Macro Econometric Income Consumption Model for India

Consumer disbursement is an of import factor that can excite the economic growing and development through the multiplier procedure. This survey aims to gauge the form of ingestion outgo and attempts to place the ingestion map for Indian Economy. The survey intends to place the determiners of ingestion and to construct a econometric theoretical account utilizing the one-year information from RBI Handbook of Statistics on Indian Economy ( 2008-2009 ) for the clip period 1970 to 2009. Following are the variables taken into consideration for empirical analysis ; Private Final Consumption Expenditure ( PFCE ) , Personal Disposable Income ( PDI ) , Rate of Interest ( ROI ) and Inflation ( INF ) . We have employed strict econometric techniques in analysing the clip series informations so as to guarantee the credibleness and dependable economic dealingss. The consequences confirm income ( PDI ) as the most important factor. The MPC calculated which ranges between 0.80 to 0.90, which is in avowal with the theoretical premises and is more or less similar to the old surveies. The decisions from the theoretical account suggest that the Keynesian Absolute Income Hypothesis is found to be appropriate to Indian context.


The relation between aggregative ingestion or aggregative nest eggs and aggregative income, by and large termed the ingestion map, it has occupied a major function in economic doctrine of all time since Keynes made it a anchor of his theoretical construction in The General Theory of Employment, Interest and money. The function of ingestion in the multiplier procedure has increased the range and kineticss of the subject which led to farther developments in this field by developing more realistic and logical ingestion ( Income ) hypothesizes. Consumption which was considered merely as a map of income was subsequently refined and redefined.

The intent of the survey is to analyze and grok the issues, tendencies and principle behind the ingestion form in India. In our survey an effort is done so as to understand and gauge the possible factors that had led development. We estimate the ingestion theoretical account in India utilizing advanced econometric tools. The survey is conducted for period from 1970 to 2009 utilizing the one-year information from RBI Hand Book of Statistics on Indian Economy.

Theoretical Model:

Consumption map indicates a functional relationship between ingestion, income and other factors. It shows how consumption outgo varies as there is alteration in the income and other factors such as age, societal position, involvement rates etc. Whereas Consumption refers to amount spent on ingestion at a given degree of income. On the other manus ingestion map refers to existent ingestion at assorted degree of income.

Major development in this regard took topographic point when In 1936 Keynes formulated a ingestion map which was the basic component in the income outgo attack to the finding of national income. Consumption map for him was the basic edifice block of multiplier analysis. Harmonizing to Keynes fringy leaning to devour is less than mean leaning to devour this is good described in the stagnancy thesis around 1940. Keynes observed this as behaviour of the ingestion outgo in the short tally over the long tally.

Keynes offered no precise functional preparation of the leaning to devour ; his analysis has come to be associated with a simple version of the ingestion map that embodies merely the more quantitative facets of his considerations, popularly known as the simple Keynesian ingestion map or Absolute Income Hypothesis ( AIH ) . The theory asserts as income rises, the theory asserts, ingestion will besides raise but non needfully at the same rate. The basic rule of the absolute income hypothesis is that the single consumers who determine what fraction of his income will he give to consumption on the footing of the absolute degree of that income. AIH provided a background for the farther surveies in this field. This resulted in the development of three more theoretical theoretical accounts viz. Relative Income Hypothesis ( RIH ) , Permanent Income Hypothesis ( PIH ) , and Life Cycle Hypothesis ( LCH ) .

Relative Income Hypothesis ( RIH ) developed by Duesenberry in 1949 conceives ingestion in relation to the income of other families and past income. It implies that the proportion of income consumed remains changeless provided that a family ‘s place on the income distribution curve holds changeless in the long tally. This is consistent with long-term grounds. Higher up the income curve, nevertheless, there is a lower mean leaning to devour. The 2nd portion of the hypothesis suggests that families find it easier to set to lifting incomes than falling incomes. There is, in other words, a “ ratchet consequence ” that holds up ingestion when income diminutions. Duesenberry ‘s analysis is based on two comparative income hypotheses. The first hypothesis is basically that consumers are non so much concerned about the absolute degree of ingestion as they are with their ingestion relation to that of remainder of population. Second hypothesis Duesenberry argues that present degrees of ingestion is non influenced simply by present degrees of absolute or comparative income, but besides by degrees of ingestion attained in old periods.

Absolute income hypothesis when captures the consequence of current income on current ingestion the theories developed at that place after focal point on the influence on income on ingestion in a wide sense. Permanent income hypothesis developed Milton Friedman further divide the income constituent into two parts. First include the lasting income constituent and ephemeral constituent the 2nd. He states that ingestion is determined by the lasting constituent and usually ephemeral income is saved.

To be more specific, The Permanent Income Hypothesis decomposes measured entire disposable income, Y, into a lasting constituent ( YP ) , and a ephemeral constituent, ( YT ) . The lasting income constituent is deemed systematic but unobservable, reflecting factors that determine the family ‘s wealth, while the ephemeral constituent reflects “ opportunity ” income fluctuations. Similarly, measured ingestion, degree Celsius, is decomposed into a lasting constituent, CP, and a ephemeral constituent, Connecticut. In giving the hypothesis empirical substance, Friedman assumes the transitory constituents to be uncorrelated across ingestion and income, and with their several lasting constituents.

A small different from these above mentioned hypotheses the Life-Cycle Hypothesis presents a chiseled linkage between the ingestion programs of an single income and income outlooks as base on ballss from childhood, through the work take parting old ages, into retirement and eventual death. The chief edifice block of life-cycle theoretical accounts is the economy and ingestion determination, i.e. , the division of income between ingestion and economy. The salvaging determination is driven by penchants between present and future ingestion ( and the public-service corporation derived from ingestion ) . Given the income watercourse the family receives over clip, the sequence of optimum ingestion and salvaging determinations over the full life can be computed. It should be noted that the standard life-cycle theoretical account as presented here is steadfastly grounded in expected public-service corporation theory and assumes rational behaviour.


Datas Used For the Survey:

We have used one-year long-term clip series informations on Private Final Consumption Expenditure, Personal Disposable Income, Gross Domestic Savings, Rate of Interest and Inflation from The Handbook of Statistics on Indian Economy 2008-2009 published by Reserve Bank of India ( 2008-2009 ) . They are represented as the followers: Private Final Consumption Expenditure ( PFCE ) , Personal Disposable Income ( PDI ) , Rate of Interest ( ROI ) and Inflation ( INF ) . Where in PFCE is the dependent variable. Econometric Methodology:

One of the major and important jobs that can be faced while covering with clip series informations is, many a times informations may be non – stationary. So avoid specious arrested development it is necessary to look into the clip series informations for stationarity utilizing unit root trials. Keeping this in head the unit root trial has been carried out for each series utilizing the Augmented Dickey-Fuller trial for the period 1970 – 2008. All the variables are non stationary at the degrees and in order to do them stationary we employed the technique of differencing. All variables other than rate of involvement is differenced twice, where ( D ) stands for differencing one time and D ( D ) for differencing twice.

Table: 1 Unit root trials with Trend and Intercept: 1970 – 2008




1st difference


( LnPFCE )


Non -stationary



( LnPDI )


Non -stationary



( LnSAV )


Non -stationary



( LnROI )


Non -stationary



( LnINF )



1 % critical value = -3.50, 5 % critical value = -2.89, 10 % critical value = -2.58

The analysis besides takes into history the slowdown construction that plays a critical function in the ingestion analysis. To analyze the function of old extremum incomes and the function of wonts the functional signifier that we can utilize is as follows:

Ct = I± + I?0Yt + I?1 Yt-1+ Iµt

Using the given functional theoretical account where Ct is ingestion at clip period ( T ) , Yt represent income at clip period ( T ) , Yt-1 stand foring one twelvemonth lagged value of income where in we can analyze the long tally effects of income on ingestion. But the above equation ( distributed slowdown theoretical account ) , since takes the slowdown of independent variable there is all possibility of meeting the job of multicolinearity. Thus we need to transform this theoretical account into some other theoretical account which takes attention of the jobs. When we have distributed slowdown theoretical accounts where slowdown construction follow the geometric signifier we can transform them utilizing the Koyack transmutation.

The transformed theoretical account AR ( 1 ) can be re written as follows:

Ct = I± + I?0Yt + I?Ct-1+ Greenwich Mean Time

This theoretical account is called a Auto regressive theoretical account where lagged value of dependant variable itself will be a independent variable. In the above theoretical account I?0 step the short tally consequence or the short tally MPC and I? measure the long tally effects, in our theoretical account it is the long tally MPC.

Estimated Equations:

Equation: 1

For the above ingestion equation the independent variables are income, rate of involvement, rising prices and a twelvemonth lagged value of the dependant variable. Harmonizing to the theoretical apparatus the coefficient of income demands a positive relationship. This is for the ground that when income additions ingestion besides increases and more over the coefficient of income indicate the MPC which is supposes to be a positive value less than one. Both our equations satisfy this status. In both the equation the coefficient of nest eggs and rate of involvement shows a negative relationship. It is obvious that when nest eggs increases ingestion lessenings because nest egg is considered as an option for ingestion and nest eggs additions when rate of involvement is high therefore when rate of involvement is high nest eggs additions and the ingestion outgo decreases. Inflation is included as an independent variable to measure the consequence of monetary values, when monetary values increases the outgo on ingestion is bound to increase so we expect a positive relation. The AR coefficient demoing a positive relation is holding a figure of theoretical deductions for illustration for lasting income hypothesis to keep good the AR coefficient should be negative. The theoretical deductions of the positive AR coefficient are explained in the undermentioned treatments.

Since the estimations are partial arrested development coefficients all the coefficients are explained by maintaining the premise, when consequence all the other variables are kept changeless what is the impact of a variable on ingestion. From equation one the value of income carbon monoxide efficient can be read as follows, when there is one per centum addition in income there will be 0.83 percent addition in ingestion. Thus a value of 0.92 in the 2nd equation for the income coefficient indicates, when there is one per centum addition in income ingestion will increase by 0.92 per centum. Theoretically the coefficient of income is the MPC which give information about the alteration in ingestion when income alterations by one unit. The bounds of MPC are zero to one and our both equation satisfies this status. It is besides of import to observe that both the equations income turns out to be the most important factor, the T values for this coefficient is 19.31 and 23.82 severally.

The coefficient of nest eggs and the rate of involvement show a negative relation which indicate an reverse relation of these variables with regard to the dependant variable ingestion, this holds good for both the equations. For both the equations the coefficient is same for nest eggs. When all other variables are kept changeless an addition in nest eggs by one unit will diminish ingestion by 0.06 per centum and for a unit addition in rate of involvement will diminish the ingestion by 0.0183 per centum in the first equation and 0.0244 per centum harmonizing to the 2nd equation. In both the equations nest eggs is backed by important t- values but involvement rates are comparatively in important in both the equations

In the first equation rising prices is one of the really important variable, it is proved that rising prices will hold a positive impact on ingestion and this was expected, this is because of the ground that in a underdeveloped state like India the upper limit is spend on the necessary trade goods therefore an addition in monetary value will increase the ingestion outgo. It is estimated that one per centum addition in rising prices will take to increase in ingestion by 0.0115 per centum.

Equation ( 1 ) is supported by statistically important T value and high R2 of 0.97 which imply 97 % , of the fluctuation in ingestion outgo is explained by the explanatory variables. A DW statistic of 2.01 regulations out the job of series car correlativity. Equation ( 2 ) is besides supported by statistically important T values and high R2 of 0.95 which imply 95 % , of the fluctuation in ingestion outgo is explained by the explanatory variables. In an AR ( 1 ) for placing the elements of car correlativity we need to look at D.W ‘h ‘ statistic. The deliberate D.W ‘h ‘ of 0.07 culls the possibility of car correlativity.

Calculation of Long Run MPC

For the given AR theoretical account ( Equation: 2 ) :

Ct = I± + I?0Yt + I?Ct-1+ Greenwich Mean Time

I? is the short tally MPC and harmonizing to theoretical theoretical accounts the I? ( MPC ) should be less than one. AR theoretical account can be used even to cipher the long tally MPC. Harmonizing to theoretical theoretical accounts long run MPC should be greater than the short tally and should be equal to one. The long tally MPC can be calculated as follows:

Long tally MPC ( I? ) = I? / 1- I?

= 0.92 / 1-0.07

= 0.989

Therefore the AR coefficient of 0.07 can be interpreted as follows, when the addition in the income is sustained, so the addition in the MPC ( long tally MPC ) out of income will be 0.989. In other words when consumers have clip to set for one unit alteration in income, they will increase their lone for approximately 0.989 per centum.

Theoretical Deductions:

Macro Econometric theoretical accounts must suit into a theoretical model and should be ready to hand in footings of policy deductions. This holds good in the instance of Consumption theoretical accounts besides. So in this regard it is necessary to formalize the theoretical account ( Equation 1 & A ; 2 ) by proving and sorting them to the income hypothesis developed.

Some of the old surveies in the Indian context conforms that for a developing economic system like India the major beginning for ingestion for any given clip period will be the current income beginning and therefore the nature of economic system fits itself into Keynesian Hypothesis. Krishnamurthy ( 1996 ) supports Keynesian apparatus with a ( 0.75 ) MPC. Pandit ( 2000 ) in Macroeconometric Policy Modeling for India: A Review of Some Analytical Issues back up the Keynesian apparatus by saying that in ingestion map follows Absolute Income Hypothesis. The consequences of a survey by Ghatak contradict with Friedman consequences. She by analyzing the Indian economic scenario for the twelvemonth ( 1919-1986 ) found that, in India the ephemeral constituent of the income besides consumed. This is because of the grounds in a underdeveloped state such as India, impermanent additions in income are likely to be consumed entirely ; this was intentionally encouraged by authorities policies to force people above the poorness line. Whereas Permanent income hypothesis argue that lasting income is consumed and nest eggs is determined by ephemeral constituent.

Equations ( 1 & A ; 2 ) confirm the important function of current income finding current ingestion which supports Keynesian statement of Absolute Income Hypothesis. The MPC value derived from both the equations satisfies the theoretical demands as proposed by Keynes ( 0 & lt ; MPC & lt ; 1 ) .

Equation ( 2 ) which is an AR theoretical account with a positive value for the AR coefficient and the deliberate long tally MPC tested equal to one turn out the Keynesian statement that the Long tally MPC & gt ; Short run MPC and the changeless behaviour of the long tally MPC.

Therefore the analysis conclude that given the one-year clip series informations for Indian economic system signifier 1970-2008, the ingestion form follows Keynesian theoretical account.

Forecasting From the Equations:

To analyze the credibleness of equations ( both [ 1 ] & A ; [ 2 ] ) proof trials are performed. In sample prognosiss are obtained in this regard for the period from 1970 to 2008. The truth of the theoretical account is tested by ciphering the Root Mean Squared Error and Theil Inequality Coefficient. The values imply that the forecasted series in theoretical account is really near to the existent series and there are no systemic inclinations to over/under gauge the existent information. Prognosiss are based on Dynamic simulations.

Table: 2 Forecasting Performance Measures

Root Mean Square Error

Theil Inequality coefficient

Equation 1



Equation 2



The Root Mean Square Error and the Theil Inequality Coefficient for both the equations are satisfactory and guarantee the credibleness of utilizing the theoretical account for prediction. ( See graph 1 & A ; 2 in appendix )

Granger Causality Tests:

Granger causality trial is a technique for finding whether one clip series is utile in calculating another. Granger causality trials reveal whether one variable reveals whether one variable farmer cause other. Pair wise Granger causality consequences for the several variables are presented below. Inferences are drawn looking at the chances. We reject the void hypothesis where the chance values are lower.

Table 3 Pair wise Granger Causality Results

Null Hypothesis:

Ob river



LnPFCE does non Granger Cause LnSAV




LnSAV does non Granger Cause LnPFCE



LnPFCE does non Granger Cause LnINF




LnINF does non Granger Cause LnPFCE



LnPFCE does non Granger Cause LnPDI




LnPDI does non Granger Cause LnPFCE



LnROI does non Granger Cause LnPFCE




LnPFCE does non Granger Cause LnROI



From the tabular array above we can deduce that nest eggs ( LnSAV ) farmer cause ingestion outgo ( LnPFCE ) , Inflation ( LnINF ) farmer cause ingestion outgo, income ( LnPDI ) farmer cause ingestion outgo ( LnPFCE ) and ingestion ( LnPFCE ) and ( LnROI ) show a bi- directional causal relationship. These consequences are supported by a strong theoretical base. It is theoretically and through empirical observation proved that ingestion outgo is influenced by income, nest eggs, and rising prices.


The present survey efforts to analyze some of the issues associating to India ‘s ingestion form and to place the important determiners that influence Indian ingestion map. The survey considers the information from 1970-2008. Datas beginnings are RBI Handbook of Statistics on Indian economic system ( 2008-2009 ) . Empirical mold is taken up by sing the theoretical issues. The economic reforms and the increasing income and population detonation have contributed to increase in the ingestion outgo in Indian ensuing in higher criterion of life. From our survey we infer that about 85 – 95 per centum addition in ingestion is as a consequence of increasing income degrees of persons in the economic system.

Identifying the major determiners of ingestion map includes more of econometrical techniques and empirical appraisals. The exercising revels that income is the most important factor that affect the ingestion any given period. Other important determiners turn out to be Savingss, Rate of Interest, and Inflation. Identifying the suited Income hypothesis for India concludes that it is Keynesian theory of Absolute Income Hypothesis that suits Indian economic system for the undermentioned grounds. First the estimations indicate the important consequence of current income on ingestion as suggested by Keynes. Second the MPC value estimated from the ( equation 1 & A ; 2 ) is in melody with the theoretical premises made by Keynes where he argues that the MPC should positive whole number less than one. The MPC calculated which ranges between 0.80 to 0.90, which is in avowal with the theoretical premises and is more or less similar to the old surveies. The MPC calculated from some of the old survey on Indian economic system are as follows:

Table: 4 MPC calculated from some of the old survey on Indian economic system







Anita Ghatak



Iyengar & A ; Moorthy



Moorthy & A ; Thore



Tinter & A ; Narayanan






Third Keynesian hypothesis argue that long tally MPC should be larger than the short tally this is established in the 2nd equation where we obtained a positive value of 0.0727 from the AR ( 1 ) coefficient. The Hypothetically tested consequences turn out that the long tally MPC is changeless and is non significantly different from one.


Figure: 1 Insample Forecasting Estimates From Equation: 1

Figure: 2 Insample Forecasting Estimates From Equation: 2