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Czech University of Life Sciences Prague

Department of Economics

Subject: Econometrics

Examples and practising

7th LESSON:
Simultaneous equations models

2012
Introduction
In this document you can found the examples which are related with 7th econometric lesson.
The content is shown below. Every subchapter has one example which is solved. Other
exercises are for practising, solution is in the end of the document.

Content
1 IDENTIFICATION OF THE MODEL ........................................................................................... 2

2 STRUCTURAL FORM, MATRICES BETA AND GAMA .......................................................... 5

3 REDUCED FORM OF A MODEL.................................................................................................. 7

4 RESULTS OF PRACTISING EXERCISES................................................................................... 9

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1 Identification of the Model
Example 1
Identify following model:
y1t = 11x1t + 13x3t + 14x4t + u1t
y2t = 21y1t + 21x1t + 22x2t-1 + 23x3t + 24x4t + u2t
y3t = y1t + y2t

Solution
Number of predetermined variables, which are in the whole model: k = 4
Namely: x1t, x2t-1, x3t, x4t

Number of endogenous variables, which are in the whole model: g = 3

Namely: y1t, y2t, y3t

Now we start to identify individual equations.

1st equation:
Number of predetermined variables, which are in the equation: k* = 3
Namely: x1t, x3t, x4t

Number of predetermined variables, which are NOT in the equation: k** = 1

Namely: x2t-1

Number of endogenous variables, which are in the equation: g = 1

Namely: y1t

Number of endogenous variables, which are in the equation minus one: g 1 = 0

In this case equation is identified

Condition of identification: k** g 1
or over-identified

1st equation 1>0 1st equation is over-identified

2nd equation:
Number of predetermined variables, which are in the equation: k* = 4
Namely: x1t, x2t-1, x3t, x4t

Number of predetermined variables, which are NOT in the equation: k** = 0

Namely: nothing

Number of endogenous variables, which are in the equation: g = 2

Namely: y1t, y2t

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Number of endogenous variables, which are in the equation minus one: g 1 = 1

In this case equation is identified

Condition of identification: k** g 1
or over-identified

2nd equation 0<1 2nd equation is under-identified

3rd equation:
Third equation is an identity equation, because it has known parameters (which are equal to
one) and the equation has not a stochastic variable (ut).
Every identity equation is automatically considered as identified; therefore we dont identify
this equation.

Conclusion:
The model is not identified, because one equation is under-identified.

Example 2
Use the model from Example 1, i.e.:
y1t = 11x1t + 13x3t + 14x4t + u1t
y2t = 21y1t + 21x1t + 22x2t-1 + 23x3t + 24x4t + u2t
y3t = y1t + y2t

Reconstruct equations to have all equations identified.

Solution
1st equation previous situation
Number of predetermined variables, which are NOT in the equation: k** = 1
Number of endogenous variables, which are in the equation minus one: g 1 = 0
Condition of identification in this case is: 1 > 0.
The first equation is over-identified.

1st equation new situation

For identified equation we have to add one missing predetermined variable, namely variable
x2t-1.
y1t = 11x1t + 12x2t-1 + 13x3t + 14x4t + u1t

Number of predetermined variables, which are NOT in the equation: k** = 0

Number of endogenous variables, which are in the equation minus one: g 1 = 0
Condition of identification modified 1st equation: 0 = 0 identified equation
The first equation is identified.

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2nd equation previous situation
Number of predetermined variables, which are NOT in the equation: k** = 0
Number of endogenous variables, which are in the equation minus one: g 1 = 1
Condition of identification in this case is: 0 < 1.
The second equation is under-identified.

2nd equation new situation

For identified equation we have to remove one predetermined variable, for example we
remove variable x4t.
y2t = 21y1t + 21x1t + 22x2t-1 + 23x3t + u2t

Number of predetermined variables, which are NOT in the equation: k** = 1

Number of endogenous variables, which are in the equation minus one: g 1 = 1
Condition of identification modified 2nd equation: 1 = 1 identified equation
The second equation is identified.

The final modified model is:

y1t = 11x1t + 12x2t-1 + 13x3t + 14x4t + u1t
y2t = 21y1t + 21x1t + 22x2t-1 + 23x3t + u2t
y3t = y1t + y2t

Practising Exercises

Exercise 1:
Identify following model:
y1t = 12y2t + 11x1t + 14x4t + u1t
y2t = 21y1t + 21x1t + 23x3t + *22y2t-1 + u2t
y3t = y1t + y2t + x2t

Exercise 2:
Identify following model:
y1t = 12y2t + 11x1t + 12x2t + 13x3t-1 + 15x5t + 16x6t + u1t
y2t = 21x1t + 22x2t + 23x3t-1 + *22y2t-1 + u2t
y3t = 31y1t + 32y2t + 31x1t + 36x6t + u3t

Exercise 3:
Identify following model:
y1t = 13y3t + 11x1t + 13x3t + 14x4t + u1t
y2t = 21y1t + 21x1t + 22x2t-1 + 23x3t + 24x4t + u2t
y3t = 31x1t + 32x2t-1 + u3t

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Exercise 4:
Identify following model:
y1t = *11y1t-1 + 11x1t + 12x2t + 19x9t + u1t
y2t = 21y1t + 21x1t + 23x3t-1 + 28x8t + 29x9t + u2t
y3t = 31y1t + 32y2t + 31x1t + 33x3t-1 + u3t
y4t = y1t + y2t y3t

Exercise 5:
Identify following model:
y1t = 20 + 8x1t 4x2t + 12x3t + u1t
y2t = 14 3y1t + 11x2t 5x4t-1 + u2t
y3t = 5 7,5y1t-1 + 7y2t + 6x1t 12x2t + 15x3t + u3t

2 Structural Form, Matrices Beta and Gama

Example
Create matrices and of the following model from previous chapter:
y1t = 11x1t + 13x3t + 14x4t + u1t
y2t = 21y1t + 21x1t + 22x2t-1 + 23x3t + 24x4t + u2t
y3t = y1t + y2t

Determine general size of matrices and size for this case.

Solution
y1t y2t y3t x1t x2t-1 x3t x4t
1 0 0 11 0 13 14

= 21 1 0 = 21 22 23 24
1 1 1 0 0 0 0

General size of matrix is [g x g], where g is a number of endogenous variables in a model.

Size of case matrix is [3 x 3].

General size of matrix is [k x g], where g is number of endogenous variables and k is

number of predetermined variables in a model.
Size of case matrix is [4 x 3].

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Practising Exercises

Exercise 1:
Create matrices and of the following model:
y1t = 12y2t + 11x1t + 14x4t + u1t
y2t = 21y1t + 21x1t + 23x3t + *22y2t-1 + u2t
y3t = y1t + y2t + x2t

Exercise 2:
Create matrices and of the following model:
y1t = 12y2t + 11x1t + 12x2t + 13x3t-1 + 15x5t + 16x6t + u1t
y2t = 21x1t + 22x2t + 23x3t-1 + 24y2t-1 + u2t
y3t = 31y1t + 32y2t + 31x1t + 36x6t + u3t

Exercise 3:
Create matrices and of the following model:
y1t = 13y3t + 11x1t + 13x3t + 14x4t + u1t
y2t = 21y1t + 21x1t + 22x2t-1 + 23x3t + 24x4t + u2t
y3t = 31x1t + 32x2t-1 + u3t

Exercise 4:
Create matrices and of the following model:
y1t = *11y1t-1 + 11x1t + 12x2t + 19x9t + u1t
y2t = 21y1t + 21x1t + 23x3t-1 + 28x8t + 29x9t + u2t
y3t = 31y1t + 32y2t + 31x1t + 33x3t-1 + u3t
y4t = y1t + y2t y3t

Exercise 5:
Create matrices and of the following model:
y1t = 20 + 8x1t 4x2t + 12x3t + u1t
y2t = 14 3y1t + 11x2t 5x4t-1 + u2t
y3t = 5 7.5y1t-1 + 7y2t + 6x1t 12x2t + 15x3t + u3t

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3 Reduced Form of a Model
Example
Compute reduced form of the following model.
y1t = 4 x2t + 3x4t-1 + u1t
y2t = 8 2y1t 2x3t x4t-1 + u2t
y3t = 2 + y2t + 3x3t 9x4t-1 + u3t

Solution
Firstly we create matrices and .
y1t y2t y3t x1t x2t x3t x4t-1
1 0 0 4 1 0 3
= 2 1 0 = 8 0 2 1
0 1 1 2 0 3 9

Secondly we compute reduced form by using matrix calculation. The formula is follows:

= 1

1 0 0 1 0 0 1 0 0
a) = 2 1 0 b) = 2 1 0
1
c) = 2 1 0
1

0 1 1 2 1 1 2 1 1

1 0 0 4 1 0 3 4 1 0 3
1
d) = = 2 1 0 8 0 2 1 = 0 2 2 7
2 1 1 2 0 3 9 2 2 1 16

The final model in reduced form is:

y1t = 4 x2t + 3x4t-1 + v1t
y2t = 2x2t 2x3t 7x4t-1 + v2t
y3t = 2 + 2x2t + x3t 16x4t-1 + v3t

7
Practising Exercises

Exercise 1:
Create matrices and of the following model and compute reduced form. Use matrix
calculation.
y1t = 3y2t + 6 + 3x2t-1 + u1t
y2t = y1t + 2 5x3t x4t + u2t
y3t = 2y2t 1 2x2t-1 + x3t + u3t

Exercise 2:
Create matrices and of the following model and compute reduced form. Use matrix
calculation.
y1t = 2y2t + 10 3x2t y2t-1 + u1t
y2t = 3y1t y3t + 5 + 4x3t + u2t
y3t = y1t + y2t + x2t

Exercise 3:
Create matrices and of the following model and compute reduced form. Use matrix
calculation.
y1t = 3x1t 2x3t-1 + 2x4t + u1t
y2t = 3y1t + 8y2t-1 + 5y3t 5x1t 2x2t + 4x4t + u2t
y3t = y1t + y2t + 8x3t

Exercise 4:
Compute reduced form of the following model. Use matrix calculation and a substitution.
Compute also values of error terms of reduced form using ut.
y1t = 3y2t + 8 + 10x2t 7x4t + u1t
y2t = 2y1t 5 15x3t 4x4t + u2t

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4 Results of practising exercises

1 Identification of the model
Exercise 1
Whole model:
k=5 Namely: x1t, x2t, x3t, x4t, y2t-1
We cant forget x2t in the identity equation
g=3 Namely: y1t, y2t, y3t

1st equation:
k* = 2 Namely: x1t, x4t
k** = 3 Namely: x2t, x3t, y2t-1
g = 2 Namely: y1t, y2t
g 1 = 1

Result: 3 > 1 over-identified equation

2nd equation:
k* = 3 Namely: x1t, x3t, y2t-1
k** = 2 Namely: x2t, x4t
g = 2 Namely: y1t, y2t
g 1 = 1

Result: 2 > 1 over-identified equation

3rd equation:
This equation is an identity equation identified equation

Exercise 2
Whole model:
k = 6 Namely: x1t, x2t, x3t-1, x5t, x6t, y2t-1
g = 3 Namely: y1t, y2t, y3t

1st equation:
k* = 5 Namely: x1t, x2t, x3t-1, x5t, x6t,
k** = 1 Namely: y2t-1
g = 2 Namely: y1t, y2t
g 1 = 1

Result: 1 = 1 identified equation

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2nd equation:
k* = 4 Namely: x1t, x2t, x3t-1, y2t-1
k** = 2 Namely: x5t, x6t,
g = 1 Namely: y2t
g 1 = 0

Result: 2 > 0 over-identified equation

3rd equation:
k* = 2 Namely: x1t, x6t
k** = 4 Namely: x2t, x3t-1, x5t, y2t-1
g = 3 Namely: y1t, y2t, y3t
g 1 = 2

Result: 4 > 2 over-identified equation

Exercise 3
Whole model:
k=4 Namely: x1t, x2t-1, x3t, x4t
g=3 Namely: y1t, y2t, y3t

1st equation:
k* = 3 Namely: x1t, x3t, x4t
k** = 1 Namely: x2t-1
g = 2 Namely: y1t, y3t
g 1 = 1

Result: 1 = 1 identified equation

2nd equation:
k* = 4 Namely: x1t, x2t-1, x3t, x4t
k** = 0
g = 2 Namely: y1t, y2t
g 1 = 1

Result: 0 < 1 under-identified equation

3rd equation:
k* = 2 Namely: x1t, x2t-1
k** = 2 Namely: x3t, x4t
g = 1 Namely: y3t
g 1 = 0

Result: 2 > 0 over-identified equation

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Exercise 4
Whole model:
k=6 Namely: x1t, x2t, x3t-1, x8t, x9t, y1t-1
g=4 Namely: y1t, y2t, y3t, y4t

1st equation:
k* = 4 Namely: y1t-1, x1t, x2t, x9t,
k** = 2 Namely: x3t-1, x8t,
g = 1 Namely: y1t
g 1 = 0

Result: 2 > 0 over-identified equation

2nd equation
k* = 4 Namely: x1t, x3t-1, x8t, x9t
k** = 2 Namely: x2t, y1t-1
g = 2 Namely: y1t, y2t
g 1 = 1

Result: 2 > 1 over-identified equation

3rd equation
k* = 2 Namely: x1t, x3t-1
k** = 4 Namely: x2t, x8t, x9t, y1t-1
g = 3 Namely: y1t, y2t, y3t
g 1 = 2

Result: 4 > 2 over-identified equation

4th equation
This equation is an identity equation identified equation

Exercise 5
Whole model:
k=6 Namely: x1t, x2t, x3t, x4t-1, y1t-1, constant term = x0t
Dont forget constant term, which is represented by numbers: 20, 14, 5 in equations
g=3 Namely: y1t, y2t, y3t

1st equation:
k* = 4 Namely: x0t, x1t, x2t, x3t,
k** = 2 Namely: x4t-1, y1t-1
g = 1 Namely: y1t
g 1 = 0
Result: 2 > 0 over-identified equation

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2nd equation
k* = 3 Namely: x0t, x2t, x4t-1
k** = 3 Namely: x1t, x3t, y1t-1
g = 2 Namely: y1t, y2t
g 1 = 1

Result: 3 > 1 over-identified equation

3rd equation
k* = 5 Namely: x0t, y1t-1, x1t, x2t, x3t
k** = 1 Namely: x4t-1,
g = 2 Namely: y2t, y3t
g 1 = 1

Result: 1 > 1 identified equation

2 Structural Form, Matrices Beta and Gama

Exercise 1
y1t y2t y3t x1t x2t x3t x4t y2t-1
1 12 0 11 0 0 14 0

= 21 1 0
= 21 0 23 0 22
*

1 1 1 0 1 0 0 0

Exercise 2
y1t y2t y3t x1t x2t x3t-1 y2t-1 x5t x6t
1 12 0 11 12 13 0 15 16

= 0 1 0
= 21 22 23 24 0 0

31 32 1 31 0 0 0 0 36

Exercise 3
y1t y2t y3t x1t x2t-1 x3t x4t
1 0 13 11 0 13 14

= 21 1 0
= 21 22 23 24

0 0 1 31 32 0 0

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Exercise 4
y1t y2t y3t y4t x1t x2t x3t-1 x8t x9t y1t-1
1 0 0 0 11 12 0 0 19 11*

1 0 0 0 0
= 21 = 21 23 28 29
31 32 1 0 31 0 33 0 0 0

1 1 1 1 0 0 0 0 0 0

Exercise 5
y1t y2t y3t const.term y1t-1 x1t x2t x3t x4t-1
1 0 0 20 0 8 4 12 0
= 3 1 0 = 14 0 0 11 0 5
0 7 1 5 7,5 6 12 15 0

3 Reduced Form of Model

Exercise 1

Matrices and :
y1t y2t y3t const.term x2t-1 x3t x4t
1 3 0 6 3 0 0
= 1 1 0 = 2 0 5 1
0 2 1 1 2 1 0

Matrix :
const.term x2t-1 x3t x4t
6 1.5 7.5 1.5
M = 4 1.5 2.5 0.5
7 1 4 1

The final model in reduced form:

y1t = 6 1.5x2t-1 + 7.5x3t + 1.5x4t + v1t
y2t = 4 1.5x2t-1 + 2.5x3t + 0.5x4t + v2t
y3t = 7 + x2t-1 4x3t x4t + v3t

13
Exercise 2

Matrices and :
y1 y2t y3t const.term x2t x3t y2t-1
1 2 0 10 3 0 1
= 3 1 1 = 5 0 4 0
1 1 1 0 1 0 0

Matrix :
const.term x2t x3t y2t-1
3 0,8 0.8 0.2
= 3,5 1.1 0.4 0.4

0,5 1.3 1.2 0.2

The final model in reduced form:

1t = 3 0.8x2t + 0.8x3t 0.2y2t-1
2t = 3.5 + 1.1x2t + 0.4x3t + 0.4y2t-1
3t = 0.5 + 1.3x2t + 1.2x3t + 0.2y2t-1

Exercise 3

Matrices and :
y1t y2t y3t x1t x2t x3t-1 x4t y2t-2
1 0 0 3 0 2 2 0
= 3 1 5 = 5 2 0 4 8
1 1 1 0 0 8 0 0

Matrix :
x1t x2t x3t-1 x4t y2t-2
3 0 2 2 0

M = 4.75 0.5 6 5 2
1.75 0.5 0 3 2

The final model in reduced form:

y1t = 3x1t 2x3t-1 + 2x4t + v1t
y2t = 4.75x1t + 0.5x2t 6x3t-1 5x4t 2y2t-2 + v2t
y3t = 1,75x1t + 0,5x2t 3x4t 2y2t-2 + v3t

14
Exercise 4

a) Substitution:
First step of substitution:
y1t = 3*[2y1t 5 15x3t 4x4t + u2t] + 8 + 10x2t 7x4t + u1t
y2t = 2*[3y2t + 8 + 10x2t 7x4t + u1t] 5 15x3t 4x4t + u2t

Second step of substitution:

y1t = 6y1t 15 45x3t 12x4t + 3u2t + 8 + 10x2t 7x4t + u1t
y2t = 6y2t + 16 + 20x2t 14x4t + 2u1t 5 15x3t 4x4t + u2t

etc.

Result after adjustment of the above equations:

7 19 1 3
y1t = 2 x 2t + 9 x3t + x4 t u1t u 2 t
5 5 5 5
11 18 2 1
y1t = 4 x 2t + 3 x3t + x 4t u1t u 2t
5 5 5 5
i.e.:
y1t = 1.4 2x2t + 9x3t + 3,8x4t 0.2u1t 0.6u2t
y2t = 2.2 4x2t + 3x3t + 3.6x4t 0.4u1t 0.2u2t

b) Matrix calculation

Matrices and :
y1t y2t const.term x2t x3t x4t
1 3 8 10 0 7
= =
2 1 5 0 15 4

Matrix :
const.term x2t x3t x4t
1. 4 2 9 3 .8
=
2. 2 4 3 3.6

Reduced form:
y1t = 1.4 2x2t + 9x3t + 3,8x4t + v1t
y2t = 2.2 4x2t + 3x3t + 3.6x4t + v2t

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Now we have to compute the value of random variables of reduced form vit.
1
Formula: vt = u t

v 0 .2 0 .6 u
vt = 1t 1 = u t = 1t
v 2 t 0 .4 0 .2 u 2t

v1t 0.2 0.6 u1t 0.2u1t 0.6u 2t

v = 0.4 0.2 u = 0.4u 0.2u
2t 2t 1t 2t

i.e., final model in reduced form:

y1t = 1.4 2x2t + 9x3t + 3,8x4t 0.2u1t 0.6u2t
y2t = 2.2 4x2t + 3x3t + 3.6x4t 0.4u1t 0.2u2t

Author:
Ing. Petra Bubkov, CULS, FEM, Department of Economics

Note:
This material has not undergone editorial or language editing. If you found some mistakes,
dont hesitate to contact me by email: bubakova@pef.czu.cz

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