The consequence of international trade on the economic system of developed every bit good as developing states has been a subject of involvement and concern to most research workers working within the kingdom of international trade. The inquiry whether trade relationships are stable over clip or non becomes important while seeking to analyse the consequence of volume of import on the economic system of a state.

The intent of this paper is to find whether there exists a long term relationship between volume of imports and its determiners for United Kingdom from 1970 Quarter1 boulder clay 2004 Quarter4. The aim here is to analyze the monetary value and income effects on volume of imports utilizing the import demand map.

For this we foremost need to analyze the hypothesis that there exists a cointegration between the volume of imports and its major determiners. Evidence of cointegration indicates a stable long term relationship between import demand map and its determiners. To take into history the long term every bit good as short term adjustment procedure of the import demand function the Error Correction Model has been used.

Harmonizing to the import demand function the volume of imports depends upon the sum of

economic activity in the state ( United Kingdom ) and the comparative monetary values of imports to domestic goods. ( Dash, 2007 ) While the measure of imports is treated as a dependant variable, income and monetary value are treated as independent variables.

A big sum of literature has been written about the aggregative import demand map demoing the consequence of monetary value of imports and GDP on volume of imports. But the literature varies widely in decisions. For illustration, Dutta and Ahmed ( 1997 ) paper on the import demand map in Bangladesh shows both monetary value and income snaps are statistically important. However, Kalyoncu, Huseyin ( 2006 ) in gauging an aggregative import demand fuction for Turkey finds monetary value snaps of demand for import to be more than the income snaps. And Sinha ( 1997 ) in gauging import demand map of Thailand finds monetary values to be wholly inelastic and lone income to be elastic.

In U.K. volume of imports is a really important portion of the GDP. U.K imports are 4th highest in the universe. The fiscal recession which hit the universe in 2007 had a really great impact on the U.K. economic system, so much so, that in 2007 U.K. had the highest current history shortage. Keeping these facts in head I expect to see a autumn in the volume of imports of U.K. in their existent value in 2008. However, it is hard to do any anticipation as to what the prognosis possibly like.

Majority of the research stuff for this paper has been gathered from the University of Cambridge library and on-line diaries. The paper is divided into 3 subdivisions: Data and Methodology, Forecasting and Conclusion.

## DATA AND METHODOLOGY

The import demand map is given by

Volimp= F ( gross domestic product, impind/ gdpdef )

Volimp is the volume of imports. GDP is the domestic income and impind/ gdpdef gives the comparative monetary values of imports to domestic goods. Here impimd bases for unit value of import monetary values and gdpdef for the GDP deflator.

The long tally import demand map for United Kingdom is as follows:

Lnvolimpt = I?0 + I?1lngdpt + I?2lnprt + ut ( 1 )

lnvolimpt = natural log of volume of import in UK ( measured in ? 1000000s chained monetary values )

lngdpt= natural log of existent GDP ( measured in ? 1000000s chained monetary values )

lnprt= natural log of ( unit value of import prices/ GDP deflator )

Greenwich Mean Time is the mistake term which is assumed to be usually distributed. The coefficients estimated from the above equation I?1 ( & gt ; 0 ) and I?2 ( & lt ; 0 ) are income and monetary value snaps severally.

The informations used is quarterly and all the variables are in existent ( non nominal ) footings.

To carry on the cointegration trial we foremost carry out unit root trials for all the variables present in equation ( 1 ) .

On carry oning the unit root trials to look into for the series to be stationary we find that all three variables at non- stationary in their degrees. However, volume of imports, gross domestic product and the comparative monetary values are stationary in their first differences. This means that each of them is an I ( 1 ) procedure with a individual unit root.

Variables

Trend and stop

intercept

none

Lnvolimp

-1.78

0.396

5.023

lngdp

-1.49

0.413

7.4

lnpr

-3.8

– 0.819

– 1.45

Since all the variables have a individual unit root we can travel in front and look into for cointegration.

To look into for cointegration the Engle- Granger ‘s Residual based ADF trial and the Johansen Cointegration trial have been used. First, equation ( 1 ) has been estimated utilizing the OLS method. Next it was checked if the remainders are stationary through the ADF trial similar to the 1s conducted above. The consequence shows that F statistic is -4.76 which can be rejected at 5 % significance degree. Therefore, the void hypothesis of non- cointegration is rejected. The volume of imports, existent GDP, and comparative monetary values are cointegrated that is the disequilibrium mistake in equation ( 1 ) forms a stationary I ( 0 ) clip series.

To look into for multivariate cointegration we use the Johansen Cointegration trial. We estimate a VAR equation for all three variables and look into for cointegration between volume of imports, monetary values of imports and GDP. We find a individual cointegration vector ( consequence in Appendix ) . Cointegration among variables implies that the variable can non travel ‘too far off ‘ in the long tally. That is, the long tally relationship is stable.

The concluding measure in the analysis is gauging an mistake rectification theoretical account ( ECM ) . As the variables in equation ( 1 ) are cointegrated we use an mistake rectification mechanism which combines both long term equilibrium relationship and short term accommodation kineticss. Through ECM we explain short tally disagreement from long term behavior in the accommodation procedure. The theoretical account consists of one- period lagged values of logs of volume of imports, monetary value of imports and GDP and difference footings of all three variables with four lagged periods.

The equation for the Error Correction Model is as follows:

a?†lnvolimpt = I±0 + I±1a?†lngdpt + I±2 a?†lngdpt-1 + I±3 a?†lngdpt-2

+ I±4a?†lngdpt-3 + I±5 a?†lngdpt-4 + I?0 a?†lnprt + I?1 a?†lnprt-1 + I?2 a?†lnprt-2

+ I?3 a?†lnprt-3 + I?4 a?†lnprt-4 + I?0 a?†lnvolimpt-1 + I?1 a?†lnvolimpt-2

+ I?2 a?†lnvolimpt-3 + I?3 a?†lnvolimpt-4 + I?lnvolimpt-1 + I·lngdpt-1

+ I»lnprt-1 + et ( 2 )

The consequences of the above arrested development are in the appendix. For the above equation we conduct the undermentioned trials:

ARCH trial for homoskedasticity. We find that the F statistic is 0.175 governing out the possibility of heteroskedasticity.

Breusch- Godfrey consecutive correlativity LM trial for consecutive correlativity gives F statistic 0.58. Again we can non reject the void hypothesis and see that there is no consecutive correlativity.

The mistake rectification theoretical account can be modified by extinguishing single variables whose t ratios are undistinguished. However, these variables might jointly be important and to happen grounds of this we conduct the Wald trial to see that all the coefficients of the variables put together are undistinguished. That is in the modified equation there in no difference term of the logs of monetary values and the one- period lagged value of natural log of monetary values.

The modified equation is:

a?†lnvolimpt = I?0 a?†lngdpt + I?1 a?†lngdpt-2 + I?2 lnvolimpt-1 + I?3 lngdpt-1

( 3 )

We find that so this is the instance. The F statistic for the Wald trial turns out to be 0.743. The coefficients of all the variables put together are undistinguished and so we arrive at equation ( 3 ) .

For this modified equation we conduct the undermentioned trials:

ARCH trial for heteroskedasticity yet once more does non reject the hypothesis of homoskedasticity. The F statistic is 0.721.

Breusch- Godfrey consecutive correlativity LM trial besides gives the consequence of no consecutive correlativity with an F statistic of 0.186.

Ramsey RESET trial for observing misspecification gives a really low F statistic of 0.0403.

Our theoretical account does non give misspecification. From the above equation we see that income snaps are positive ( the coefficient on dlngdp is 0.986, on dlngdp ( -2 ) is 0.549 and on lngdp ( -1 ) is 0.512 ) . The coefficient on lnvolimpt-1 that is I?2 ( -0.2403 ) is negative. However, in the long tally monetary values have no consequence on the volume of imports.

From the above equation we calculate the accommodation parametric quantity say I»= -I?2 = 0.240372

And the long tally snap I?= -I?3 / I?2 = – ( 0.512069/ -0.240372 ) = 2.13 ( & gt ; 1 ) . That is extremely income rubber band.

Since the period taken here is really long we need to look into if there was any structural interruption during this period. We use the Zhou interruption point trial to find structural interruptions and we find one in the twelvemonth 1980.

Chow Breakpoint Test: 1980Q1A

Null Hypothesis: No interruptions at specified breakpoints

F-statistic

3.238781

Prob. F ( 18,99 )

0.0001

Log likelihood ratio

62.50806

Prob. Chi-Square ( 18 )

0.0000

Wald StatisticA

58.29806

Prob. Chi-Square ( 18 )

0.0000

The ground for this structural interruption is due to U.K. using a monetarist policy to implemented to control rise in rising prices and public disbursement get downing 1979 under Thatcher authorities. There was heavy denationalization of nationalised industries and this period saw a really high rate of unemployment. The recession in the early 80 ‘s shows up as a structural interruption for 1970 Q1 to 2004 Q4 period.

## Prediction

Using the bing dataset from 1970 Q1 to 2004 Q4 we forecast volume of imports for 1970 Q1 to 2008 Q4. For this we expand the bing informations set to include values from 2005 Q1 to 2008 Q4 for all variables. Then utilizing the modified ECM we forecast volume of imports and compare it with the existent result by plotting the two graphs together below.

-.12

-.08

-.04

.00

.04

.08

.12

.16

1970

1975

1980

1985

1990

1995

2000

2005

Calciferol

Liter

Nitrogen

Volt

Oxygen

Liter

I

Meter

Phosphorus

1

Volt

Oxygen

Liter

I

Meter

Phosphorus

F

Roentgen

The bluish line is the existent volume of imports up to 2008 Q4 and the ruddy line is the prognosis. As can be seen from the graph prognosis shows that the volume of imports falls get downing 2007 and is go oning to fall past 2008. In actuality, the volume of imports do fall, but the bead is much sharper than the prognosis. The highly crisp diminution in volume of imports of U.K. in 2007 can be attributed to the fact that in that twelvemonth U.K. had the highest current history shortage in the universe.

## Decision

In the twelvemonth 2007 fiscal crisis hit the universe economic system. U.K. was anticipating a growing in GDP of 3.1 % in 2007 and 2.3 % in 2008 ( IMF prognosis ) . However, growing in GDP fell by 0.1 % in this period. Harmonizing to the ECM theoretical account volume of imports and GDP are straight related. If GDP rises so so do volume of imports and vice- versa. In 2007- 2008 due to fall in GDP volume of imports fell every bit good. The volume of imports are determined chiefly by the GDP and it might take some clip before the volume of imports start lifting once more. This is because U.K. due to its past economic history ( recession in early 80s ) may take longer to acquire out of recession in comparing to other European states. However, the chief decision of this undertaking is that volume of imports of U.K. are extremely income elastic whereas the comparative monetary values of imported goods to domestic goods have no long tally impact on them.

Mentions

Mentions

Dash, A.K. , ( 2005 ) , “ An Econometric Appraisal of Aggregate Import Demand Function of India ” , Department of Economics, University of Hyderabad, India

Dutta, D. , and N. ahmed ( 1997 ) , “ An Aggregate Import Demand Function for Bangladesh: A Cointegration Approach ” , Applied Economics, 31 ( 1999 ) : 465-472

Kalyoncu, Huseyin ( April 2006 ) , “ An aggregative Import Demand Function for Turkey: a cointegration analysis ” , Munich Personal RePEc Archive

Sinha, D. ( 1997 ) , “ Determinants of import demand in Thailand ” , International Economic Journal, Volume 11, Number 4, pp. 73- 83.

Tsangyao Chang, Yuan- Hong Ho, Chiung- Ju Huang ( June 2005 ) , “ A Re-examination of South Korea ‘s Aggregate Import Demand Function: The Bounds trial Analysis ” , Journal of Economic Development, volume30

Tang T.C. , and H.A. Mohammad ( 2000 ) , “ An aggregative Import demand fuction for Malaya: A cointegration and Error Correction Analysis ” , Utara Management Review, 1, 43-57

Wooldridge, J.M. , ( 2006 ) , Introduction to Econometrics

Thomas, R.L. , ( 1997 ) , Modern Econometrics, An debut

Datas Beginnings:

For imports unit values ( index ) and GDP deflator ( index ) the information beginning is Quarterly Data for U.K. from the IMF International Financial Statistics as suggested by the online informations beginning of University of Cambridge. Web site:

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For volume of imports measured in ( ? 1000000s chained volume monetary values ) and Real GDP measured in ( ? 1000000s chained volume monetary values ) the information beginning used is the Office of National Statistics of U.K. Website: www.statistics.gov.uk/default.asp

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