Question

Professor Adams decides to teach his 10 students how the stock market works.​ Therefore, he plans to develop a virtual stock market for the class that includes five different shares. Students are given​ $50 each to invest in any of the five shares. This exercise helps the students understand the overall stock market investing process. Which of the following statements is true for the above​ case? A. It is not a​ model, and its predictions cannot be checked with empirical evidence. B. It is a​ model, and its predictions can be checked with empirical evidence. C. It is a model.​ However, its predictions cannot be checked with empirical evidence. D. It is not a​ model, though its predictions can be checked with empirical evidence. In the virtual model developed by​ Professor, when demand for a particular share consists of​ 10% of all student​ investors, the share price is ​$10. When demand increases to​ 30% of the student​ investors, the price increases to ​$13. ​However, in an actual stock​ market, it is generally​ noticed, when demand consists of​ 10% of all​ investors, a share price of ​$130 increases to ​$220 when demand for the share is increases to​ 30% of the total investors. ​Therefore, by testing the accuracy of the model and the real​ data, we find that the share prices in the virtual stock market increases by nothing​% compared to nothing​% increase in actual stock market. ​(Round your answer to the nearest percent​.) ​Therefore, we conclude that the model is ▼ inaccurate accurate compared to the actual data. Which of the following are true about a​ model? ​(Check all that apply​.) A. The outcomes of the model are used in comparison with the actual data. B. It is a simplified description of a theory. C. It makes hypotheses on empirical evidence. D. It is not always the exact replica of the data. Click to select your answer(s).

Answer 1

Solution:

The given description of a virtual share market in the class, indeed serves as an example for a model. Models can be of the following types: either the one comprising of certain variables and equations to study the impact of one (or several) factor(s) on another. This is called theoretical model, which are mainly used in economics. Another can be a virtual model, which is creating a replica scenario of the real world at a small scale (that is with a few number of players involved). This is the case stated in our question. Also, note that all models are made basically to serve this one main purpose: to see how things behave in real world. To check the predictions with empirical evidences and studies made on the actual world. So, the correct option is B) It is a model and its predictions can be checked with empirical evidence. (and soon, we will see the comparison).

Percentage change in share prices in the virtual stock market = ((13 - 10)/10)*100 = 30%

Percentage change in share prices in the actual stock market = ((220 - 130)/130)*100 = 69% (nearly)

Therefore, by testing the accuracy of the model and the real​ data, we find that the share prices in the virtual stock market increases by 30% compared to 69​% increase in actual stock market. Due to such high difference in the percentage change of share prices in the two, we conclude that the model is inaccurate, compared to the actual data.

About any model, the following things are true:

A. The outcomes of the model are used in comparison with the actual data (as we had already seen and discussed above as the basic purpose of a model).

B. It is a simplified version of a theory (as well as of something practical). Stating theory here refers that we are talking about theoretical models, or economic models.

C. Sure, all models make hypothesis on empirical evidence, and checks whether the accuracy of the models, this is a scientific methodology.

D. A model might not always be exact replica of the data, due to few constraints such as lack of complete knowledge, a lot lower number of observations, etc. (in our example as well, model was not the exact replica).

Thus, all four mentioned above apply to be true about a model.