods must precede their consumption,
• production rates also influence consumption rates,
• when the rate of production exceeds the rate of consumption for any period a quantity of that good—called savings—accumulates,
• savings supports increased production by allowing producers to commit more labor or capital to the production of future goods

As a mental construct, I have created three sets of models of a simple economy. These sets individually show:

• the steps of the development of a generalized economic model.
• the behavior of a simple economy.
• the effect of a type of intervention on that simple economy.

Because of the connection of these sets I have included a consolidated summary and conclusion for the three sets.

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A Caution

I need to make it clear from the outset that building models can neither prove economic theory nor can they represent real economic systems. Because of the extreme complexity of even the smallest economic system, only the system itself can act as an accurate model of the system. In addition, that complexity precludes proving cause and effect relationships in economic theory. Those relationships can only be established through sound economic reasoning.

Good modeling, on the other hand, can provide demonstrations of the economic theories, i.e. someone building a model must work from theory to the model, not the other way around.

Summary of the Models

The following summarizes the segments of this presentation of a model simple economic system:

Developing a Model

Many factors make creating a realistic model of an economy very difficult. In this part we deal with the difficulties of creating a model that effectively demonstrates the processes of a market without committing errors of aggregation.

The Simple Economy

The model of the simple economy demonstrates the relationships between production, consumption, and savings. The structure of those relationships causes short-term changes to consumption to lead to contrary influences in the long-run.

Economic Intervention

Intervention creates counterintuitive, unintended, consequences. This model demonstrates how, by encouraging consumption in the short-term, government intervention leads to lower consumption in the long-run.

Summary & Conclusion

The summary and conclusion ties these three models together. Although presented separately, the expression of sound economic principles and theories tie these models together.

Again, I suggest you view these models in sequence.