A young economist visits a client to give a presentation. The client compliments the economist’s watch and asks if he can hold it. The economist happily obliges.
Upon looking at the watch more closely, the client chuckles, “I think the time on your watch is off.”
The economist is shocked and says that is impossible.
He then explains how his watch is synced with an atomic clock every night. He describes how the atomic clock is extremely accurate, since it is based off complex physics that tap into the power of atoms. He further elaborates how satellite signals help sync his watch with the atomic clock and the process of doing so uses sound mathematical models that even incorporate Einstein’s theory of relativity.
The economist then pulls out a piece of paper and starts to write a series of equations and draws diagrams to further explain things. He finally concludes by confidently pointing at his paper, “The proof is all here—There is no way that my watch is wrong.”
The client is speechless.
After a long silence, the economist smiles, “I see you are impressed with my knowledge of physics. I want to let you know my economic models are based on similarly rigorous mathematics and theory. I can assure you these models are as accurate as my watch.”
There is a pause.
“That’s what I am worried about,” the client finally mutters. “You are so impressed by your theories and mathematical formulas that you forgot that you changed time zones when you came here. I was politely trying to hint that you were an hour late to this meeting since your watch hadn’t been readjusted since your flight.
If your economic models are as accurate as your watch, we are in trouble.”
Models make assumptions to simplify and explain things that are more complex. The assumptions used for modeling are often unrealistic, but can simplify reality to give us useful insights. This is why, when designed and used correctly, models can be great.
However, sometimes the mathematical and theoretical rigor behind a model causes people to have a false sense of confidence in it. This can cause them to forget the limits of the model or forget to regularly reevaluate the assumptions behind it.
The biggest misconceptions about economics often occur when people over-rely on economic models based on faulty assumptions. Such errors can result in serious problems, like major policy errors by governments or disastrous bets in financial markets.