The principle of this model is that there often exist a long run equilibrium relationship between 2

economic variables. In the short run, there maybe disequilibrium. With error correctionin

mechanism, the proportion of the disequiibrium in one period is corrected in next period.

Suppose that the long run relation between Yt and Xt is of the form

Yt = KXt (10.20)

K is a fixed constant

Taking logarithms of both sides of equation (10.20), we obtain

Ln Yt = ln K + ln Xt or yt = k + xt (10.21)

Where the lowercase letters are used to denote logarithms. Because yt-1= k + xt-1, we have,

Delta yt = delta xt (10.22)

Delta adalah perubahan dari periode t-1 ke t.

A general short run model with lagged adjustment is of the following form :

yt =β 0+ βxt+ β 2 xt −1+ α 1 yt −1+ μt (10.23)

Under what conditions will the short run model be consistent with the long run model? To

examine this question, let yt = y* and xt = x* for all t. jadi (setting mut=0 in the long run) :

Y*(1-alpha1) = beta0 + (beta1 + beta2)x*