Your Textbook Uses the Following Example of Simultaneous Causality Bias $\gamma _ { 0 }$

question 44

Essay

Your textbook uses the following example of simultaneous causality bias of a two equation system:
Y_i = β₀ + β₁X_i + u_i

X_i = $\gamma _ { 0 }$ + $\gamma _ { 1 }$ Y_i + v_i
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 D⁰ and S⁰. 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:

Supply

The complete quantity of a product or service that can be bought at a specific price point.

Supply Schedule

A table or graph showing the quantity of a good or service that producers are willing and able to supply at various prices.

Quantity Supplied

The inventory of products or services that is put up for sale by producers at a specified rate.

Price

The amount of money required to purchase a good or service in the market.