Answer to Question #227971 in Microeconomics for Graylin Lapi

Question

Differentiate between an exogenous variable and an endogenous variable in an economic model? Why isn’t it useful to construct an economic model that contains only exogenous variables (and no endogenous variables)?

Answer 1

An Exogenous variable is defined as the type of variable in an economic model, where the model explains the economic processes by using variables and the relationship between the variables. An exogenous variable is referred to as a variable that exists outside the economic model, i.e. the factors outside the model determine the value of the exogenous variable. This means that the variables within the economic model do not affect the exogenous model, i.e. these variables are independent variables and the model is not capable of predicting the value of the exogenous variable.

Example : The modelling of a farms production of corn. There are variables which can either affect or not affect the crops . There are external factors like weather or the pests that could affect and ruin the crops. These are the exogenous variables. 

 

An Endogenous variable is defined as the type of variable in an economic model which has a value that is determined by the model. The Endogenous variable is referred to as a dependent variable. This means that is depends on the other variables within the given model. Due to these endogenous variables, a model can predict the values of this variable. This kind is variable is completely opposite to exogenous variable. 

Example : Suppose a bakery decides how many cookies it is gonna produce daily. In this aspect, the endogenous variable is how many cookies the bakery is able to sell, i.e. it is the number of cookies sold by the bakery, as it depends on other factors like the ingredients of the cookie and the number of employees working at the bakery. 

 

We know that Exogenous Variables are the variables that are taken as given in an economic model, which means that they are determined by a process which is outside the economic model, whereas, the endogenous variables are determined from within the economic model. Therefore, if there are no endogenous variables in the economic model, the model would not serve much purpose as the values of the exogenous variables would not be predicted.