Price and Income Elasticities of Disaggregated Import Demand in Sri Lanka

Tm Udayanthi Tennakeen

doi:10.4038/ss.v40i1.4681

Abstract

The purpose of this study is to investigate Sri Lanka’s disaggregated import demand functions and their price and income elasticities, for the post-liberalization period of 1977-2007. Although there exist many studies examining aggregate import demand, there appears to be a dearth of studies on estimating price and income elasticities import demand functions of Sri Lanka at a disaggregated level. This study aims at filling this gap by estimating disaggregated price and income elasticities for three major categories of imports, viz. consumer goods, intermediate goods and investment goods. To this end, the paper employs standard characterizations of import demand functions extensively discussed in the literature. The econometric estimates reveal that relative price is inelastic for all categories of consumer goods, intermediate goods and investment goods, implying that consumers may be less price sensitive. Further, the paper also examines the effects of changes in national income and foreign exchange availability on the demand for imported goods in Sri Lanka during 1977-2007. Based on these results several policy implications could be derived with regard to dependence on foreign trade, international finance, foreign reserve management and exchange rates, public finance, particularly taxation, as well as the impact of import demand in the face of external shocks on domestic prices and inflation. DOI: http://dx.doi.org/10.4038/ss.v40i1.4681 Staff Studies – Volume 40 Numbers 1 & 2, 59-77

Highlights

Foreign trade is one of the major determinants of a country’s foreign exchange flow
To formulate or implement a policy related to foreign trade, it is very important to have a clear picture on the export and import demand determinants and their elasticity
The composition of exports changed from domination by the agricultural sector to industrial sector while imports change to intermediate goods from consumer goods (See Appendix 1)

Summary

Introduction

Foreign trade is one of the major determinants of a country’s foreign exchange flow. While exports bring foreign exchange to the country, imports help in increasing the utility of consumers through raising the level and variety of goods and services consumed. The government can source revenue through taxes on exports and imports. To formulate or implement a policy related to foreign trade, it is very important to have a clear picture on the export and import demand determinants and their elasticity. Elasticity of import demand is useful to make policy decisions on optimal trade taxes, currency devaluation to improve the balance of trade, estimation of the government revenue from trade related taxes and estimation of the fiscal implications of trade liberalisation. Studies range from cross-sectional work across countries to time-series research of individual countries on export and import demand functions. A number of studies have focused on estimating the aggregate import demand in several countries, while some researchers have estimated disaggregated1/ import demand functions. Estimating only the aggregated demand function could be misleading if the disaggregated functions behave differently

Objective of the study

Chapter Outline

Theoretical Consideration and Review of Literature

Methodology and the Model

Conclusion

Summary and Conclusions