Question

HANT UNE (O POINTS) 1) Assume that a simple economy could be described by the following system of equa Ct = Bo + B1Yt + ulj It-1, where Cis consumption, Y is income, and I is inve C IS Consumption, Y is income, and I is investment. This may be a prim society which does not trade with other islands. There is no government, and the only wood and invested (saved) is sunflower seeds.) Assume the presence of the GDP identity, Y-C+I. If you estimated the consumption function, what sort of problem involving internal validity may be present? Answer:

Answer 1

Here there are two equations.

=> “Ct = b0 + b1*Yt + ui” and “Y = C+I”, where “ui” is the error term. Now, if “Y” increases implied “Ct” increases from the 1^st equation. Similarly, as “Ct” increases implied “Yt” increases from the 2^nd equation. So, there are two way relationship between them. So, if we apply the OLS method to estimate the unknown parameters then the estimated parameter will be biased and inconsistent.