Estimation of Consumption Functions: The Case of Bangladesh, India, Nepal, Pakistan and Sri Lanka

Abstract

The study uses annual data from 1971 to 2013 and applies Keynesian Consumption Function (KCF) and the Permanent Income Hypothesis (PIH) in order to estimate consumption functions of SAARC countries. The empirical results show that in the short run, the difference between KCF and PIH under Marginal Propensity to Consume (MPCs) is quite large. This difference, therefore, indicates that in the short run consumers’ consumption decision are based on current income. However, another point worth noting is that, in the short run smaller values of MPCs under the PIH indicate that consumers are unable to anticipate their future income in developing countries, like Bangladesh, India, Nepal, Pakistan and Sri Lanka. Moreover, the study also estimates the MPCs under the PIH in the long run. The results demonstrate that in the long run the values of MPCs are higher than the MPCs while using PIH, which indicates that in the long run consumers anticipate their future income and accordingly make consumption decisions on the basis of permanent income.