Question #57800

Consider the following demand and supply model for money. Demand for Money: Mt to the power d=alpha0+alpha1yt+alpha2Rt+alpha3Pt+u1t
Supply of Money: Mt to the power s=beta 0+ beta1yt+u2t where M = Money, Y = Income, P = Price, and R = rate of interest Assume that R and P are pre-determined. a) Check the identification status of demand and supply equations above. b) What method would you use to estimate the supply equation?

Expert's answer

Demand for Money: Mt to the power d=alpha0+alpha1yt+alpha2Rt+alpha3Pt+u1t

Supply of Money: Mt to the power s=beta 0+ beta1yt+u2t,

where M = Money, Y = Income, P = Price, and R = rate of interest, R and P are pre-determined.

If the demand for Money is Mtd=alpha0+alpha1Yt+alpha2Rt+alpha3Pt+u1t and the supply of Money is Mts=beta 0+ beta1yt+u2t, then in equilibrium Md = Ms, so: alpha0+alpha1Yt+alpha2Rt+alpha3Pt+u1t = beta 0+ beta1yt+u2t.

a) If one and only one value of each structural coefficient is compatible with the reduced form coefficients the model is said to be just identified or exactly identified, so our demand and supply equations above cannot be identified.

b) To estimate the supply equation we can't use any technique, as our demand and supply equations above cannot be identified.

Supply of Money: Mt to the power s=beta 0+ beta1yt+u2t,

where M = Money, Y = Income, P = Price, and R = rate of interest, R and P are pre-determined.

If the demand for Money is Mtd=alpha0+alpha1Yt+alpha2Rt+alpha3Pt+u1t and the supply of Money is Mts=beta 0+ beta1yt+u2t, then in equilibrium Md = Ms, so: alpha0+alpha1Yt+alpha2Rt+alpha3Pt+u1t = beta 0+ beta1yt+u2t.

a) If one and only one value of each structural coefficient is compatible with the reduced form coefficients the model is said to be just identified or exactly identified, so our demand and supply equations above cannot be identified.

b) To estimate the supply equation we can't use any technique, as our demand and supply equations above cannot be identified.

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