Economic Models and PED

Question: Discuss about the Economic Models and PED. Answer: Introduction: An economic model entails a simplified depiction of reality meant to provide hypotheses concerning economic behavior which can be tested (Arnold, 2013). Economists use an economic model a tool for predicting future changes in the economy. In a nutshell, economists measure past associations among variables like tax rates, consumer spending, employment, household income and interest rates and then attempt to predict how variations in some factors will influence the future trend of others (Elliott Timmermann, 2016). Although the forecast from the econometric models may not be accurate, the information yielded from these models is important to the activities and functioning of the government. Therefore, the argument that economic models are false and so government should ignore their predictions is not reasonable. Econometric makes use of mathematics, statistical inference, and economic theory to quantify an economic event. Therefore, it translates theoretical economic models into a crucial tool of policymaking that forms the basis for government operations (Hansen Sargent, 2014). For example, when formulating the monetary policy, the central bankers need to understand the possible effect of variations in the official interest rate on the Gross Domestic Product and inflation levels. In such scenarios, economic models are essential tools in availing the required background information through prediction. More importantly, the economic models build structure and eliminate unfocused thinking by compelling econometricians to formalize ideas that may be based mainly on intuition (Gillespie, 2014). Furthermore, economic models possess an abundance of predictive successes. The models are valuable tools that assist the government to examine, formulate and comprehend interactive correlations in the economy (Mankiw, 2014). The gravity model is a useful example of the model applied to the international trade to offer predictions insights. The model provides forecasts on bilateral trade flows based on economic dimensions and distance between two units. For instance, the gravity model is used to determine the impact of treaties and alliance on the trade activities. From an empirical perspective, the gravity model has been a great success. In summary, economic models may have some limitations, but that does not mean they should be ignored when making important decisions about the economy. The models provide important guidance to the operations and activities of the government (Bergeijk Brakman, 2010). Price Elasticity of Demand Price elasticity of demand is a common term used in economics when analyzing the responsiveness of price. It is a measure of the association between a variation in the amount demanded of a given commodity and a fluctuation in its price. If a small variation in the price is associated with a large change in the amount purchased, then the good is said to be elastic, that is, responsive to price variations. On the other hand, in case a significant deviation in the price is associated with a small change of quantity demanded, then the good or service is said to be inelastic (McTaggart, Findlay, Parkin, 2015). This section of the paper concentrates on the estimates of price elasticity of demand of cereals, vegetable oils, and milk. The price elasticity of demand estimates of these products is extracted from an accounting journal titled Demand Analysis for Major Consumer Commodities in Jordan. The price elasticity of demand for cereals is estimated at -0.51 (Haddad, 2013). Since this coefficient is less than one, the price elasticity of demand for cereals is said to be inelastic. Therefore, a significant change in the price of grains will result in a small shift in the cereals bought. More precisely, 1% increase in the price of grains will lead to 0.51% drop in cereals demanded by the clients. The correlation between cereals and price obeys the law of demand. Moreover, the sellers of cereals in the market can increase their revenues by raising the price because the cereals are less responsive to changes in the price. The relationship between cereals demanded, and its price shows that this product is a necessity. The grains are vital for life, and the individuals in this particular community must buy them even if the prices shoot up. P1-P2 is greater than Q1-Q2, that is, a big change in the price of cereals (P1-P2) results in a small variation in the quantity of cereals purchased (Q1-Q2) The price elasticity of demand for Vegetable oils is estimated at -0.01 (Haddad, 2013). Like the cereals, the price elasticity of vegetable oils is inelastic. However, the PED for vegetable oils is more inelastic than that of cereals. A huge deviation in the price of vegetable oils will result in a small variation in the quantity of vegetable oil demanded by this group of consumers. A 1% increase in the price of vegetable oils will cause a 0.01% decrease in vegetable oils demanded. The negative sign on the coefficient of vegetable PED exhibits that the association between vegetable oils and its price agrees with the law of demand. Likewise, the distributors of the vegetable oils can freely increase the prices to maximize their revenues since this particular product is highly irresponsive to changes in the price. The price elasticity of demand for this commodity indicates that the commodity is an essential. Whether the prices increases or drops, individuals will still buy the vegetable oil. A huge change in the price of vegetable oils (P1-P2) leads to a small change in the quantity of vegetable oil demanded (Q1-Q2). The price elasticity of milk oils is estimated at -0.06 (Haddad, 2013). This coefficient shows that the PED for this good is inelastic. Milk is highly irresponsive to price changes than the cereals. Like the other two commodities, a substantial deviation in the price of milk will cause a slight fluctuation of milk bought. A 1% increase in the price of milk will result in a 0.01% decline in the quantity of milk purchased. Since milk is highly irresponsive to price changes, the farmers can increase their revenues by raising the prices of milk. The association that exists between milk and the price clearly shows that estimate complies with economic theory. Moreover, the price elasticity of this product is determined by the necessity nature of this commodity. Consumers will continue to purchase milk even if the farmers hike the price. A large change in the price of milk (P1-P2) results in a small variation in the amount of milk purchased (Q1-Q2). References Arnold, R. A. (2013). Economics. Mason, Ohio: South-Western. Bergeijk, P. A., Brakman, S. (2010). The gravity model in international trade : advances and applications. Cambridge [u.a.]: Cambridge Univ. Press . Elliott, G., Timmermann, A. (2016). Economi forecasting. Princeton and Oxford Princeton University Press . Gillespie, A. (2014). Foundations of economics. Oxford : Oxford Univ. Press. Haddad, A. M. (2013). Demand Analysis for Major Consumer Commodities in Jordan. Journal Of Accounting, Business Management, 20(2) , 33-64. Hansen, L. P., Sargent, T. J. (2014). Uncertainty within economic models. Hackensack, New Jersey : World Scientific. Mankiw, N. G. (2014). Principles of economics. Stamford, CT : Cengage Learning. McTaggart, D., Findlay, C. C., Parkin, M. (2015). Economics. Frenchs Forest, N.S.W: Pearson.