Endogenous Variable

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Last Updated:November 30, 2023

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What Is an Endogenous Variable?

An endogenous variable describes a variable within a statistical model that is influenced by other variables within that same model rather than external factors.

In Economics, a variable is any characteristic, number, or quantity that can be measured or counted. Variables can be independent or dependent depending upon the type of model.

Dependent variables are called Endogenous variables, and Independent variables are called Exogenous variables. These variables are also known as internal or explanatory variables.

This variable is a relationship variable influenced by other variables in the same system or model. It is "endogenous" to the system because its value is determined from within rather than imposed from the outside.

Look at the example of a cause-and-effect relationship. Let's say there are two variables. Here, one variable (assume A) affects another variable (assume B), and the value of B affects the value of A. A and B are dependent on each other and are called endogenous variables.

According to OECD Statistics:

"Endogenous variables designate variables in an economic/econometric model that are explained, or predicted, by that model."

On the contrary, an exogenous variable is a factor that comes from outside a situation and affects what is happening inside it. For example, the weather affects an athlete's performance. (in which the temperature is something outside the situation).

Key Takeaways

Endogenous variables are elements within a system that are influenced by internal components rather than external factors, impacting relationships within models.
Endogenous variables are often referred to as dependent variables in economics, representing characteristics like GDP, fiscal policies, and housing prices, which are shaped by internal dynamics.
They provide insights into cause-and-effect relationships within systems, enhancing predictions, decision-making, and policy formulation.
Understanding endogenous variables helps unravel the complexities of interconnected systems, contributing to better modeling, predictions, and practical solutions.

Understanding Endogenous Variable

Endogenous variables are the ones that can be controlled or influenced because they come from within the system. External factors not part of the model can also impact these variables.

External variables, like shifting consumer tastes, technological developments, or political activities, might impact these variables and make it harder to anticipate them. Nevertheless, these variables remain the central economic concept and are employed in multiple models and analyses.

Exogenous variables come from outside the system and are generally outside our control. However, it's worth noting that not all of these variables can be controlled, and not all exogenous variables are entirely outside our control.

Some exogenous variables, such as government policies or natural disasters, can be affected by human actions. Meanwhile, some of these variables, such as emotions, can be challenging to control.

In some economic models, these variables can assist in predicting financial crises and bubbles. However, one needs to go through a wide range of factors while anticipating something like a crisis, not just the variables.

Studying internal variables has led to significant advancements in understanding

Economic growth
Business cycles
Financial crises

Note

Endogenous variables are generally represented mathematically, using simultaneous equations, algebra, statistics, and regression analysis techniques.

Endogenous variable Examples

Numerous systems, factors, and components would contribute to the structure of a cause-and-effect relationship.

A few examples of those determinants are:

1. Economic growth

The Gross Domestic Product (GDP) is an excellent example of an endogenous variable since it is influenced by investments, how much people spend, and government decisions and policies.

Similarly, the per capita income evaluates the average income of an individual in a country. Again, various items like changes in productivity, workforce participation, and income allotment could impact this. These things will collectively impact the economy.

2. Fiscal Policy

The fiscal policy represents the government's decisions respecting its spending and taxation policies. Consequently, these resolutions can impact economic activities, inflation, and other variables.

Suppose the government increases its spending on infrastructure plans; it will provide employment and boost economic growth. Conversely, if the government raises taxes, it can lower consumer spending and economic activity.

Fiscal policy is an internal variable because it is decided by the government's own decisions and can have a feedback effect on the economy.

3. Housing prices

The price of a house is decided by multiple components, such as:

Demand and supply on the market
Interest rates
Inflation
Demography
Location
Quality
Rules around how houses can be built and used

Policies or changes in the housing market would also affect these factors.

Note

The composite cooperation of supply-demand, economic, population, and governing factors decides a specific market's housing prices.

4. Employment

The total open vacancies, average pay, and skill level can affect someone's employment situation, whether they are already employed or looking for work. Any policies or decisions made within the job market can also change these factors.

Some economic factors, particularly GDP, inflation, and interest rates, and demographic factors, like population growth and migration patterns, can become the dependent variables in employment.

5. Capital Structure

The concept of capital structure describes how business finance its operations, i.e., the proportion of debt and equity utilized to finance investments and business expansion.

A company's capital structure is endogenous since it depends on various internal variables, such as earnings, cash flow, ownership control, and investment choices of a business.

If a business has strong positive cash flow, it may be more likely to deploy debt to fund operations against equity because debt can incur a lower cost than equity.

In contrast, the company may need to issue equity to obtain cash, suppose it has too much debt and restricted access to debt financing.

Note

In business, sales can be observed as a dependent variable as it is influenced by numerous factors, like the quality of the product or service, marketing, pricing strategies, market needs, and so on.

Endogenous Variable importance

These variables help us understand the connections between various economic factors. By understanding these relationships, we can make better future predictions.

The critical importance of these variables includes the following:

1. Expertise in causal relationships.

Expertise in causal relationships means understanding how different factors in a particular area are connected and how they influence each other.

This knowledge lets experts make informed predictions for the future and develop practical approaches for dealing with changes and challenges in their areas of expertise.

In areas like research and analysis, identifying causal relationships is important because it allows one to understand the root causes of a particular phenomenon, find solutions, and help predict how changes in one factor will impact other elements.

By understanding the causal relationships between variables, we can understand how different system parts are connected and how they will change in response to other occasions or conditions.

2. Progressed predictions and selections.

Progress in predictions and selections indicates improving our ability to predict what will happen in the future and make better choices based on that information.

By making progress in these predictions and selections, we can make better-informed decisions that lead to better outcomes for everyone. In addition, researchers can make predictions and decisions more accurately by including variables in models.

Note

In economics, a model that considers these variables can give a better idea of market behavior, allowing them to make better investment decisions.

3. Higher policy layout

Higher policy refers to when leaders make important decisions about the future of a particular area or society. They must consider many items and ensure their choices suit everyone in the long run.

They are essential in higher policy layouts because they give insights into the relationships between different elements within a system. By understanding these relationships, policymakers can make informed decisions about reaching their goals and improving societal results.

4. Understanding complicated structures.

It signifies learning more about how different system parts are connected and work together. When people know more about complex things, they can make better predictions and decisions about the time ahead.

Understanding complicated structures is getting a better handle on all the different pieces and how they fit together. This helps us make better predictions and plans, especially in complex fields like transportation, money, and health.

Endogenous Variables Applications

Endogenous Variables help solve complex systems and relationships in multiple areas of life. Therefore, they play an essential role in different fields and real-life applications. Namely:

1. Economics

Economics is the study of how society manages its limited resources to meet the unlimited needs and wants of the people. These variables are applied in economics to determine the behavior and the relationships between people, businesses, and government.

They play a significant part in four main areas:

Understanding the whole economy's big picture (Macroeconomic models).
Understanding how individual businesses and people make decisions (Microeconomic models).
Understanding what affects a country's economic growth (Growth models).
Understanding how money, interest rates, and inflation work together (Monetary models).

2. International Trade

In international trade, dependent variables play a vital role in deciding the competitiveness of countries in global markets.

Some critical determinants that affect international trade are as follows:

Exchange rates
Trade balances
Technology level

These determinants determine the country's overall position in international trade.

Note

Understanding these variables helps policymakers design effective policies to promote a country's exports, improve its competitiveness, and also aids business concerns to make decisions prudently regarding trading goods and services in the international market.

3. Risk Management

It identifies, assesses, and manages risks linked with financial instruments and portfolios.

Variables associated with risk management are:

Credit ratings
Income level
Default rates

These variables can be used in risk management models to assess the likelihood and potential impact of different risks.

Financial institutions and risk managers can use these variables in risk management models to identify and assess risks more accurately and make more informed decisions about managing those risks. This can help to reduce losses and improve overall financial performance.

4. Public health

Public health is a part of health economics. Public health consists of looking after the health of all people in a specific society rather than just treating individual patients.

In this field, researchers can identify the causes of health conditions among people and resolve the issues regarding limited access to clean water, nutritious food, and a safe place to live.

Applying internal variables in health economics models assists policymakers and analysts make more wise decisions about distributing healthcare resources and upgrading health outcomes.

5. Econometrics

It is the study of economics using numbers and statistics; econometrics helps us to understand how the economy works and operates—studying a large amount of data and using mathematics to identify connections and patterns aid in solving economic challenges.

Imagine an individual is researching the connection between income and education. Because it is influenced by other variables like access to educational resources, family history, and personal motivation, education may be seen as an endogenous variable.

In this case, while researching the relationship between education and income, econometricians will consider these aspects while studying the connection and can deliver excellent conclusions derived from mathematically expressing the relationship.