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How to complete a model

Frank Krysiak introduces three more building blocks needed to describe an economic model: consumer behaviour, markets and the natural environment.

Economic models consist of building blocks. In addition to these blocks, you will need three more types of building blocks for your construction:

  • consumer behaviour
  • markets
  • natural environment

These blocks serve to connect the dots left open by your model of firm behaviour. They have to be chosen so that they fit to each other and to the model of firm behaviour that you have selected.

Consumer behaviour

In general, economic models describe consumers as choosing between different goods while being subject to a budget constraint. However, in environmental economic models, we focus on emissions so that the choice among different goods is not that important. We rarely need much sophistication for the consumer side, and thus, we usually extend the model of firm behaviour in the simplest possible way.

If you have selected the Emission Choice Model (ECM) for firm behaviour, there is very little to do in depicting consumer behaviour. The Emission Choice Model describes only emissions. Thus, in the case of the Emission Choice Model, you only add a damage function to your description of firm behaviour.

If you selected the Output Abatement Choice Model (OACM), firms produce output and emissions. On the consumer side, you thus have to describe the well-being derived from consuming the product and the damage caused by emissions.

In case of the Input Choice Model (ICM), you also have to describe where the inputs come from. Thus, you will usually need a model that describes labour supply, capital supply, and the supply of all other factors.

Markets and the natural environment

In most cases, we can use balancing equations to both ends. A market is modelled by assuming that what flows into the market has to equal what is drawn from the market. We already used this approach in your very first example where you analyzed the supply-demand balance of an electricity system. Similar, environmental aspects can often be added via definition or balance equations. For example how emissions accumulate in the atmosphere or wastewater of different firms gathers in a lake.

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Exploring Possible Futures: Modeling in Environmental and Energy Economics

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