Suppose that a fad for oats (resulting from the announcement of the health benefits of oat bran) has made you toy with the idea of becoming a broker in the oat market. Before spending your money, you decide to build a simple model of supply and demand (identical to those in Sections 14.1 and 14.2) of the market for oats:

Q_Dt = β₀ + β₁P_t + β₂YD_t + ε_Dt

Q_St = α₀ + α₁P_t + α₂W_t + ε_St

Q_Dt = Q_St

Where:

QD_t = the quantity of oats demanded in time period t

QS_t = the quantity of oats supplied in time period t

P_t = the price of oats in time period t

W_t = average oat-farmer wages in time period t

YD_t = disposable income in time period t

a. You notice that no left-hand-side variable appears on the right side of either of your stochastic simultaneous equations. Does this mean that OLS estimation will encounter no simultaneity bias? Why or why not?

b. You expect that when Pt goes up, Q_Dt will fall. Does this mean that if you encounter simultaneity bias in the demand equation, it will be negative instead of the positive bias we typically associate with OLS estimation of simultaneous equations? Explain your answer.

c. Carefully outline how you would apply 2SLS to this system. How many equations (including reduced forms) would you have to estimate? Specify precisely which variables would be in each equation.

d. Given the following hypothetical data, estimate OLS and 2SLS versions of your oat supply and demand equations.

e. Compare your OLS and 2SLS estimates. How do they compare with your prior expectations? Which equation do you prefer? Why?