Paper#5

2940605: Quantitative Methods in Economic Analysis

Application of Cointegration and ECM

A PAPER
ON COINTEGRATION OF CONSUMPTION AND INCOME

BY
SK. ASHIQUER RAHMAN
ID#4585974929

A Thesis Submitted In Partial Fulfillment of the Requirement for the Degree of Masters in
International Economics and Finance

TO,
DR.BANGORN TUBTIMTONG
ASSISTANT PROFESSOR

Masters in International Economics and Finance

Faculty of Economics,
Chulalongkorn University, Phayathai Road,
Bangkok-10330,Thailand.Tel: (662) 218 6295, (662) 218 6218,Fax:(662) 218 6295,
E-mail: ief@chula.ac.th, http://www.econ.chula.ac.th/programme/ma_inter.html
  
Wilsdcats Activities   2002

Letter of Transmittal
June 25, 2002
Dr.Bangorn Tubtimtong
Assistant Professor,
Masters in International Economics and Finance
Faculty of Economics,
Chulalongkorn University,
Phayathai Road, Bangkok, Thailand

Subject: Letter of Transmittal.

Dear Madam,

Here is my paper on " the co-interaction of consumption and income” that I was assigned. It was a
great opportunity for me to acquire practical knowledge of the Quantitative Methods in Economic
Analysis and forecasting

I have concentrated my best effort to achieve the objectives of the report and hope that my
endeavor will serve the purpose.

I believe that the knowledge and experience I have gathered during my paper preparation will
immensely help me in my professional life. I will be obliged if you kindly approve this effort.

Sincerely yours

Sk. Ashiquer Rahman

Id#4585974929
Masters in International Economics and Finance
Bangkok, Thailand

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Wilsdcats Activities   2002

Preface

Any institutional education would not be completed if it were confined within theoretical aspects.
Every branch of education has become more competed by their practical application and
accomplishment of full knowledge. We shall be benefited by our education if we can effectively
apply the institutional education in practical fields. Hence, we all need practical education to apply
theoretical knowledge in real world. By considering this importance “faculty of economics”
arranges the Quantitative Methods in Economic Analysis courses for the students of Masters in
International Economics and Finance. As a part of this program my topic was selected as “the co-
interaction of consumption and income”

I tried my best to conduct an effective study by arrange and analysis data. There may be some
mistakes, which are truly unintentional. So, I would request to look at the matter with merciful
mind.

Sk. Ashiquer Rahman

Id#4585974929
Chulalongkorn University
Masters in International Economics and Finance
Bangkok, Thailand

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Wilsdcats Activities   2002

Acknowledgement

First, all praises go to almighty Allah, the most gracious, the most merciful to give me the ability for
all these I have done.

Then I would like to thank Ms. Wanwadee Wongmongkol. Now I would like to thank
Dr.Bangorn Tubtimtong Assistant Professor, Chulalongkorn University, Phayathai Road,
Bangkok,Thailand to give me the opportunity to do this project.

I would also like to thank Professor. Paitoon Wiboonchutikula, Ph.D ,Associate professor and
Chairperson of Faculty of Economics, Chulalongkorn University & Professor Salinee. Secretatery
international economics and finance. My striking thanks go to honorable sir Dr. MN.Sirker who
has helped me in all aspect to prepare the report.

I would like to thank lab incharge Ms. Mink . Last but not the least I wish to thank my
friends, William Lloyed ,Nakarin and Athipat, for their very helpful discussions.

Sk. Ashiquer Rahman

Id#4585974929
Chulalongkorn University
Masters in International Economics and Finance
Bangkok, Thailand

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Table of Content

Title Page

Letter of Transmittal ii

Preface iii
Acknowledgement iv
Table Of Content v
Statement Of The Problem 1-1

Literature Review 1-1

Formulation Of General Model 1-2
Data Sources &Description 2-3
Model Estimation And Hypothesis Testing 3-5
Interpretation Of The Results And Conclusions 5--6

Limitations Of The Study And Possible Extensions 6-6

References 6-6

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  The co-interaction of consumption and income 
 

Statement of the Problem 

This paper studies the co-interaction of consumption and income. But the consumption expenditure is a
complex matter. It depends on the income. If income increases in a dollar, consumption increases by a
fraction of a dollar. This fraction is the marginal propensity to consume on the simplest ways to express
such a relation of dependency is as a linear function:
C=a+bY
Where C is the consumption expenditure, Y is the national income and "a" and "b" is constant.
In this paper, we will consider a relation between the consumption and the income. Moreover this paper
will use an econometric method to estimate parameters in the model, apply some test to verify the result we
acquire and then conclude the model.

General model: 

Ct=β1+β2YDt+εt

Where:
Ct( G C ) = C o n s u m p t i o n E x p e n d i t u r e

YDt(GYD)= Income

Before some testing process we have to establish random walks model because regressing one random walk
against another can lead to spurious results in that conventional significance tests will tend to indicate a
relationship between the two variables when in fact none exists. This is one reason why it is important to test
for random walks. If a test fails to reject the hypothesis of a random walk, one can difference the series
question before using it in regression. Since many economic time series seem to follow random walks, this
suggests that one will typically want to difference a variable before using it in regression. While this is
acceptable, differencing may result in a loss of information about the long- run relationship between t w o
variables

    Data sources and description 

Due to time and scope, quarterly time series data from 1954.1 to 1995.21 There are 166 observation.

The data has been collected from sheet. In addition with this purpose the book of (i) Econometric models

and Economic forecast ( by- Robert S. pindyck and Doniel L.), fourth edition, (ii) Basic Econometrics.

Domandar N. Gujrati. fourth edition, have been used. . After analysis the result, I'll attach a copy of data.

 
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  The co-interaction of consumption and income 
 

Descriptive statistics of each variable:

Date: 11/15/09
Time: 12:22
Sample: 1954:1 1995:2

GC GYD

Mean 1578.775 1726.075

Median 950.4500 1071.650
Maximum 4851.029 5201.000
Minimum 236.4000 258.6000
Std. Dev. 1388.838 1496.928
Skewness 0.878114 0.838759
Kurtosis 2.424395 2.350241

Jarque-Bera 23.62498 22.38407

Probability 0.000007 0.000014

Observations 166 166

GYD

Model Estimation 

 
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For the model estimation, we will do some test about the co- integration of consumption and income.
Now we apply the least square method for the ADF test and output is show below:

ADF Test Statistic 9.623256 1% Critical Value* -3.4713

5% Critical Value -2.8791
10% Critical Value -2.5760
*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(GC)
Method: Least Squares
Date: 11/15/09 Time: 13:01
Sample(adjusted): 1954:3 1995:2
Included observations: 164 after adjusting endpoints
Variable Coefficient Std. Error t-Statistic Prob.
GC(-1) 0.014044 0.001459 9.623256 0.0000
D(GC(-1)) 0.022907 0.079927 0.286596 0.7748
C 5.479646 1.914002 2.862926 0.0048
R-squared 0.613585 Mean dependent var 28.12152
Adjusted R-squared 0.608785 S.D. dependent var 25.13435
S.E. of regression 15.72083 Akaike info criterion 8.365973
Sum squared resid 39790.26 Schwarz criterion 8.422678
Log likelihood -683.0098 F-statistic 127.8253
Durbin-Watson stat 2.011854 Prob(F-statistic) 0.000000

ADF Test Statistic 9.692602 1% Critical Value* -3.4713

5% Critical Value -2.8791
10% Critical Value -2.5760
*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(GYD)
Method: Least Squares
Date: 11/15/09 Time: 13:04
Sample(adjusted): 1954:3 1995:2
Included observations: 164 after adjusting endpoints
Variable Coefficient Std. Error t-Statistic Prob.
GYD(-1) 0.015977 0.001648 9.692602 0.0000
D(GYD(-1)) -0.157648 0.080974 -1.946904 0.0533
C 7.489210 2.671796 2.803062 0.0057
R-squared 0.468437 Mean dependent var 30.13659
Adjusted R-squared 0.461834 S.D. dependent var 29.98479
S.E. of regression 21.99678 Akaike info criterion 9.037792

 
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  The co-interaction of consumption and income 
 

Sum squared resid 77901.16 Schwarz criterion 9.094497

Log likelihood -738.0990 F-statistic 70.94031
Durbin-Watson stat 1.912886 Prob(F-statistic) 0.000000

Vector Error Correction Estimates: 

Date: 11/15/09 Time: 13:16

Sample(adjusted): 1954:4 1995:2
Included observations: 163 after adjusting
endpoints
Standard errors & t-statistics in parentheses
Cointegrating Eq: CointEq1
D(GC(-1)) 1.000000

D(GYD(-1)) -0.949584
(0.03716)
(-25.5512)

C 0.825001
Error Correction: D(GC,2) D(GYD,2)
CointEq1 -0.480847 1.265850
(0.11620) (0.12944)
(-4.13802) (9.77945)

D(GC(-1),2) -0.338085 -0.242504

(0.09645) (0.10744)
(-3.50512) (-2.25706)

D(GYD(-1),2) -0.278621 -0.053315

(0.06086) (0.06779)
(-4.57800) (-0.78643)

C 0.643335 0.181223
(1.26298) (1.40686)
(0.50938) (0.12881)
R-squared 0.461454 0.710258
Adj. R-squared 0.451293 0.704791
Sum sq. resids 41319.57 51269.99
S.E. equation 16.12053 17.95697
F-statistic 45.41319 129.9214
Log likelihood -682.4173 -700.0025
Akaike AIC 8.422298 8.638068
Schwarz SC 8.498218 8.713988
Mean dependent 0.408840 0.087730
S.D. dependent 21.76252 33.04977

 
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Determinant Residual 72079.53

Covariance
Log Likelihood -1374.194
Akaike Information Criteria 16.98398
Schwarz Criteria 17.17378

Result   and conclusion 

We have tested whether real consumption spending and real income are co-integrated, using quarterly data
from 1954:1 to 1952:2. we first test whether each variable is a random walk using the augmented Dickey-
Fuller test. Running this test, first for consumption and then for the income and case include logs for the
change in the variable, always yields test statistics that fail to reject the random walk h Hypothesis. Next run a
co-integrated regression of consumption C against income from the Durbin-Watson statistics. We can see it
value and comparing the critical value. We can reject the hypothesis at a random walk at the 5% level.
Running a Dickey-Fuller test on the residuals of the regression also leads to a rejection of the random walk
hypothesis at the 5% level.

Limitation of the study and possible extension 

There is no limitation on getting the essential data and information. The data which are collected, I have

assumed the all information true and collected. I have some limitation from the span of time, besides I did

not get enough facility to use EVIEWs program for me. Notwithstanding these limitations, it is expected that it

will also contribute in a merger to have better under standing of the condition of the single equation model.

Acknowledgement 

I am grateful to our beloved professor Dr. Bangorn Tubtimtong for his contribution and his moral

assistance.

 
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  The co-interaction of consumption and income 
 

References. 

1.Damonder N. Gujarati , Basic Econometrics, McGraw-Hill, fourth edition.

2. Robert S Pindyck and Daniel L Rubinfeld, Econometric model and forecast

 
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Appendix

 
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