Structural Form
As an example, we use a system of two equations. Both equations are linear. The system models the supply and demand of some specific good. The quantity of the demand varies inversely with the price: a higher price decreases demand. The quantity of the supply varies directly with the price: a higher price makes supply more profitable. In formulas:
- supply:
- demand:
with positive bS and negative bD. This is the structural form of the equation system: the equations are derived from the theory. (In this case, the economic theory of supply and demand.)
The two endogenous variables are the traded quantity Q and the price P, defined by the two equations of the system. Of course there are always as many endogenous variables as there are equations.
Read more about this topic: Reduced Form
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