The effect of international trade on the economy of developed as well as developing nations has been a topic of interest and concern to most researchers working within the realm of international trade. The question whether trade relationships are stable over time or not becomes crucial while trying to analyze the effect of volume of import on the economy of a country.
The purpose of this paper is to determine whether there exists a long term relationship between volume of imports and its determinants for United Kingdom from 1970 Quarter1 till 2004 Quarter4. The objective here is to study the price and income effects on volume of imports using the import demand function.
For this we first need to examine the hypothesis that there exists a cointegration between the volume of imports and its major determinants. Evidence of cointegration indicates a stable long term relationship between import demand function and its determinants. To take into account the long term as well as short term adjustment process of the import demand function the Error Correction Model has been used.
According to the import demand function the volume of imports depends upon the amount of economic activity in the country (United Kingdom) and the relative prices of imports to domestic goods. (Dash, 2007) While the quantity of imports is treated as a dependent variable, income and price are treated as independent variables.
A large amount of literature has been written about the aggregate import demand function showing the effect of price of imports and GDP on volume of imports. But the literature varies widely in conclusions. For example, Dutta and Ahmed (1997) paper on the import demand function in Bangladesh shows both price and income elasticities are statistically significant. However, Kalyoncu, Huseyin (2006) in estimating an aggregate import demand fuction for Turkey finds price elasticities of demand for import to be more than the income elasticities. And Sinha (1997) in estimating import demand function of Thailand finds prices to be altogether inelastic and only income to be elastic.
In U.K. volume of imports is a very significant part of the GDP. U.K imports are fourth highest in the world. The financial recession which hit the world in 2007 had a very great impact on the U.K. economy, so much so, that in 2007 U.K. had the highest current account deficit. Keeping these facts in mind I expect to see a fall in the volume of imports of U.K. in their actual value in 2008. However, it is difficult to make any prediction as to what the forecast maybe like.
Majority of the research material for this paper has been gathered from the University of Cambridge library and online journals. The paper is divided into 3 sections: Data and Methodology, Forecasting and Conclusion.
DATA AND METHODOLOGY
The import demand function is given byVolimp= F ( gdp, impind/ gdpdef)
Volimp is the volume of imports. GDP is the domestic income and impind/ gdpdef gives the relative prices of imports to domestic goods. Here impimd stands for unit value of import prices and gdpdef for the GDP deflator.
The long run import demand function for United Kingdom is as follows:
Lnvolimpt = Î20 + Î21lngdpt + Î22lnprt + ut (1)
lnvolimpt = natural log of volume of import in UK ( measured in ￡ millions chained prices)
lngdpt= natural log of real GDP (measured in ￡ millions chained prices)
lnprt= natural log of (unit value of import prices/ GDP deflator)
ut is the error term which is assumed to be normally distributed. The coefficients estimated from the above equation Î21 (> 0) and Î22 (< 0) are income and price elasticities respectively.
The data used is quarterly and all the variables are in real (not nominal) terms.
To conduct the cointegration test we first carr