Answer to Question #221470 in Microeconomics for Christell

Question

Explain five features of a good economic model

Answer 1

1. Parsimony

Parsimonious models are simple models in the sense that they rely on relatively few special assumptions and they leave the researcher with relatively few degrees of freedom.3 Parsimonious models are desirable because they prevent the researcher from consciously or subconsciously manipulating the model so that it over-fits the available facts. Over-fitting occurs when a model works very well in a given situation, but fails to make accurate out-of-sample predictions. For example, if a model incorporates a large set of qualitative psychological biases then the model is nonparsimonious, since selective combination of those biases will enable the researcher to tweak the model so that it ―explains‖ almost any pattern of observations.

2. Tractability

Tractable models are easy to analyze. Models with maximal tractability can be solved with analytic methods – i.e. paper and pencil calculations. At the other extreme, minimally tractable models cannot be solved even with a computer, since the necessary computations/simulations would take too long. For instance, optimization is typically not computationally feasible when there are dozens of continuous state variables – in such cases, numerical solution times are measured on the scale of years or centuries. 

3. Conceptual insightfulness

Conceptually insightful models reveal fundamental properties of economic behavior or economic systems. For example, the model of concave utility identifies the key property of risk aversion. The concept of concave utility is useful even though it makes only qualitative predictions. An optimizing framework like Nash Equilibrium is also conceptually insightful even though it relies on an assumption that is empirically false – perfect rationality. The concept of Nash Equilibrium clarifies some abstract ideas about equilibrium that are important to understand even if the Nash framework is an incomplete explanation of real-world behavior. Finally, many models are conceptually useful because they provide normative insights

4. Generalizability

Generalizable models can be applied to relatively wide range of situations. For example, a generalizable model of risk aversion could be used to analyze risk aversion in settings with small or large stakes, as well as risk aversion with respect to losses or gains. A generalizable model of learning could be used to study learning dynamics in settings with a discrete action set or a continuous action set or an action set with a mixture of discrete and continuous actions. A generalizable model of intertemporal choice could be used to study decisions with consequences that occur in minutes or decades. 

5. Falsifiability 

Falsifiability and prediction are the same concept. A model is falsifiable if and only if the model makes nontrivial predictions that can in principle be empirically falsified. If a model makes no falsifiable predictions, then the model can not be empirically evaluated.