Consider the following supply and demand model

where \(Q\) is the quantity, \(P\) is the price, and \(W\) is the wage rate, which is assumed exogenous. Data on these variables are in Table 11.7.

a. Derive the algebraic form of the reduced-form equations, \(Q=\theta_{1}+\theta_{2} W+v_{2}\) and \(P=\pi_{1}+\pi_{2} W+v_{1}\), expressing the reduced-form parameters in terms of the structural parameters.

b. Which structural parameters can you solve for from the results in part (a)? Which equation is "identified"?

c. The estimated reduced-form equations are \(\hat{Q}=5+0.5 \mathrm{~W}\) and \(\hat{P}=2.4+1 W\). Solve for the identified structural parameters. This is the method of indirect least squares.

d. Obtain the fitted values from the reduced-form equation for \(P\), and apply 2SLS to obtain estimates of the demand equation.

Transcribed Image Text:

Demand: Q = +P;+ edir Supply: Q = B + BP; + 3 W; + e si B3 +e