Economics Model Building

Economic Models

Models are used in economics to illustrate theories.
For example governments can use models to find out what would happen if they increased or decreased the base rate in their central bank.
Models are estimations based on past data.
Companies also use models.
For example what would happen if taxes or prices are lowered or increased.
However models can also be very misleading because they involve assumptions and variables can be plenty.
Historical data can help make more accurate models and predictions.
For example an assumption would be that if you lower taxes, people will spend more money, increasing tax rates. However it rarely works in reality.

Central banks do monetary policies and governments do fiscal policies.
Monetary policies are the tools a central bank has in order to support sustainable economic growth through controlling interest and thus the availability of money.
Fiscal policies are the use of government taxes to influence economic conditions.

Households need money, thus they seek for occupations.
They have skills that can be sold in markets.
There are two markets: the market for factors of production and the market for commodities.
The four factors of production are labor, land, capital and management.
The households provide factors of production for firms, such as labor.
The households get paid for in commodities (usually money).
In the market for commodities households use payments for commodities which makes money flow to firms.
Income from labor then can flow from the firms to the households as salaries for example.
This description doesn't account for leakages and inputs from the government.
Additionally it doesn't account for exchanges between firms.
Non-governmental organizations such as the European Union and their affects aren't included.
Lastly banks and their base rates aren't included.
Foreign countries also affect the circular flow of economies, due to exports and imports between countries.
With all these things taken into account, such models can be very useful for governmental or corporate decisions.
For example if the bank increases interest to reduce demand and thus inflation, it could affect a lot of things.
For example it could reduce the amount of products sold for a company making them lay off workers or it could also increase their profits due to the increased interest.
The main principle about the circular flow of economics is the circulation of money.