Read this section on the reasoning behind economic models, which are just representations of reality or theoretical thinking for understanding something. Pay attention to the explanation about the Circular Flow Diagram (Figure 2), which represents how the economy and its actors are related to one another. Make sure to answer the quiz questions.
Answer to Try It
- Apply knowledge of economic theory to assert the form of the relationship.
Incorrect. Theory is useful for hypothesizing a relationship but if no existing data are available and experimental data are infeasible economists cannot support their theory.
- Plot projected future data points of each variable against each other in a graph to visualize the potential future form the relationship.
Incorrect. Using existing data, not projected possible future data, is a more cost-effective and valid means of establishing and testing relationships between economic variables.
- Conduct behavioral experiments and make quantitative observations that indicate the form of the relationship.
Correct. Behavioral economics is becoming increasingly important in validating common economic theories and developing new ones.
Correct. As the price of X rises, the quantity of X purchased falls and therefore the relationship can be deemed negative or "inverse".
Incorrect. As the price of X rises, the quantity of X purchased falls and therefore the relationship cannot be positive.
Incorrect. As the price of X rises, the quantity of X purchased falls and therefore the relationship cannot be constant.