An endogenous variable is a variable that depends on other variables in a statistical and/or economic model. If the value changes for an endogenous variable, it is because there are changes to its relationships with other variables in the same model. Therefore, it is similar to a dependent variable because both are influenced by one or more independent variables.
An exogenous variable is the exact opposite of an endogenous variable because it is a variable that depends on external factors outside of the model, so it is not impacted by variables within the model. In real-life situations, however, some variables may not be entirely endogenous, as they can be influenced by factors both external and internal to the model. Therefore, variables are often partly endogenous and partly exogenous.
Examples of an Endogenous Variable
1. Equilibrium in supply and demand
The equilibrium price and quantity in a supply and demand economic model is an endogenous variable. It is because there can be many factors that influence supply and demand, which impact the equilibrium price and quantity.
Examples of factors that influence supply and demand include changes in income, changes in consumer preference, growth in the economy, availability of alternative goods and services, etc.
In economic or statistical models that include income, it is considered to be an endogenous variable. For example, changes in income are dependent on variables such as changes in consumer expenditure or changes in consumers’ buying power.
3. Interest rate
In economic models with an interest rate, it is endogenous because the interest rate can depend on various factors, such as changes in the prime rate, strengthening of the local currency, and fluctuations in the supply and demand of money.
Besides the field of economics, endogenous variables can also be found in other fields of study. Agricultural inputs are also considered to be endogenous. For example, the amount of crop yields is endogenous because it is dependent on many other variables, such as the weather, soil fertility, water availability, pests, and diseases.
The level and quality of education received by an individual is also an endogenous variable. It is because an individual’s level of education often relies on multiple factors, including income, geographic location, and socioeconomic status.
Correlation with the Error Term
An endogenous variable is correlated with many other factors in an econometric model, which also includes the error term. An econometric model is a model that uses statistical methods to analyze economic data and relationships.
An error term refers to a variable in a model that accounts for the deviation, which is developed when a model does not fully represent the actual relationship between the independent and dependent variables.
Applications of Endogenous Variables
Endogenous variables are an essential part of econometrics, economic modeling, and linear regression. It is important because it shows how a variable influences another variable and the effect that comes with it.
Understanding variables is important when conducting research, such as in data analysis, analyzing relationships between numbers, and understanding quantitative outcomes. It is also used in research for many different fields besides economics and statistics, including sociology, psychology, meteorology, and political science.
For example, modeling endogenous variables is a useful skill in developing ideas in the social sciences, demonstrating value in progressing research. Since education is endogenous, as explained above, researchers in the social sciences use such an idea to explore what factors may impact education in developing countries. Focusing on the factors can help researchers figure out ways to target the root of educational issues.
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