An economic model, as a framework used to demonstrate in a comprehensible way how complex economic processes function, attempts to approximate the reality of economics. Whether it is a useful model depends on a number of factors. The model should first of all be simple. Next it should deal with important economic facts, providing a framework for important issues. The model should supply a useful methodology or economic intuition. It must also be true and credible.
An economic model is an incomplete system
An economic model that is considered “true” is one that can be validated, in other words, shown to be true. Economics is different from a science such as chemistry. In economics, it is difficult to perform controlled experiment due to outside factors. An economic model of necessity is an incomplete system and economic truth only a partial glimpse of reality, with the economic model as a window on this glimpse.
There are two sides of economics – the positive (what really exists) and the normative (what should be). Therefore even if an economic model cannot be validated, economists may value it for its normative aspect.
A good economic model is credible
In this context, a model can be described as a way to explain certain conclusions based on inferences, or causal chains, connecting a small set of variables. The economic model is to be considered good (that is, a credible window on economic reality) if the following three conditions apply: the model is based on plausible assumptions, the results themselves (that is, the explanation the model leads to) are plausible and the model’s conclusions are not overly sensitive to its assumptions.
A good economic model follows the 3Rs of economic research
The 3Rs of economic research require that a model be Realistic, Relevant and Robust. It should, in addition, be verifiable. A realistic model is based on plausible assumptions, which are the foundation of good research. Its assumptions must fairly accurately represent economic reality. A model is relevant when its assumptions provide a plausible explanation for the conclusions and it produces results that are strong and of the first order.
To be relevant, the model should conform to the 3 Ss: it is backed by a Story, or clear intuition; it is Simple; and the model implies plausible Sizes. A robust economic model means that its conclusions are not overly sensitive to small changes in its assumptions. Finally, the model should be verifiable, possessing the basic ABCs – Alternative, Byproducts and Calibration. Its conclusions may be verified by either statistical or anecdotal evidence.