The Identification Problem

In this chapter we consider the nature and significance of the identification problem. The crux of the identification problem is as follows: Recall the demand-and-supply model introduced in Section 18.2. Suppose that we have time series data on Q and P only and no additional information (such as income of the consumer, price prevailing in the previous period, and weather condition). The identification problem then consists in seeking an answer to this question: Given only the data on P and Q, how do we know whether we are estimating the demand function or the supply function? Alternatively, if we think we are fitting a demand function, how do we guarantee that it is, in fact, the demand function that we are estimating and not something else?

A moment's reflection will reveal that an answer to the preceding question is necessary before one proceeds to estimate the parameters of our demand function. In this chapter we shall show how the identification problem is resolved. We first introduce a few notations and definitions and then illustrate the identification problem with several examples. This is followed by the rules that may be used to find out whether an equation in a simultaneous-equation model is identified, that is, whether it is the relationship that we are actually estimating, be it the demand or supply function or something else.

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