Why is simplification essential in economic modelling?

Simplification is essential in economic modelling to make complex economic systems manageable and understandable.

Economic modelling is a tool used by economists to understand, predict, and explain economic phenomena. The real world economy is incredibly complex, with countless variables interacting in intricate ways. If economists tried to include every single variable in their models, they would quickly become unmanageably complex and virtually impossible to use. Therefore, simplification is necessary to make these models usable.

Simplification in economic modelling involves making assumptions to reduce the complexity of economic phenomena. For example, in the model of perfect competition, it is assumed that there are many buyers and sellers, all selling an identical product, with perfect information and no barriers to entry or exit. Of course, these conditions rarely, if ever, exist in the real world. However, by making these assumptions, economists can create a model that is simple enough to understand and use, but still captures the essential features of competition in a market.

Moreover, simplification allows economists to focus on the effects of one or two variables at a time. By holding all other variables constant, economists can analyse the impact of a change in one variable on another. This is known as the ceteris paribus assumption, which is Latin for 'all other things being equal'. This assumption is crucial for understanding cause and effect in economics.

However, it's important to remember that the simplifications and assumptions made in economic models are not an accurate reflection of reality. They are merely tools to help us understand the complex world of economics. Therefore, the predictions made by these models should be taken with a grain of salt, as they are based on simplified versions of reality.

In conclusion, simplification is essential in economic modelling because it makes complex economic systems manageable and understandable. It allows economists to focus on the effects of individual variables and to make predictions about economic behaviour. However, the assumptions made in these models are not an accurate reflection of reality, so their predictions should be interpreted with caution.