Governments and Businesses use Economic Models

Question: Discuss about the Governments and Businesses use Economic Models. Answer: Introduction: Economic models are an indispensable part of economic decision making in the modern world. Governments and businesses use economic models in making decisions about production and performance. Essentially, economic models are simplified frameworks used in describing the operation of a business or the economy as a whole (Zenghelis, 2014). Today, they are used in making simulations on how the economy would respond following variations in certain variables. In addition, they are useful in making forecasts about future conditions. Furthermore, they are essential in examining the impact of transformative change on the entire economy. Most importantly, they are useful in making decisions on matters pertaining to production and trade. In this regard, it is noteworthy that economic models are useful economic instruments and their predictions should be implemented by governments to achieve efficiency. To begin with, economic models are imperative as they help governments in making production decisions within the economy. Precisely, the Production Possibility Frontier model acts as a useful tool in the determination of the various combinations of two products that can be produced within a country efficiently (Beggs, 2011). More specifically, this model helps economic agents to determine all the maximum output possibilities of two goods that can be produced efficiently given the available set of resources. Hence, it helps the government to decide on the mix of commodities that can be produced in the country without being wasteful. Moreover, it allows agents to achieve Pareto efficiency by producing within the nations PPF curve. In this regard, businesses and the government strive to ensure that production occurs within their PPF since any production below the curve results in inefficient use of resources. The Production Possibility Frontier Apart from helping in production decisions, economic models may be used in determining the economys absolute advantage. Particularly, the absolute advantage of a country is important as it helps in deciding which commodities should be produced in the economy (Khan, n.d.). Essentially, the absolute advantage arises when a country can produce more and better quality goods than its rivals. Thus, agents can use this concept to determine goods that can be produced within the nation a lower cost per unit than the cost at which its trading partners can produce the same product (Beggs, 2014). Afterward, using this knowledge, they can decide to specialize in the production of this product. Consequently, specializing in the production of a commodity that the country has an absolute advantage allows the country to export more of the product and reap greater proceeds and profits. In turn, this benefits the nations economy. In addition, these models play a significant role in helping the government to make decisions about international trade. Typically, the government utilizes the concept of comparative advantage to determine the products that the country can sell in the international market. Characteristically, a state has a comparative advantage if it can manufacture a given commodity at a lower opportunity cost than others (Comparative Advantage, n.d.). By using this model, government agents can distinguish the commodities which can be produced at a lower relative marginal cost compared to its trading partners. In effect, the country can specialize in the production of the commodity that it has a comparative advantage and export the product to the international community. Consequently, this allows the country to benefit more from trading in the product. Illustration of comparative and absolute advantage Country 1 Country 2 Wheat 200 50 Television 100 50 In this case, country 1 has an absolute advantage in the manufacturing of both goods. However, it has a comparative advantage in the production of wheat only. Specifically, this is because the opportunity cost associated with the manufacture of wheat is one unit of television. Contrariwise, if it were to specialize in producing TV, it will have to give up 2 units of wheat for every one unit of TV manufactured. All in all, all things considered, economic models play a significant role in the modern economy. As illustrated, these models help businesses and the government in making decisions about production and international trade. For this reasons, their predictions should be not be ignored. Instead, governments should strive to understand and implement them to achieve economic efficiency in the country. The price elasticity of demand of a product plays a significant role in the modern economy. Often, consumers make purchasing and consumption decisions based on the price of the product. Thus, the willingness of a consumer to purchase a product after its price changes depends on the need of the consumer for that product (Khan, n.d.). For this reason, essential goods and services have a relatively inelastic demand while luxury products have a relatively elastic demand (Russo et al., 2013). Notably, food products are essential and necessary commodities. Thus, even when the price of food changes by a large proportion, the demand for the product changes only by a small percentage. Profoundly, a majority of food commodities have a relatively inelastic demand. According to the Food and Agricultural Policy Research Institute (FAPRI) database (2017), Barley has an own-price elasticity of -0.47 in Australia. Predominantly, the magnitude of the responsiveness of buyers to changes in the price of the product is 0.47 units. Thus, an increase in the price of barley by one unit results in a drop in its demand by 0.47 units (FAPRI, 2017). In this case, it is rational to conclude that barley has a relatively inelastic demand. PED for Long Grain Rice Notably, rice is an essential product in most households. For this reason, changes in the price of the product results in a small shift in in its demand. According to the FAPRI (2017), the magnitude of change in demand following fluctuations in the price of rice is only 0.01. That is to say, an increase in the price of rice by unit results in a 0.01 change in its demand (FAPRI, 2017). Thus, one can deduce from this data that rice has an almost unitary elastic demand in the United States. Just like other food products, corn is a primary commodity in a majority of households in China. In this regard, the FAPRI (2017) reports that the PED for corn has a magnitude of 0.06 units. Hence, a unit change in the price of corn results in a change in its demand by 0.06 units only. In this regard, the commodity has a relatively inelastic demand. References Beggs, J. (2014). Absolute and Comparative Advantage. ThoughtCo.com. Retrieved from https://www.thoughtco.com/absolute-and-comparative-advantage-1146792. Beggs, J. (2014). The Production Possibilities Frontier. ThoughtCo.com. Retrieved from https://www.thoughtco.com/the-production-possibilities-frontier-1147851. Comparative Advantage. Library of Economics and Liberty. Retrieved from https://www.econlib.org/library/Topics/Details/comparativeadvantage.html. FAPRI - Elasticity Database (2017). Food and Agricultural Policy Research Institute. Retrieved from https://www.fapri.iastate.edu/tools/elasticity.aspx. Khan, S. Comparative Advantage and Absolute Advantage. Khan Academy. Retrieved from https://www.khanacademy.org/economics-finance-domain/microeconomics/choices-opp-cost-tutorial/gains-from-trade-tutorial/v/comparative-advantage-and-absolute-advantage. Khan, S. Price elasticity of demand. Khan Academy. Retrieved from https://www.khanacademy.org/economics-finance-domain/microeconomics/elasticity-tutorial/price-elasticity-tutorial/v/price-elasticity-of-demand Russo, C., Green, R., Howitt, R. (2013). Estimation of Supply and Demand Elasticities of California Commodities. Department of Agricultural and Resource Economics University of California, Davis. Retrieved from https://www.cdfa.ca.gov/files/pdf/DemandSupplyElasticityMajorCACrops.pdf. Zenghelis, D. (2014). What do economic models tell us? The London School of Economic and Political Science. Retrieved from https://www.lse.ac.uk/GranthamInstitute/news/why-economic-models-tell-us-so-little-about-the-future-2/.