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  • 8/14/2019 ics 806-Week 9


    November 2009


    Economic models and multi-agent systems

    Session Topics

    1. Definitions Economy; Economics

    2. Economic Models

    3. Types of models

    4. Limitaitons of Economic Models

    5. Economic Processes

    6. Exercises

  • 8/14/2019 ics 806-Week 9


  • 8/14/2019 ics 806-Week 9


    November 2009


    Economic models and multi-agent systemsEconomic Models ((Wikipedia, (http://en.wikipedia.org/wiki/Model_(economics)))Modelsare simplified frameworks designed to illuminate complex processes.

    In economics, a model is a theoreticalconstruct that represents

    economic processesby a set of variablesand a set of logicalandquantitative relationships between them.

    The role of Economic modelsSimplification - reduces the complexity arising from the diversity of factors

    that determine economic activity; these factors include: individualandcooperativedecision processes, resourcelimitations, environmentalandgeographical constraints, institutionaland legalrequirements and purelyrandomfluctuations.

    Selection -enables determination of the facts that are considered, and howthey can be compiled. For example inflationis a general economicconcept, but to measure inflation requires a model of behavior, so thatone can differentiate between real changes in price, and changes in pricewhich are to be attributed to inflation.

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    Other roles of economic modelsForecastingeconomic activity in a way in which conclusions are logicallyrelated to assumptions;

    Proposing economic policyto modify future economic activity;

    Presenting reasoned arguments to politically justify economic policy atthe national level, to explain and influence companystrategy at thelevel of the firm, or to provide intelligent advice for household

    economic decisions at the level of households;

    Planningand allocation, in the case of centrally plannedeconomies, andon a smaller scale in logisticsand managementof businesses.

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    Types of modelsStochastic models based on stochastic (probabilistic/random chance)

    processes. They model economically observable values over time.Examples of these are autoregressive moving average models.

    Non-stochastic mathematical models - may be purely qualitative (forexample, models involved in some aspect of social choicetheory) orquantitative (involving rationalization of financial variables, for examplewith hyperbolic coordinates, and/or specific forms of functionalrelationshipsbetween variables). (dependent var = f(independent variables))

    Qualitative models - include scenario planningin which possible futureevents are played out; non-numerical decision tree analysis. Qualitativemodels often suffer from lack of precision.

    Accountingmodel - based on the premise that for every creditthere is a

    debit. Algebraic sum of inflows = sinks sources.

    Optimality and constrained optimization models - Other quantitative modelsare based on principles such as profitor utility maximization.

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    Example of Optimality and constrained optimization model

    comparative statisticsof taxationon the profit-maximizing firm.

    where p(x) is the price that a product commands in the market if it issupplied at the rate x, xp(x) is the revenue obtained from selling theproduct, C(x) is the cost of bringing the product to marketat the rate x,and tis the tax that the firm must pay per unit of the product sold.

    The profit maximization assumption states that a firm will produce at theoutput rate xif that rate maximizes the firm's profit. Using differentialcalculuswe can obtain conditions on xunder which this holds. The firstorder maximization condition for xis

    Regarding xis an implicitly defined function of tby this equation, oneconcludes that the derivativeof xwith respect to thas the same sign as

    second derivative which is negative if the second order conditionsfor alocal maximumare satisfied.

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    Demand model for an individual product

    Q(X) = f[P(X), P(Y), A(X),Y,T, O]

    where Q(X) quantity demanded of good X, P(X) price ofgood X, P(Y) price of another good Y, A(X) advertisingexpenditure on good X, Y real disposable income ofconsumers in the market, T consumer tastes and Oother factors. (Trefor Jones(2005). Business economics and managerial decision making. JohnWiley & Sons, Ltd. p. 85)

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    November 2009Demand supply equilibrium (Dominic Salvatore, Eugene Diuliol(2003). Principles of Economics.Shaums easy outline series)

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    Resource supply-demand (Dominic Salvatore, Eugene Diuliol(2003). Principles ofEconomics. Shaums easy outline series)

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    Aggregate modelsMacroeconomics needs to deal with aggregate quantities

    such as output, the price level, the interest rate and soon.

    Macroeconomic models may lump together differentvariables into a single quantity such as output or price.For instance, in the Keynesian model a functionalrelationship between consumption and nationalincome:

    C = f(Y), where Y is disposable income.

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    Limitations of economic modelsRestrictive, unrealistic assumptions. Economic models such as perfect-

    competition equilibriummarket models are based on perfect information, anidentical product, and inability of individual agents to significantly affect totaloutput or demand. When these assumptions are met, the resulting staticequilibrium conditions will be Pareto-optimal. One can interpret optimality as

    an ideal situation in which each agent can do no better. When theseassumptions fail, for instance under imperfect information or productdifferentiation, the model cannot be used to draw these conclusions.

    Omitted details. A great danger inherent in the simplification required to fit theentire economy into a model is omitting critical elements. Making the modelas simple as possible can be an art form, but the details left out may be

    contentious. For example: market models often exclude externalitiessuch asunpunished pollution; environmental economicsalso omit key financial

    considerations from its models for example the returns to solar powerinvestments are sometimes modelled without a discount factor; financial

    modelscan be oversimplified by relying on historically unprecedentedarbitrage-free markets, probably underestimating the chance of crises, and

    under-pricing or under-planning for risk.

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    Economic process (TLFeBook(2006) p.22)

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    Peter E. Kennedy (2000) Macroeconomic Essentials: Understanding Economics in the

    News. The MIT Press , Second Edition, P. Section 4.3

    Economic process, another perspective

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    The search for profits is what bringsmost new goods and services to themarket.

    (Dominic Salvatore, Eugene Diuliol(2003). Principles of Economics.Shaums easy outline series)

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    End of Session (Week 9) Exercises1. Define the terms economy, economics

    2. Outline economic models

    3. Outline various types of economic models

    4. Describe the limitations of economic models

    5. Describe various economic processes

    6. What is the relevance of Economics to Multi-AgentSystems?

    7. Compare economic models and multi-agent systems