Economic models: The compass to understand markets (including crypto)

The economy seems complicated because everything is connected. But here's the trick: economists created “models” to break down the chaos into understandable pieces.

What is an economic model?

Basically, it's a Lego block game. You take the key elements (price, quantity, demand, supply), connect them with mathematical equations, and voila: you have a map to predict what happens in the market.

What are they for?

• Explain why prices go up or down
• Predict inflation, unemployment, future trends
• Help governments and companies make decisions without wasting money

The basic components

Variables: Elements that change (price, quantity, income, interest rates).

Parameters: Fixed values that define how variables behave.

Equations: The mathematical logic that connects everything. Example: the Phillips Curve shows the relationship between inflation and unemployment.

Assumptions: Simplifications to avoid total chaos. E.g.: “markets are competitive” or “people make rational decisions” (yes, we know that in crypto that's a joke 😏).

Real-world example: the apple market

Imagine you want to predict the equilibrium price of apples.

Defines:

• Demand: Qd = 200 − 50P (for every $1 that the price increases, 50 fewer apples are sold)
• Offer: Qs = -50 + 100P ( for each $1 that rises, they produce 100 more )

Both are equal: 200 − 50P = -50 + 100P

Result: Equilibrium price = $1.67 per apple, 117 apples sold.

If the price goes up more, there is excess supply (surplus). If it goes down, there is a lack of apples (deficit).

Types of models that exist

• Visuals: Basic supply-demand charts and diagrams (offer-demand basic)
• Mathematicians: Pure equations, for those who like numbers
• Empirical: They use real data to validate theories
• Simulations: Programs that test scenarios without breaking anything
• Dynamic vs Static: Dynamics include time (more realistic, but complex); statics are a snapshot in time.

And what about crypto?

Price Dynamics: Supply-demand models work here as well. If BTC has a limited supply of (21M coins) and demand increases, the price goes up. Simple.

Transaction costs: If fees are high, fewer people use the network. If they decrease, there is more activity. Models predict this.

Future scenarios: Simulations show what happens if regulations change, technology improves, or the average user starts to use more crypto.

The limitations (because nothing is perfect)

❌ Unrealistic assumptions: They assume perfect competition and rational people, but in crypto you see pure FOMO and market manipulation every day.

❌ Over-simplification: They overlook important factors. A supply-demand model doesn't tell you what happens if Elon tweets something random.

What they are really used for

✅ Politicians = They use models to know if a policy will work before spending billions.

✅ Companies = Predict future demand, plan production.

✅ Investors and analysts = Understand market dynamics to make better decisions.

Conclusion

Economic models are like a flight simulator for the economy. They are not perfect ( reality always surprises ), but they provide a solid framework to understand why markets move the way they do, in tradfi or in crypto.

More information about tokenomics, liquidity, and financial crises in our other posts.