Scribd
Upload
29 views4 pages

Simultaneous Equation System

Uploaded by

akhtarulbiostat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
29 views4 pages

Simultaneous Equation System

Uploaded by

akhtarulbiostat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
You are on page 1/ 4

Simultaneous Equation Model

Simultaneous Equation System:


In single regression equation models, one variable (the dependent variable ) is expressed as a
linear function of one or more variables (the explanatory variables ) in such models an
implicit assumption is that the cause and effect relationship, if any between and the is
unidirectional. The explanatory variables are the cause and the dependent variable is the effect.

However, in many situation there is a two is a two way (or simultaneous) flow of influence
among economic variables, that is on economic variables affects another economic variables and
is in turn affected by it (them).

Thus in regression of money on the rate of interest the single equation methodology
assumes implicitly that the rate of interest is fixed and times to find out the response of money
demanded to the changes in the level of the interest rate. But if the rate of interest depends on
the demand for money, we need to consider two equations, one relating to and another
relating to . And this leads us to consider simultaneous equation models.

Example: Demand and Supply Model


The price of a commodity and the quantity and sold are determined by the intersection of
the demand and supply curves for that commodity. Now we may write the empirical demand
and supply function as

A prior is expected to be negative (down-ward sloping demand curve) and is expected to


positive (upward sloping supply curve).
It is easy to see that and are jointly dependent variables. If for example, in changes
because of changes in other variables affecting (such as income, wealth and tests), the
demand curve will shift upward if is positive and downward if is negative.

Figure: Interdependence of price and quantity


As in figure shows, a shift in the demand curve changes both and . Similarly a change in
(because of strikes, weather import and export restrictions etc) will shift the supply curve, again
affecting both and . Because of this simultaneous dependence between and , and
in and and in can not be independent.
Endogenous Variables:
Simultaneous Equation Model~1 of 4
In the context of the simultaneous equation models, the jointly dependent variables are called
endogenous variable.

Exogenous Variable:
In simultaneous equation models, the variables that are truly no-stochastic or can be so regarded
are called the exogenous or predetermine variables.

What happens if the parameters of each equation are estimated by OLS, disregarding
other equations in the simultaneous equation system?
One of the crucial assumptions of the method of OLS is that the explanatory variables are
either non-stochastic or if stochastic (random), are distributed independently of the stochastic
disturbance term. If neither of these condions is met, then OLS estimators of simultaneous
equation models are not only biased but also inconsistent.

Suppose a hypothetical system of equations:

Where, and are mutually dependent or endogenous variables and is an exogenous


variable and and are the stochastic disturbance terms. The variables and are both
stochastic.

Here OLS cannot be applied to estimate the parameters unless it can be shown that the stochastic
explanatory variable is distributed independent of and similarly the stochastic
explanatory variable in is distributed independently of . In this situation, OLS method
leads to inconsistent estimate.

Simultaneous Equation Bias: Inconsistency of OLS Estimators


The bias arising from the application of classical least squares to an equation belonging to a
system of simultaneous relations is called simultaneous equations bias.

Let us consider the simple Keynisian model of income determination.

Assumptions:
Simultaneous Equation Model~2 of 4
Since is positive, the covariance between and is bound to be different from zero. So that
and are correlated, which violates the assumption of the classical linear regression model
that the disturbances are independent or at least uncorrelated with the explanatory variables.
Now we get from

Substituting the value of in we have,

Taking expectation on both sides we have,

So that is a biased estimator of unless the term is zero.

Equation indicates that is non-zero. Since is a population concept and


is therefore different from , which is a simple measure, although, as the sample size
increases indefinitely the latter will tend toward the former.

An estimator is said to be consistent if its probability lilmit (or ) is equal to its true
(population) value. By applying the rules of to we get,
Simultaneous Equation Model~3 of 4
Simultaneous Equation Model~4 of 4

You might also like