QUESTION 4

In econometrics, endogeneity broadly refers to situations in which an explanatory variable is

correlated with the error term. Example Agricultural inputs are also considered to be endogenous.
For example, the amount of crop yields is endogenous because it is dependent on many other
variables, such as the weather, soil fertility, water availability, pests, and diseases. Bias in
endogeneity caused by simultaneous causality, which occurs when one (or more) independent
variable is jointly determined with the dependent variable, i.e. when independent variables and
dependent variables simultaneously cause each other and causal effects run reciprocally. The
following are sources of endogeneity

Measurement Error

We have found out that source of endogeneity is derived from measurement error. This arises
principally because we are not able to fully observe all variables all the time. We might attempt to
create that variable through calculations using other variables. In the case of measurement error, a
variable x is not observed, but an indicator x* for the variable can be observed. The indicator, x* is
not a perfect measure of x and, thus, contains some error. When a linear relationship is defined
using this indicator (e.g., regressing a variable y on x*), the measurement error is taken up by the
error term in the regression making x* associated with the error term, which violates the
assumption of the linear regression model

Omitted Variables

In this case, the endogeneity comes from an uncontrolled confounding variable, a variable that is
correlated with both the independent variable in the model and with the error term. (Equivalently,
the omitted variable affects the independent variable and separately affects the dependent
variable.) When a regressor x, which is correlated with both the dependent variable and one or more
of the other regressors, is (mistakenly) left out of a regression model (or is unmeasured and not
available for use in the regression model), the variance explained by the omitted variable falls on the
error term. Regressors will be associated with the error term due to the association between the
omitted variable and other regressors. We note that endogeneity emanating from omitted variables
and sample selection bias are distinct, although endogeneity in certain forms

Simultaneity

Simultaneity is where the explanatory variable is jointly determined with the dependent variable. In
other words, X causes Y but Y also causes X. It is one cause of endogeneity (the other two are
omitted variables and measurement error) also occurs when multiple outcome variables exist, with
none of the outcome variables capable of being expressed solely as a function of the exogenous
regressors. For any given linear model among this system of outcomes, only one of the outcome
variables is on the left side of the equation, with the other outcome variables among the regressors
on the right side. These other outcome variables also have their own linear models with each one on
the left and the other outcomes and any exogenous variables on the right. As a result, causality runs
in both directions (from X to Y and from Y to X). The key problem with simultaneity is that as any
exogenous variable changes, the effects cannot be confined to any one of these linear models. Any
change that alters one endogenous variable, in turn, will alter another endogenous variable, and so
forth, cascading through the system. Because of this cascading effect, the error in each linear model
and the endogenous regressors throughout the system are not independen