Wage-price Model:

The  model  of money wage  and  price  determination is  a  good  example  of  SEM. According to the model  the wage  rate is determined by  unemployment rate  in  the economy  and  the  rate of  price  change (that  is,  inflation)  in  an  unrestricted labour market. The rate of  inflation, on the other hand, is a function of the change in wage rate and money  supply.

As  the  price variable  P  enters into the wage equation and  the wage variable W  enters into the price equation, the two variables are jointly dependent on each  other. Moreover, the  explanatory variable  P in and W  in price equation are stochastic in nature. Recall that  in OLS  it  is assumed that ,the explanatory variables are not  stochastic. Therefore, these stochastic explanatory variables are expectcdly correlated  with  the stochastic disturbance  terms.  This correlation  violijtes  the assumption of OLS that error term  is  independent of  independent variabl'e. Thus the classical OLS method  is ,lot applicable  for estimation of the parameters of the two equations individually.