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Functional Relationships and Economic Models

1) A function represents the mathematical relationship between dependent and independent variables, with the dependent variable determined by the corresponding values of the independent variables. 2) Functions can be classified based on their role, mathematical form, and number of independent variables. Common roles include definitional, behavioral, and equilibrium equations. Functions can also be linear or non-linear, and univariate or multivariate. 3) An economic model uses simplified mathematical functions like demand and supply curves to represent economic relationships between variables and understand or predict economic events. Models express the essential features of economic systems in a clear way.

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1K views4 pages

Functional Relationships and Economic Models

1) A function represents the mathematical relationship between dependent and independent variables, with the dependent variable determined by the corresponding values of the independent variables. 2) Functions can be classified based on their role, mathematical form, and number of independent variables. Common roles include definitional, behavioral, and equilibrium equations. Functions can also be linear or non-linear, and univariate or multivariate. 3) An economic model uses simplified mathematical functions like demand and supply curves to represent economic relationships between variables and understand or predict economic events. Models express the essential features of economic systems in a clear way.

Uploaded by

Bellindah G
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FUNCTIONAL RELATIONSHIP AND ECONOMIC MODELS

A function is a mathematical relationship of dependent and independent variables. It is a


mathematical rule that determines the values of dependent variables from the corresponding
values of independent variables. It is also referred to as an equation or model. If for instance
demand is a function of (determined by) price then demand is the dependent variable and price is
the independent variable.

Types of Functions
Functions or equations can be classified on the basis of:
1. Role of the function
2. Mathematical form
3. Number of independent variables

a) Role of the function


1) Definitional equations
This sets up an identity between two alternate expressions that have exactly the same
meaning. They often use the identical equality sign (≡)
e.g

 ≡ TR – TC
E≡C+I+G
Y ≡ C + S +T (national Y derived from C, S,T)
2) Behavioral equations

They specify the manner in which a variable behaves in response to changes in other
variables, which may be either human behavioral or non-human behavioral. This expresses
dependent (endogenous) variables as a function of independent (exogenous) variables.

Qd = f(P)

3) Equilibrium equations (Conditional Equations)

This is an equation of equality of quantities.

Demand = supply Qd = Qs = Q for equilibrium in the market


Marginal revenue = marginal cost MR = MC for profit maximization.

4) Technical function

They describe technical or institutional relations. This include Production, consumption function,
tax function, etc

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Q = f(K, L, T)

b) Mathematical form

1) Linear functions
This refers to functions of degree one i.e. the highest power of an independent variable is
one. Linear functions when graphed produce straight lines.
For example: y = ax, y = 5x+ 3.

2) Non linear equations


This refers to functions of degree more than one i.e. the highest power of an independent
variable is greater than one. Non-linear functions when graphed produce curves.
For example: y = ax2, y = 3x2+ 4x
c) Number of independent variables

1. Univariate functions
These are functions which have one independent variable.
For example: y = ax
2. Multivariate functions
These are functions which have more than one independent variable.
For example: z = 5x + 3y

Mathematical expressions of Functions


The functional relationship

Y=f(X1, X2,……., Xn)……………………………………………………….(2.1)

Means that there is a systematic relationship between the dependent variable y and the
independent variable variables X1, X2,…..Xn and that there is a unique value of y for any set of
values of the independent variables. For example demand =f (price, income, etc)

An Economic Model

An economic model is a simplified description of economic reality that is used to understand and
predict an economic event (i. e relationship between variables).

Economic models are generated from economic behavior of individual units such as consumers’
producers, government agents, arms of government and interaction between them. Models help
to eliminate irrelevant details which allow economist to focus on the essential features of
economic reality. Models are expressed mathematically as functions, e.g. and demand and supply
functions

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Demand function: Qd = f(P) = a – bP . ……………………………… ….(2.2)

Supply Function : Qs = f(P) = c + dP ……………………………………(2.3)

Qd
The slope of the demand curve is given as  b
P
From the economic theory, the demand curve has a negative slope and shows that the quantity of
output that consumers are willing to buy increases as prices decreases.

Qs
The supply curve slopes upwards from left to right (  d ). This shows that the quantity of
P
output that firms will produce and offer for sale at each price increases as price rises.

Figure 2.1 Graphical representation of supply and Demand curves

Price
per S
Excess Supply
Unit

P2

Pe

P1

QS Qe QD Quanity per unit


of time
Equilibrium Condition: (Q)

Qd = Qs……………………………………………………………….

Numerical Example: Excess Demand

Qd = 14- 2P

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Qs = 2+4P

Determine equilibrium price and quantity.

Solution

At equilibrium Qd = Qs

14 – 2P = 2 + 4P

14 – 2 = 2P + 4P

12 = 6P

12
Pe  2
6

Substituting Pe = 2 into the supply function yields equilibrium quantity

Q e = 2 + 4P e

= 2+ 4 (2)

= 10

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