The following two structural equations represent a simple demand-supply model:
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Demand: Qt ¼ a0 þ a1Pt þ a2Yt þu1t
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a1 0 and
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a2 > 0
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Supply: Qt ¼ b0 þ b1Pt þ u2t
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b1 > 0
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where Q is quantity, P is price, and Y is consumers' income. It is assumed that the market is cleared in every year so that Qt represents both quantity bought and sold in year t.
(a) Why is this a simultaneous-equations model?
(b) Which are the endogenous and exogenous variables of the system?
(c) Why would the estimation of the demand and supply function by OLS give biased and inconsistent parameter estimates?