Finance:Exogenous and endogenous variables

Short description: Classification of variables in economic models

For the term in biology, see Endogeny (biology). For the term in econometrics, see Endogeneity (econometrics). For other uses, see Exogeny.

In an economic model, an exogenous variable is one whose measure is determined outside the model and is imposed on the model, and an exogenous change is a change in an exogenous variable. In contrast, an endogenous variable is a variable whose measure is determined by the model. An endogenous change is a change in an endogenous variable in response to an exogenous change that is imposed upon the model.

The term 'endogeneity' in econometrics has a related but distinct meaning. An endogenous random variable is correlated with the error term in the econometric model, while an exogenous variable is not.

Examples

In the LM model of interest rate determination, the supply of and demand for money determine the interest rate contingent on the level of the money supply, so the money supply is an exogenous variable and the interest rate is an endogenous variable.

Sub-models and models

An economic variable can be exogenous in some models and endogenous in others. In particular this can happen when one model also serves as a component of a broader model. For example, the IS model of only the goods market derives the market-clearing (and thus endogenous) level of output depending on the exogenously imposed level of interest rates, since interest rates affect the physical investment component of the demand for goods. In contrast, the LM model of only the money market takes income (which identically equals output) as exogenously given and affecting money demand; here equilibrium of money supply and money demand endogenously determines the interest rate. But when the IS model and the LM model are combined to give the IS-LM model, both the interest rate and output are endogenously determined.

See also

• Cambridge capital controversy