Economics

How to Build an Economic Model in Your Spare Time
by

Hal R. Varian
UC Berkeley December 1994 Current version: July 25, 2009

Abstract. This is an essay for Passion and Craft: Economists at Work, edited by Michael Szenberg, University of Michigan Press, 1997.

Keywords.

Address. Hal R. Varian, Dean, School of Information Mangement and Systems, UC Berkeley. Web pagehttp://www.sims.berkeley.edu~hal

How to Build an Economic Model in Your Spare Time Hal R. Varian

Most of my work in economics involves constructing theoretical models. Over the years, I have developed some ways of doing this that may be worth describing to those who aspire to practice this art. In reality the process is much more haphazard than my description would suggest—the model of research that I describeis an idealization of reality, much like the economic models that I create. But there is probably enough connection with reality to make the description useful—which I hope is also true for my economic models.

1. Getting ideas The first step is to get an idea. This is not all that hard to do. The tricky part is to get a good idea. The way you do this is to come up with lots and lots of ideasand throw out all the ones that aren’t good. But where to get ideas, that’s the question. Most graduate students are convinced that the way you get ideas is to read journal articles. But in my experience journals really aren’t a very good source of original ideas. You can get lots of things from journal articles—technique, insight, even truth. But most of the time you will only get someone else’sideas. True, they may leave a few loose ends lying around that you can pick up on, but the reason they are loose is probably that the author thought about them a while and couldn’t figure out what to do with them or decided they were too tedious to bother with—which means that it is likely that you will find yourself in the same situation. My suggestion is rather different: I think that you should lookfor your ideas outside the academic journals—in newspapers, in magazines, in conversations, and in TV and radio programs. When you read the newspaper, look for the articles about economics . . . and then look at the ones that aren’t about economics, because lots of the time they end up being about economics too. Magazines are usually better than newspapers because they go into issues in moredepth. On the other hand, a shallower analysis may be more 1

stimulating: there’s nothing like a fallacious argument to stimulate research.1 Conversations, especially with people in business, are often very fruitful. Commerce is conducted in many ways, and most of them have never been subjected to a serious economic analysis. Of course you have to be careful not to believe everything you hear—people in business usually know a set of rules that work well for running their own business, but they often have no idea of where these rules come from or why they work, and this is really what economists tend to find interesting. In many cases your ideas can come from your own life and experiences. One of my favorite pieces of my own work is the paper I wrote on “A Model of Sales”. I had decided toget a new TV so I followed the ads in the newspaper to get an idea of how much it would cost. I noticed that the prices fluctuated quite a bit from week to week. It occurred to me that the challenge to economics was not why the prices were sometimes low (i.e., during sales) but why they were ever high. Who would be so foolish as to buy when the price was high since everyone knew that the item wouldbe on sale in a few weeks? But there must be such people, otherwise the stores would never find it profitable to charge a high price. Armed with this insight, I was able to generate a model of sales. In my model there were two kinds of consumers: informed consumers who read the ads and uninformed consumers who didn’t read the ads. The stores had sales in order to price discriminate between the...