Definition of Predetermined Variable
Predetermined variables are variables in an economic model whose past values and current values are known and not subject to future randomness. These variables typically play a critical role in econometric models as they are decided in the past and influence current economic decisions and outcomes, but are not influenced by future states of the world.
Example
Suppose a government sets a budget for infrastructure spending at the beginning of a fiscal year. This budget allocation is an example of a predetermined variable as it is decided based on past data and current economic conditions. The actual value is known at the time of implementation and remains unaffected by future economic fluctuations for the rest of the fiscal period.
In another scenario, think about a firm that signs a contract committing to buy a certain amount of raw materials at a fixed price over the next quarter. The quantity and price of raw materials are predetermined variables as they are fixed by the contract based on current agreements and past negotiations. Even if the market price of raw materials fluctuates during the quarter, the terms of this contract remain unchanged.
Why Predetermined Variables Matter
Predetermined variables are crucial for economic modeling and forecasting. They help in simplifying models and making accurate predictions because their values are known beforehand, reducing uncertainty in the model. These variables allow economists to isolate and analyze the impact of other variables that can change due to future events.
Moreover, predetermined variables are essential in the context of policy analysis. Knowing the fixed components allows policymakers to better estimate the outcomes of fiscal or monetary policies. For instance, understanding the predetermined costs in a budget can help in assessing the flexibility of government spending in response to economic shocks.
Frequently Asked Questions (FAQ)
How do predetermined variables differ from endogenous and exogenous variables?
Predetermined variables differ from endogenous and exogenous variables based on their role and influence in an economic model:
- Endogenous Variables: These are variables whose values are determined within the model by the interaction of other variables in the system. For example, in a supply and demand model, the equilibrium price is an endogenous variable because it’s determined by the intersection of supply and demand curves.
- Exogenous Variables: These variables come from outside the model and are not affected by the system’s dynamics. For instance, technological advancements in a production function are often considered exogenous because they influence productivity but are not explained within the model itself.
- Predetermined Variables: Unlike the above, predetermined variables have fixed values based on past decisions and are not subject to future uncertainty. They lie somewhere in between, as they are determined outside the model but influence the model’s outcome.
What are some common examples of predetermined variables in economic models?
Common examples of predetermined variables include:
- Past investment in infrastructure
- Previously agreed labor contracts
- Committed budget expenditures
- Historical interest rates
- Existing inventories of goods
These examples illustrate how predetermined variables are set based on past actions or decisions and remain constant over the analysis period.
Can a variable be both predetermined and endogenous in different contexts?
Yes, a variable can be both predetermined and endogenous depending on the context and timing of the analysis. For example, capital stock in an economic growth model can be considered predetermined in the short run because it is determined by past investments and cannot change immediately. However, in the long run, capital stock becomes an endogenous variable because it is influenced by investment decisions within the model.
How do predetermined variables impact econometric analysis?
Predetermined variables significantly impact econometric analysis by reducing model uncertainty and helping to identify causal relationships. Since their values are already known and not subject to future changes, they provide a stable foundation for analyzing the effects of other variables. This stability makes it easier to isolate the true influence of endogenous variables on the outcomes being studied, leading to more accurate and reliable econometric models.
What tools or methods are used to identify predetermined variables in a dataset?
Identifying predetermined variables in a dataset typically involves:
- Reviewing past data and historical records to identify fixed values.
- Consulting domain experts who have insights into which variables are decided based on past actions or plans.
- Using econometric techniques like time-series analysis to distinguish between variables affected by past decisions and those influenced by current or future states.
These methods help ensure that models accurately reflect the structure and dynamics of the economic system being analyzed.