Your Textbook Uses the Following Example of Simultaneous Causality Bias

question 10

Essay

Your textbook uses the following example of simultaneous causality bias of a two equation system:
Yi = β0 + β1Xi + ui
Xi = + Yi + vi
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?

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