Market analysts often estimate reduced form regression models in practice. When would this approach be appropriate?

ACE 427 Fall 2020 Homework 1 Due date: Beginning of class, Tuesday, September 14th, 2021 1. Consider the following supply and demand model for wheat,

QDt = a – b Pt + c It (Demand) QSt = d + e Pt – f Ft (Supply) QDt = QSt (Equilibrium)

where It is the income of wheat consumers and Ft is the price of nitrogen fertilizer. a. Solve for the equilibrium price of wheat in this supply and demand model. b. What is the sign of the change in wheat prices as income increases? How much does the

price of wheat change when income increases by one unit? c. Assuming you had the data for the variables, could the single equation model you derived

for price be estimated using linear regression? Explain. d. The equation you solved for in part (a) is called the reduced form of a supply and demand

model. If you estimate the reduced form via linear regression, can you recover estimates for the underlying structural parameters (a,b,c,d,e,f)? Why or why not? What does this imply about using the reduced form regression slope estimates to estimate supply and demand price elasticities?

e. Market analysts often estimate reduced form regression models in practice. When would this approach be appropriate? Be brief. 50 words or less.

QDt = a – b Pt + c It (Demand)
QSt = d + e Pt – f Ft (Supply)
QDt = QSt (Equilibrium)

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