3. Suppose you have the following simple Keynesian macroeconomic model: co.-Ao +

Question

3. Suppose you have the following simple Keynesian macroeconomic model: co.-Ao + .YD, + 2C0t-1 + Elt Where: = Gross Donnestic Product (GDP) in year t. Co,- total personal consumption in year t. = total gross private domestic investment in year t. Gi- government purchases of goods and services in year t. NXt= net exports of goods and services in year t. = net taxes in year t. the interest rate in year t. YD- disposable income in year t. (a) Are your equations structural or reduced-form? (3 marks) (b) How many and what are the endogenous and exogenous/predetermined variables? (3 marks) (c) Are the equations over-, under- or just identified? (3 marks) (d) Carefully outline how you will apply 2SLS to this system. How many equations (including reduced form) would you have to estimate and which variables will be in which equation. (6 marks)

Explanation / Answer

a). the equations are in structural form because in reduced form, the equation represents the key endogenous variable as a function of exogenous variable.

b). Endogenous variable: The endogenous variables are those that are determined by the forces in the system. Crucial endogenous variable is Y and the other endogenous variable is CO, I

Total = 3

Exogenous variable: the exogenous variables are those fixed, determined by the forces outside the system. The exogenous variables in the Simple Keynesian model include: G, T, r

Total = 3

c)

d) equation 1 and 2 can be estimated by 2SLS.

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