2/7/12

What is an exogenous variable?


With respect to economics, an exogenous variable is a variable that is independent or determined outside of the model.  This means that an exogenous variable has a one way relationship with the model in question, it influences or impacts that model AND is not affected by the model.

For example, let's say that the amount of tax you pay, is 20% of your income.  We could write this as:

tax you pay = .2 * your income
or
T=.2Y


Here, T is endogenous and Y is exogenous.  Your income is determined outside of the model, and is used to figure out how much tax you are going to pay.  Y is exogenous because it does not depend on the value of T, it is the other way around.  Think about it, if you pay more taxes, does your income go up?  No, it is your income going up that causes the amount of taxes you pay to go up.

An exogenous variable will always be on the right hand side of the equation, such as Y in the equation above.  It is possible to have an endogenous variable on the right hand side of a multi-equation set, but this will only become an issue in more advanced classes.

Generally, when graphing an exogenous and endogenous variable, the exogenous variable goes on the X axis (which is why time always goes on the X axis) and the endogenous variable goes on the Y axis.  This is because we want to see how the Y axis variable reacts to changes in the X axis variable.

Does it make sense for a change in temperature to cause a change in time?  No, because time is exogenous in this model


However, in our typical supply and demand graph, these have been reversed.  Most economists agree that price drives quantity, but for some reason, in the history of economics, this was switched around and we are stuck with our typical supply and demand graph as you see it today.



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