I have tried to decipher the difference between reduced form and structural form many times, but this time it seems pretty clear.
Structural/Standard models are based on a theory/assumption. They derive a relationship (based on a theory) and estimate parameters of the model. These models show true economic variables and has some economic meaning and interpretation. Sometimes, simultaneous equations are having endogenous variables which cause a loop of feedback relationship between equations. If parameters are estimated on structural model (with endogenous variables), these parameters would be biased and inconsistent. (Refer Ban Lambert https://www.youtube.com/watch?v=3j5IeuvSebQ).
In order to resolve this problem, we use reduced form models. In structural model, simultaneous equations are solved (after substitution) for endogenous variables. Reduced form model has no economic interpretation, though reduced form model can be converted in structural form. All equations in reduced form are exogenous and its parameters would be unbiased and consistent. (Refer http://en.wikipedia.org/wiki/Reduced_form). Reduced form models are widely used in modern economics and finance.
In order to resolve this problem, we use reduced form models. In structural model, simultaneous equations are solved (after substitution) for endogenous variables. Reduced form model has no economic interpretation, though reduced form model can be converted in structural form. All equations in reduced form are exogenous and its parameters would be unbiased and consistent. (Refer http://en.wikipedia.org/wiki/Reduced_form). Reduced form models are widely used in modern economics and finance.
