Role of Expenditure Components on Import Demand in Iran

Abstract

The paper uses imperfect substitution approach to derive the aggregate import demand function on the basis of disaggregated expenditure components. This derived import demand function is then empirically tested for Iran by using co-integration and error correction mechanism. The empirical results show that the elasticity of import demand with respect to different macroeconomic components of final expenditure is different. The household consumption expenditure and export of goods and services have negative, but household consumption expenditure significantly and export of goods and services insignificant relationship with import demand in Iran. The findings indicate that use of aggregate expenditure variable in the aggregate import demand function leads to aggregation bias because different macroeconomic components of final expenditure have different import contents. The model derived in this study provides in-depth guidelines for macroeconomic policy decisions in order to overcome the problem of persistent trade deficit in the country.