Consider the following simple macroeconomic model: C, ?0 + ?,K + ?2r, + ?,W, + u\" ; Consumption Function l, = ?? + ßir, + ?), + ?,Y,-| + u 2, ; Investment Function Yo+Yl, +,M,+ Interest Rate Equation where Ci is consumption at time t, Y, is income, r, is interest rate, W, is wealth, I, is investment, M, is money supply Note that a lagged endogenous variable should be treated as an exogenous variable. 1. State the endogenous variables 2. State the exogenous variables Using the order condition foridentification, evaluate the identifiability of the parameters in investment equation. Explain, step by step, how one can estimate the coefficients of the investment equation using the 2SLS (two-stage least squares) method. 4. nel su Which of the following is true for the parameter estimation of investment equation? a. OLS estimator is unbiased but inconsistent b. 2SLS estimator is unbiased and consistent c. OLS estimator is biased but consistent iS 2SLS estimator is biased but consistent Each question carries an equal mark of 1. Solution Here the variables are consumption (c), income(y), investment (I) and money supply (m) Answer 1 endegeneous variable: These are the variables whose value depends on dependent as well as independent variables Consumption(c): It is a function of income (y) as well as interest rate (r) Investment(i): It is a function of income (y) as well as interest rate (r) Income(Y): It is a function of Wealty (w) as well as income (Y) Answer 2 exegeneous variable: These are the variables whose value depends on independent variables only. MONEY SUPPLY(M)= is fixed by the central bank and is independent of any dependent variable. Interest Rate (r): is fixed by the central bank and is independent of any dependent variable. Note: For both M,r THE BASIC DEPENDENT VARIABLE IS inflation Answer 3 Given Investment Equation: B(0)+ B(1)r(1)+ B(2)Y(t-1) + U(2) B(0): It is intercept of equation so it has to be positive i.e <0 B(1): it is a function of r so it is negative i.e> 0 B(2): it is a function of Y ( One lagged time period i.e t-1). so it is nothing basically savings from previous income period so it is positive i.e <0 U(2): Nothing Can be said Answer 4 Step 1: Identify endegeneous variable (with erroe term co-relation)... This is the problematic variable Step 2:After which an intrument variable is created in place of problamatic variable. Step 3:Then we creat a new variable using the instrument variable. After Which the model-estimated values from above are used in place of the actual values of the problematic predictors..

1. Consider the following simple macroeconomic model: C, ?0 + ?,K + ?2r, + ?,W, + u" ;
Consumption Function l, = ?? + ßir, + ?), + ?,Y,-| + u 2, ; Investment Function Yo+Yl, +,M,+
Interest Rate Equation where Ci is consumption at time t, Y, is income, r, is interest rate, W, is
wealth, I, is investment, M, is money supply Note that a lagged endogenous variable should be
treated as an exogenous variable. 1. State the endogenous variables 2. State the exogenous
variables Using the order condition foridentification, evaluate the identifiability of the
parameters in investment equation. Explain, step by step, how one can estimate the coefficients
of the investment equation using the 2SLS (two-stage least squares) method. 4. nel su Which of
the following is true for the parameter estimation of investment equation? a. OLS estimator is
unbiased but inconsistent b. 2SLS estimator is unbiased and consistent c. OLS estimator is biased
but consistent iS 2SLS estimator is biased but consistent Each question carries an equal mark of
1.
Solution
Here the variables are consumption (c), income(y), investment (I) and money supply (m)
Answer 1
endegeneous variable: These are the variables whose value depends on dependent as well as
independent variables
Consumption(c): It is a function of income (y) as well as interest rate (r)
Investment(i): It is a function of income (y) as well as interest rate (r)
Income(Y): It is a function of Wealty (w) as well as income (Y)
Answer 2
exegeneous variable: These are the variables whose value depends on independent variables
only.
MONEY SUPPLY(M)= is fixed by the central bank and is independent of any dependent
variable.
Interest Rate (r): is fixed by the central bank and is independent of any dependent variable.
Note: For both M,r THE BASIC DEPENDENT VARIABLE IS inflation
Answer 3
Given Investment Equation: B(0)+ B(1)r(1)+ B(2)Y(t-1) + U(2)
B(0): It is intercept of equation so it has to be positive i.e <0
B(1): it is a function of r so it is negative i.e> 0
B(2): it is a function of Y ( One lagged time period i.e t-1). so it is nothing basically savings from
previous income period so it is positive i.e <0

2. U(2): Nothing Can be said
Answer 4
Step 1: Identify endegeneous variable (with erroe term co-relation)... This is the problematic
variable
Step 2:After which an intrument variable is created in place of problamatic variable.
Step 3:Then we creat a new variable using the instrument variable.
After Which the model-estimated values from above are used in place of the actual values of the
problematic predictors.