There is a continuing interplay between models and data in the study of
economic relationships. A model is a simplified framework
to organize how we think about a problem.
Data or facts are essential for two reasons. They suggest
relationships which we should aim to explain and they allow us to test our
hypotheses and to quantify the effects that they imply.
Tables present data in a form easily understood. Time-series data
are values of a given variable at different points in time. Cross-section
data refer to the same point in time but to different values of the
same variable across different people.
Index numbers express data relative to some given base
value.
Many index numbers refer to averages of many variables. The retail
price index summarizes changes in the prices of all goods bought
by households. It weights the price of each good by its importance in the
budget of a typical household.
The annual percentage change in the retail price index is the usual measure
of inflation, the rate at which prices in general are changing.
Nominal or current price variables refer to values at
the prices ruling when the variable was measured. Real or constant
price variables adjust nominal variables for changes in the general
level of prices. They are inflation-adjusted measures.
Scatter diagrams show the relationship between two variables
plotted in the diagram. By fitting a line through these points we summarize
the average relationship between the two variables. Econometrics uses
computers to fit average relationships between many variables simultaneously.
In principle this allows us to get round the ‘other things equal’
problem, which always applies in two dimensions.
Analytical diagrams are often useful in building a model. They show relationships
between two variables holding other things equal. If we wish to change one
of these other things, we have to shift the line or curve we have shown in
our diagram
To understand how the economy works we need both theory and facts. We need
theory to know what facts to look for: there are too many facts for the facts
alone to tell us the correct answer. Facts without theory are useless but
theory without facts is unsupported assertion. We need both.
