1. What is the purpose of an economic model?
An economic model simplifies reality in order to explain, predict, or understand economic behavior and outcomes. It highlights essential relationships and removes unnecessary detail so economists can analyze how variables interact.
2. How can marginal analysis be used to explain rational behavior?
Marginal analysis examines the additional (marginal) benefits and additional (marginal) costs of an action.
A rational person makes decisions only when marginal benefit ≥ marginal cost, and chooses the option that maximizes net gain. This explains how individuals decide how much of a good to consume, how much labor to supply, or how many resources to allocate.
3. Give an example of a behavioral assumption in an economic model. What is the purpose of using behavioral assumptions in economic models?
Example: Consumers are assumed to maximize satisfaction (utility) given their limited income.
Purpose: Behavioral assumptions simplify complex human actions so models can make clear predictions. Without assumptions, models would become too complicated to understand or apply.
4. A person makes decisions by habit. This person considers neither the benefits nor the costs of his or her actions. Can the person be considered rational?
Yes—if the habitual behavior consistently leads to outcomes that align with the person’s goals.
Economists define rationality as being purposeful, not necessarily calculating. If habits effectively help the person achieve what they value, the behavior can still be considered rational in economic terms.
5. In what ways do economic theories and models abstract from reality? Why are unrealistic models useful?
Economic models abstract by:
- Holding some variables constant (ceteris paribus).
- Assuming simplified behavior (e.g., rational decision-making, perfect information).
- Ignoring real-world complexities to focus on key relationships.
Why unrealistic models are useful:
- They allow economists to isolate cause-and-effect.
- They make predictions clearer and easier to test.
- Even simplified models can provide accurate insights about how the real economy behaves