Neglected Method of Separating Demand and Supply in Time Series Regression

Abstract

This article argues that in many markets, quantity is demand determined in the short run but price is supply determined, and that the dynamic restrictions between price and quantity implied by the model have been widely neglected in empirical research. Two examples illustrate our point—the demand and supply relationships between inflation and unemployment and between the terms of trade and the trade balance. In both, specifying quantity as a function of lagged prices in demand and price as a function of lagged quantities in supply (rather than concentrating on exogenous shift determinants) is sufficient to separate demand and supply.

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