Economic theories try to define the relationship between different economic variables. These relationships can be expressed into varieties of firms like graphs, tables, mathematical equations, and so on to make them more undersetting and more general. If the theoretical relations or theoretical models are checked against real-world data and if empirical data verify the relationship postulated by the theory then they become acceptable and fitted for policy prescription. So based on the methodology of the study and their area of coverage model in economics may be economic model/deterministic and econometric model/stochastic model.
Economic models are those models in which outcomes are precisely determined through the known relationship among states and events without any space or room for random variation. In the economic model, a given input will always produce the same output. They deal with systematic and definite outcomes as opposed to random results and they don’t make allowances for errors. Economic models thus hypothesize an exact relationship between the economic variables. These models allow one to make predictions and see how one variable affects the other.
Econometric models are also known as statistical analytical tools that estimate the probability of an event occurring based on past historical data. Econometric models are mathematical representations of economic theories with the residual phenomenon. Unlike the economic model, the stochastic or econometric model includes the element of randomness. This model is likely to produce different results even with the same initial conditions. There is always an element of uncertainty involved which implies that there are possible alternative solutions. Thus econometric models include both economic models and the randomness of real life.
Major differences between the economic model and econometric model can be presented below;
| Economic Model | Econometric Model |
| It shows the economic relationship between different economic variables. | It measures the values of parameters in economic relationships. |
| The economic model is the theoretical construct that represents the complex economic process or association between economic variables. | An econometric model is the combination of mathematical, statistical, and economic concepts that represents the mathematical estimate of the variables or parameters there in the identified model. |
| Economic models are qualitative but by nature, they are based on mathematical models as they ignore residual variables. | Econometric models are extensively statistical or future forecast oriented and thus based on statistical models. |
| Economic models attempt to exhibit the logical relationship between different variables considered in the model. | Econometric models focus on calculating the numerical values and direction of variables considered in the model. |
| The economic model is directly linked with the mathematical model as in mathematical economics all the economic models are applied to express them in quantitative form. | Econometric models are also directly linked with the mathematical model but it is used for further empirical forecasting and extension of an economic model or mathematical model. |
| The outcome of the economic model is almost certain and exact. It means all the economic models are developed with a set of fixed assumptions/conditions so the outcome is also almost fixed. | The econometric model includes the residual variables/uncertainty so their outcome is not fixed and unknown, unlike the economic model. So the outcome of econometric models may be certain but not exact. |
| Economic models are deterministic models. Deterministic models do not include the error term. | All the econometric models are stochastic and econometrics assumes all the economic models as stochastic by including the error terms. |
| Economic models forecast the future values of economic variables regardless of their uncertainty or degree of probability. | Econometric models forecast the future values of economic magnitudes with a certain degree of probability. |
| Y=B1+B2X, Keynesian consumption function is an example of an economic model. This relation is deterministic. | Y=B1+B2X+ U. This stochastic relation is an example of the econometric model. |
| Economic models do not have anything to do with the significance testing of the variables and parameters. | Econometric models require significant testing of their parameters. |
| There is no uncertainty in the values of variables in the model at any point in time in the case of an economic model. | There are linear as well as non-linear relations in the econometric model so there is a possibility of uncertainty n the value of variables in any particular instant of time. |
| Economic models allow for random elements which might affect the exact relationship and tender it in stochastic character. | Econometric models take randomness as an essential element of the model. So all the economic models in econometric models as probabilistic models. |
| Economic models are less powerful to predict the future. | Econometric models are more powerful to predict the future. |
Thus models are widely used in economics to communicate economic condition, relation, cause, and effect among the variables and each model ought to be based on solid theoretical ground. Whatever the type of the models, they have certain assumptions and the goodness of the model is based on the degree of realism of assumptions the developer has taken into consideration. The varieties of models in economics have shown the extent and areas of use of economics.