When does an independent variable become endogenous?
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An independent variable is any variable that is used to explain another (dependent) variable. That is, in the usual regression set-up, Y = a + Xb, where Y is dependent and X independent.
What we would really like, though, is for X to be exogenous: it causes Y, and not the other way around. Like, for example, if you raise price, demand goes down. That is, if you can simply decide on a higher price, you’ll find lower demand.
However, if demand goes up — for some reason, people want a product more — than you can raise price. If you merely observe that system, you’d conclude that higher prices are associated with higher demand: the opposite of what you concluded before.
And that is because, in that latter situation, price is endogenous: it cannot be independently manipulated, and it is being caused BY the dependent variable, instead of the other way around.
In practice, many variables mutually “cause” one another, which is why economists like to look at “acts of God” like earthquakes, and look at their effects, since it’s pretty clear the effects aren’t causing the earthquakes.
What we would really like, though, is for X to be exogenous: it causes Y, and not the other way around. Like, for example, if you raise price, demand goes down. That is, if you can simply decide on a higher price, you’ll find lower demand.
However, if demand goes up — for some reason, people want a product more — than you can raise price. If you merely observe that system, you’d conclude that higher prices are associated with higher demand: the opposite of what you concluded before.
And that is because, in that latter situation, price is endogenous: it cannot be independently manipulated, and it is being caused BY the dependent variable, instead of the other way around.
In practice, many variables mutually “cause” one another, which is why economists like to look at “acts of God” like earthquakes, and look at their effects, since it’s pretty clear the effects aren’t causing the earthquakes.
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