Which Form 8655 Reduced 2024

This video will cover simultaneous equations and the use of instrumental variables to model models with endogenous independent variables. By the end of this video, you should feel comfortable explaining the meaning of endogenous and exogenous variables, solving a system of simultaneous equations in terms of the exogenous variables (also known as the reduced form), determining whether an equation is identified, and assessing the validity of proposed instrumental variables. Let's turn back to the hypothetical market for fresh oranges that we considered earlier. Here, quantity demanded depends on price (P), while the quantity supplied depends on both price and weather (W). Let's introduce two new definitions to help us talk about the variables in this model. An endogenous variable is determined by a system of equations. Notice that quantity (Q) appears in both the demand and supply relationship, as does price (P). Both quantity and price are jointly determined by the system of equations, so they are endogenous. This is consistent with the Greek root "endo," which means "inside." An exogenous variable, on the other hand, is determined outside of the system. Notice that weather (W) appears only in the supply equation. Whether affects quantity supplied, but is not part of the demand relationship. Accordingly, weather is an exogenous variable. This is consistent with the Greek root "exo," which means "outside." Now, how do we estimate the parameters (betas and alphas) of the demand and supply relationships? We might try using OLS (Ordinary Least Squares) regression in Stata to regress quantity (Q) on price (P) and attempt to estimate the parameter beta2 in the demand equation. However, it is worth noting that the independent variable (price) is also an endogenous variable. We will see shortly that this is a problem. Recall that the OLS regression would produce unbiased estimates only...