sample open question&answer 1

Discuss the issue of idealization in economic models by: (a) explaining the different ways in which models idealize, (b) providing an example of a model that idealizes in at least one such way, and by (c) discussing some implications of the view that models always idealize.

To explain the different ways in which models could be idealized, William Wimsatt’s list of types of idealization will be considered and explained. Wimsatt elaborated on several aspects related to economic models idealizations, focusing on 5 main criteria of idealization:

1. A model has only local applicability.

2. A model might be idealized, thus the conditions applied can never be found in real world,

but these conditions could still be applied as approximations.

3. A model might be incomplete, thus not taking into account some relevant variables.

4.An incomplete model could lead to erroneous descriptions about the interactions of the

included variables (e.g. producing “spurious” correlations when there is no interaction

between the variables, or showing independence when an interaction is present).

5. A model might give a “wrong-headed picture of nature” (e.g. wrong interactions, inexistent

properties, etc.)

A famous example, that tends to idealize, is Hottelin g’s model of minimal differentiation, also known as Hotteling’s law. The model makes the following assumptions: there are two vendors (A & B), located in a one dimensional space (represented by a straight line) and more specifically, each of the vendors is located on the opposite side from each other; the buyers are equally distributed along the straight line; costs of production for each A and

B are equal to zero; the demand is perfectly inelastic (thus, buyers are willing to purchase one unit of product no matter what). If the vendors would not have a fixed location, each of them would prefer to be located in such a way so that the vendor could sell to more buyers, thus get a larger segment where no competitors are present. Considering this, it can be anticipated that the vendors will move towards each other until reaching a point in the middle of the line, being located in a very close proximity to each other (however not occupying the same point on the straight line).

Considering the abovementioned list of idealizations, Hotteling’s model appears to be false regarding all five points:

1.The model fails to predict and explain within its intended domain, which could be the case

if the vendors do not compete via prices, even though they could, or they involve into a

price war as a result of producing identical products.

2.One of the model’s assumptions is the fact that the vendors operate in a one-dimensional

world, which is an unrealistic assumption.

3.Other factors that could influence consumer’s decisions are omitted, focusing solely on the

distance between the vendors, however other factors could have an impact on the buying

behavior, such as: habit, other customers in the shop, acquaintance with the vendor, etc.

4.There are some strong assumptions made, such as: linear transportation costs, or perfectly

inelastic demand which could lead to incorrect descriptions about the interactions.

5.The considered reason why vendors are moving so closely towards each other is

maximizing their own profits, but what if this actually happened because of some other

reasons: imitation, chance, etc.