Theory as Model Building
Young children learn much about the world around them by playing with toy
versions of real objects. For instance, they often put together models of cars,
trains, or planes. These models are far from realistic, but the model-builder
1-2
CHAPTER 1 The Science of Macroeconomics | 7
The Unemployment Rate in the U.S. Economy The unemployment rate measures
the percentage of people in the labor force who do not have jobs. This figure shows
that the economy always has some unemployment and that the amount fluctuates
from year to year.
Source: U.S. Department of Labor and U.S. Bureau of the Census (Historical Statistics of the United States:
Colonial Times to 1970).
FIGURE 1-3
1900
25
20
15
10
5
0
Percent unemployed
1910
World
War I
Great
Depression
World
War II
Korean
War
Vietnam
War
First oil price shock
Second oil price shock
1920 1930 1940
Year
1950 1960 1970 1980 1990 2000
9/11
terrorist
attack
learns a lot from them nonetheless. The model illustrates the essence of the real
object it is designed to resemble. (In addition, for many children, building
models is fun.)
Economists also use models to understand the world, but an economist’s
model is more likely to be made of symbols and equations than plastic and
glue. Economists build their “toy economies” to help explain economic variables,
such as GDP, inflation, and unemployment. Economic models illustrate,
often in mathematical terms, the relationships among the variables. Models
are useful because they help us to dispense with irrelevant details and to focus
on underlying connections. (In addition, for many economists, building models
is fun.)
Models have two kinds of variables: endogenous variables and exogenous variables.
Endogenous variables are those variables that a model tries to explain.
Exogenous variables are those variables that a model takes as given. The purpose
of a model is to show how the exogenous variables affect the endogenous
variables. In other words, as Figure 1-4 illustrates, exogenous variables come from
outside the model and serve as the model’s input, whereas endogenous variables
are determined within the model and are the model’s output.