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ENDOGENOUS VARIABLE AND EXOGENOUS VARIABLE

They are the observable variables and usually there are more variables than the number of
equations in the model. Some of the variables are supposed to be determined by forces
completely outside the model and their values are assumed to be given. Such variables area
called “EXOGENOUS VARIABLES”. Variables like “government policy, population etc. are
the example of exogenous variables. It is treated like a parameter in solving the equations of a
model.
The variable whose values are determined by the system when parameters disturbances and
exogenous variables are given are called “ ENDOGENOUS VARIABLES”. Endogenous
variables cannot affect the value of exogenous variables. Bu the values of exogenous variables
influence the value of endogenous variables.

TYPE 1 ERROR
The decision to accept or reject the null hypothesis H0 is made on the basis of information
supplied by the sample observations. It is possible the conclusion drawn on the basis of a
particular sample may not be true in aspect of population. When the test procedure rejects a
hypothesis when it ought to have been accepted, it is called “type 1 error”.

NULL HYPOTHESIS
It implies a neutral or non-committal attitude of the statistician in testing the hypothesis. It is a
hypothesis of absence of relationship or absence of difference between sample static and
population parameters.
β0 = 0 is the null hypothesis.

LEVEL OF SIGNIFICANCE
The validity of a hypothesis H0 is against the alternative hypothesis H1 is tested at a certain
level. The LEVEL OF SIGNIFICANCE determines the confidence within which a statistician
accepts a null hypothesis. 5% is the level of significance and 95% is the level of confidence.

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R 2(R SQUARE) AND R2( R BAR SQUARE)

R SQUARE . IS THE MEASURE OF “ GOODNESS OF FIT: IT MEASURES HOW WELL
THE REGRESSION LINE FITS THE OBSERVED DATA. R2 lies between 0 and 1
Ie 0<R2>1
WHEN THERE IS INCLUSION OF ADDITIONAL EXPLANATORY VARIABLES IN THE
FUNCTION IT CAN NEVER REDUCE R2 AND WILL USUALLY INCREASE IT. TO
CORRECT FOR THIS DEFECT, WE ADJUST R2 BY TAKING INTO ACCOUN THE
DEGREE OF FREEDOM, WHICH CLEARLY DECREASE AS NEW INDEPENDENT
VARIABLE, KNOWN AS (R BAR SQUARE). IT IS ALSO KNOWN AS “ LOSS OF
DEGREE OF FREEDOM”.

TYPE 2 ERROR
WHEN THE TEST LEADS TO ACCEPTANCE OF A FALSE HYPOTHESIS IT IS CALLED
TYPE 2 ERROR.
CRITICAL REGION
WHILE ACCEPTING OR REJECTING A NULL HYPOTHESIS AT A GIVEN LEVEL OF
SIGNIFICANCE THE REGION OF REJECTION IS CALLED AS CRITICAL REGION
WEHREAS THE OTHER REGION IS CALLED AS REGION OF ACCEPTANCE.

PROBLEM OF IDENTIFICATION
PROBLEM OF IDENTIFICATION IMPLIES OUT WHETHER NUMBERICAL ESTIMATES
OF THE PARAMETERS OF TH ESTRUCTURAL EQUATION CAN BE OBTAINED FROM
THE ESTIMATED REDUCED FORM OF COEFFICIENT. IF THIS IS POSSIBLE THEN WE
SAY THAT TH EEQUATION IS IDENTIFIED. IDENTIFICATION PROBLEM ARISE
ONLY FOR THOSE EQUATIONS, WHICH HAVE COEFFICIENTS WHICH HAVE TO BE
ESTIMATED STATISTICALLY.

ORDER CONDITION AND RANK CONDITION

ORDER CONDITION: FOR AN EQUATION TO BE IDENTIFIED THE TOTAL NO. OF
VARIABLES EXLUDED FROM IT BUT INCLUDED IN OTHER EQUATIONS OF THE

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MODEL MUST BE ATEAST AS GREAT AS THE NO OF EQUATIONS OF THE SYSTEM

MINUS ONE.
RANK CONDITION: IN A SYSTEM OF G EQUATIONS ANY PARTICULAR EQUATION
IS IDENTIFIED IF AND ONLY IF IT IS POSSIBLE TO CONSTRUCT ATLEAST ONE
NON-ZERO DETERMINANT OF ORDER (G-1) FROM THE CO-EFFICIENT OF THE
VARIABLES EXCLUDED FROM THAT PARTICULAR EQUATION BUT CONTAINED IN
THE OTHER EQUATIONS OF THE MODEL.

STRUCTURAL FORM AND REDUCED FORM OF SIMULTANEOUS EQUATION MODEL

The equations appearing in a simultaneous equation model are called structural or behavioral
equations. They describe the structure or behaviour of the economy or a producing firm in an
econometric model. The parameters of these equations are called “structural parameters”. The
number of such equations in a model is equal to the no. of endogenous or jointly dependent
variables.
Reduced form equations are those equations, which express the endogenous variables only in
terms of the predetermined variables and the stochastic disturbances. Reduced form equations
can be obtained in 2 ways
1. Express the endogenous variables directly as functions of the predetermined variables.
2. solve the structural system of endogenous variables in terms of predetermined variables,
the structural parameters and disturbances.

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Econometrics:
The social science in which tools of economic theory mathematics and statistical inferences
are applied to the analysis of economic phenomena.
Econometrics model
Representing any situation by mathematical equation is called a model. A model of the ype
Y= β1 + β2X + u is called econometric model. Here y is the dependent. E is the explanatory
and u is the disturbance term. It stands for all those variables which indirectly affect y but
are not included in model building process initially. The absence of these variables is
compensated by the presence of u.
Some variables outside the model is called exogenous variables . eg government policy.
Other variables whose value determined by the system called endogenous variable.
Methodology of econometric research or stepwise procedure of conducting ecotrix
study
1. hypothesis statement
2. specification of model
3. estimation of parameters
4. statistical verification
5. use of model for forecasting or estimating or policy decision
Features
1. Model is always based on the assumption
2. Model is assumed to capture the crucial features of the system
3. Model would help n the understanding the real life system
4. Model can predict the future movement of the system and possibly control these
movements to improve the economic welfare.
Structural form
It contains a complete system of equations which are either definitional or stochastic.
Definitional equations are in the form of identities. They are supposed to hold exactly and
contains no unknown parameter.
e.g. Y = C +I
where y: total national income
c= consumption
I= investment

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The remaining equations in the model are stochastic.

REDUCED FORM:
Endogenous variable as a function of parameters and exogenous variables.
Given d = α + bp
S = α + βp + cr
D=s
Reduced form of the model is obtained by solving above three equations.
ASSUMPTIONS OF THE LINEAR STOCHASTIC REGRESSION MODEL
a. stochastic assumption of OLS”
1. u is the random real variable
2. the mean value of u in any particular period is 0
3. assumption of homo-scedasticity
4. assumption of normality
5. the random terms of difference of different observations (ui, yi) are
independent. Cov (ui, yi) = 0 therefore i ≠ j
6. u is independent of explanatory variables
7. the explanatory variables are measured without error
b. other assumptions of OLS
1. the explanatory variables are not perfectly linearly correlated i.e. there is no
multicorrelation.
2. the macro variables are correctly aggregated.
3. the relationship being estimatedis identified.
4. the relationship is correctly estimated
ASSUMPTIONS OF MULTIPLE REGRESSION MODEL
1. mean of u is 0
2. no serial correlation
3. homoscedasticity
4. cov (u, xi) = 0
5. model is correctly specified
6. model is linear in parameters.
7. no exact collinearity between the x-variables i.e explanatory variables.

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