Economists use models to investigate parts of the economy that would be difficult to study all at once. A model simplifies reality by selecting features that are relevant to a particular economic question and setting aside others. Many of those features are represented by variables, factors, or quantities that can change or take different values. Prices, wages, income, unemployment, consumer spending, interest rates, and production can all serve as variables. By examining variables, economists can investigate how different parts of an economy may be related.
Examining Relationships Between Variables
Economic models often focus on relationships between variables. Economists may change or compare the value of one variable and observe what happens to another. Sometimes two variables move in the same direction, while in other cases an increase in one is associated with a decrease in another. Examining these patterns allows economists to investigate relationships that may be difficult to identify when many economic changes are occurring simultaneously. Economists might investigate questions such as:
What happens to consumer spending when income changes?
What happens to investment when interest rates change?
What happens to the quantity consumers purchase when a product’s price changes?
What happens to production when the amount of labor or capital changes?
Consider a model examining the relationship between the price of a product and the quantity consumers purchase. Price is one variable, and quantity purchased is another. An economist can compare different prices and observe the quantities purchased by the model under those conditions. If quantity changes as price changes, the model represents a relationship between the variables. The economist can then examine the pattern and consider what it suggests about consumer behavior.
Holding Other Factors Constant
Real economic situations are more complicated because many variables can change at the same time. A consumer’s decision to purchase a product might be influenced by price, income, preferences, expectations, and the prices of other products. If all these factors changed simultaneously, determining which changes were connected to the outcome would be difficult. Economists therefore often hold some factors constant while examining a particular relationship. This allows them to isolate selected variables and study their relationship more precisely.
Suppose an economist wants to investigate the relationship between price and quantity purchased. The economist might allow price to change while assuming that income, preferences, and other conditions remain constant. This does not mean those other factors are unimportant in the real economy. Instead, holding them constant establishes the conditions for the investigation. The economist can focus on one relationship without other changes complicating the analysis.
Using Variables to Investigate Change
Variables can play different roles within a model. Some variables may be changed or set during an investigation, while others respond according to relationships built into the model. For example, an economist could change an interest rate and observe how the level of business investment responds. Recognizing what is being changed and what is being observed helps economists understand the relationship a model is designed to investigate.
The model below is called a production possibilities curve, or PPC. Like many economic models, it uses variables to represent selected features of an economic situation. In this model, the quantities produced are variables because their values can change. Changing one variable lets economists observe what happens to the other while holding conditions such as available resources constant. By comparing these changing values, economists can use the model to investigate the relationship between the variables and consider what that relationship reveals about production choices.
Changing variables also allows economists to conduct what-if investigations. They can ask what might happen if interest rates rise, household income falls, production costs increase, or another economic condition changes. Using the PPC above, for example, economists might ask what would happen to the possible combinations of goods produced if the amount of available resources changed. They could compare the resulting production possibilities with those shown in the original model. The model generates outcomes based on its variables, relationships, and assumptions. Economists can compare those outcomes to identify patterns. Then they can develop explanations and predict possible economic results.
Interpreting What a Model Shows
The relationships produced by models must be interpreted carefully. A change in one variable followed by a change in another within a model does not automatically prove that the same result will occur in the real economy. Factors that were held constant or excluded from the model may still influence actual economic behavior. Economists therefore consider what changed, what was observed, which conditions were held constant, and which assumptions shaped the results. Understanding these elements helps economists determine what conclusions a model can reasonably support.