Your Textbook Uses the Following Example of Simultaneous Causality Bias

question 21

Essay

Your textbook uses the following example of simultaneous causality bias of a two
equation system: $$\begin{array} { c } Y _ { i } = \beta _ { 0 } + \beta _ { 1 } X _ { i } + u _ { i } \\\\X _ { i } = \gamma _ { 0 } + \gamma _ { 1 } Y _ { i } + v _ { i }\end{array}$$ To be more specific, think of the first equation as a demand equation for a certain good, where $Y$ is the quantity demanded and $X$ is the price. The second equation then represents the supply equation, with a third equation establishing that demand equals supply. Sketch the market outcome over a few periods and explain why it is impossible to identify the demand and supply curves in such a situation. Next assume that an additional variable enters the demand equation: income. In a new graph, draw the initial position of the demand and supply curves and label them $D ^ { 0 }$ and $S ^ { 0 }$ . Now allow for income to take on four different values and sketch what happens to the two curves. Is there a pattern that you see which suggests that you might be able to identify one of the two equations with real-life data?

---

Definitions:

Equipment Held

Assets in the form of machinery or other equipment that a company owns and uses in its operations.

Standby Purposes

Standby purposes involve situations where credit or resources are held in reserve to be utilized in specific circumstances or emergencies.

Actuarial Information

Data and analysis used to evaluate the financial implications of risk and uncertainty, often used in insurance and pensions.

Market Rate

The dominant interest rate in the market for investments with comparable risk and duration.