determination of import demand in pakistan: the role of expenditure components

The paper uses imperfect substitution approach to derive the aggregate import demand function on the basis of disaggregated expenditure components. This derived import demand function is then empirically tested for Pakistan by using co-integration and error correction mechanism. The empirical results show that elasticity of import demand with respect to different macro components of final expenditure is different. The import demand in Pakistan is affected positively and significantly by all expenditure components. The relative prices have negative but insignificant relationship with import demand in Pakistan. The findings indicate that use of aggregate expenditure variable in the aggregate import demand function leads to aggregation bias because different macro components of final expenditure have different import contents. The model derived in this study provides indepth guidelines for macroeconomic policy decisions in order to overcome the problem of persistent trade deficit in the country.