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EPOKA UNIVERSITY Final consumption expenditure in Albania Relationship of final consumption expenditure with GDP per capita, gross savings and net taxes on product. (1985-2013) Rovena Leka Abstract The purpose of this paper is to investigate the relationship of GDP per capita, gross saving and net taxes on final consumption expenditure in Albania, how those factors have effect on final consumption expenditure. To test the relationship is needed a statistical analysis to determine how these variables affect the overall consumption of Albania gathering data from 1985-2013. Objective of this study are to identify the effect of GDP per capita, gross saving and net taxes on final expenditure consumption and to assess the relationship of GDP per capita, gross saving and net taxes of final expenditure consumption using econometric analysis. From the analysis of econometric is defined that there is a positive relationship between GDP per capita and final consumption expenditure, the dependent variable. It has a negative relationship between gross savings and final consumption expenditure. It has a positive relationship between net taxes on products and final consumption expenditure. Key words: GDP per capita, gross savings, net tax, final consumption expenditure. 2 Table of Contents Abstract ......................................................................................................................................................... 2 Introduction ................................................................................................................................................... 4 Methodology ................................................................................................................................................. 5 Literature Review.......................................................................................................................................... 6 1. Theoretical essential.............................................................................................................................. 7 1.1 Definition of Household final consumption expenditure ................................................................... 7 1.2 Definition and calculation GDP per capita .......................................................................................... 8 1.3 Savings............................................................................................................................................... 10 1.4 Net taxes on products ....................................................................................................................... 11 2. Regression Analysis ............................................................................................................................ 12 3. Conclusion .......................................................................................................................................... 15 4. Bibliography ........................................................................................................................................ 16 3 Introduction The most common measure of the amount of stuff produced in the whole economy is termed Gross Domestic Product (GDP). “GDP is total currency value of all final goods and services produced in an economy over some time period /year.”1 Consumption is basic economic activity that individuals encounter in their everyday lives. Goods and services are consumed daily to meet needs and wants of people. Expenditure on consumption contributes as a portion of the Gross Domestic Product that is also known as the income of the country. Consumption is established to be very influential in evaluating the growth of a country; also consumption is a function of national income. The purpose of this paper is to investigate the effect of GDP per capita, gross saving and net taxes on final expenditure consumption and to assess the relationship of GDP per capita, gross saving and net taxes of final expenditure consumption using econometric analysis. The organization of this paper is made by three parts. First part represent an introduction of factors how they are in Albania and their effect in final consumption, second part shows data and methodology used for this paper and the third part present the econometric analysis result how the variables have indicated in final consumption expenditure in Albania from 1985 to 2013. From the analysis of econometric is defined that there is a positive relationship between GDP per capita and final consumption expenditure, the dependent variable. It has a negative relationship between gross savings and final consumption expenditure. It has a positive relationship between net taxes on products and final consumption expenditure. 1 Investopedia 4 Methodology This study is designed to appraise the fundamental economic relationship between Gross Domestic Product and Final Consumption Expenditure of Albania using time series data from year 1985-2013. The data includes Final Consumption Expenditure, GDP per capita, Gross Saving and Net Tax on goods. All the variables are measured in same units in current US $. The hypothesis to be tested is the expectations and the relationship of each independent variable on the dependent variable. The study employed regression analysis to verify the relationship between Gross Domestic Product per capita and final consumption expenditure in Albania. This study may be supported by several theories about consumption proposed by different economists. John Maynard Keynes published General Theory in 1936 based on book of Mankiw (2010). John Maynard Keynes considered the consumption function as the single reason for fluctuations happening in the economy. Keynes suggested that an individual's marginal propensity to consume (MPC) is between zero and one. He explained that men are supposed to increase their consumption as their income increases, but not as much as the increase in their income. Also, Keynes proposed that average propensity to consume (APC) falls as income arises. This means that rich people are expected to save more than poor people that have less income. Keynes function of consumption is written as follows: _ _ C = C + cY C >0, 0 <c<1 C is consumption; Y is disposable income, C is a constant and c is marginal propensity to consume. When consumer spend they also take into consideration how much to save. The more they spend today, the less they will spend in the future. Consumption differs over people’s lives by considering a country’s income or GDP. Having gross savings let the country to have more income. 5 Literature Review According to a study made by (Nakagawa, 1999) that analyze the importance of the different types of uncertainty on the household saving rate in the Japan according to the age and incomes. This paper include that income risk is important for the low to middle income. Also it suggest that stagnation of household disposable income and the decline in household wealth have been the main causes of the stagnation of household consumption during the 1990s and early 2000s in Japan and increased uncertainty about the future does not affect a major cause of the stagnation of household consumption. Another study is made by (HORIOKA, 2003) concerning with the Stagnation of Household Final Consumption Expenditure in case of Japan during the 1990s and the early 2000s. Stagnation of household disposable income was a major cause of the stagnation of household consumption and that it has caused household consumption to be more stagnant, stagnation of household consumption during this period was due at least partly to the decline in household wealth, another result was that uncertainty does not effect on the stagnation of household consumption. Also reduced in future prospect effects in consumption because increased in employment decreased in consumption. Another paper which continues with household consumption and GDP is (UYGUR, 1994) aimed to develop an instrument to predict household disposable income and consumption expenditure by household composition asset ownership and other human capita variables. (SVENNEBYE, 2008), studied the period from 2005 to 2007. It is focus on results of gross domestic product, GDP per capita in the 27 EU member states and looks at the level of actual individual consumption per capita and at countries comparative price levels. Luxembourg stands out with a GDP per capita far above any other of the countries covered. This is to a significant extent due to a particular property of the country’s economy: Luxembourg has a large number of cross-border workers relative to its resident population. While they contribute substantially to GDP, these workers are not included in the population figure used to calculate GDP per capita. This does not mean that the figure for Luxembourg is wrong, but it does indicate that GDP per capita cannot be used uncritically as an accurate indicator of, for instance, residents' material living standards. Other Member States with a high GDP per capita, 20 percent 6 or more above the EU overall level, are Ireland, the Netherlands, Austria, Sweden and Denmark. The case of Ireland is particularly interesting, because comparable statistics from a few years back used to indicate that the country had a lower GDP per capita than most of the other, old EU Member States. The positive development for Ireland continues throughout the years 20052007. However, because many companies resident in Ireland are foreign-owned, it is not surprising that Ireland's consumption per capita is far more in line with other EU Member States than its GDP per capita. 1. Theoretical essential In this part will be explain some of the basic theoretical essential which this study is based. The largest component of final uses of GDP is Household final consumption which in general around 60% of GDP. It is an essential variable for economic analysis of demand. 1.1 Definition of Household final consumption expenditure “Household final consumption expenditure covers all purchases made by resident households (home or abroad) to meet their everyday needs: food, clothing, housing services (rents), energy, transport, durable goods (notably cars), spending on health.” 2 there are not included buying residence. Household’s final consumption expenditure is formed as follow: + purchases of consumption goods and services + own products (agricultural, gardening and collected products) + imputed dwelling income from an owner-occupied dwelling and a dwelling provided as a benefit in kind + goods and services received + current transfers comparable to consumption (e.g. church tax and labour union membership fees and interest on consumption loans) 2 OECDi Library 7 = total consumption expenditure Consumption is made up of the goods and services bought by households. It includes three subcategories that are: nondurable goods, durable goods and services. First subcategory includes food, clothing and goods that temporarily exist. In durable goods are involved cars and computers, goods last longer. In third subcategories, services are involved haircuts, dentist visit and spas. 1.2 Definition and calculation GDP per capita Gross domestic product is a macroeconomic measure of output. This measure helps when a country is more or less productive and in turn whether it is headed for a recession or a bull market. The GDP per capita measure of GDP indicates whether the country's workforce is generally becoming more or less productive that is, whether the country's workforce is efficiently producing goods and services that consumers want. In this study is used derivation of the GDP which is the GDP per capita. Gross domestic product show the market value of final goods and services produced within a country in a given period. It is one of the main indicators for the standard of living also GDP is related to national accounts. 𝐺𝐷𝑃 𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 = GDP Total number of population Where: GDP represent gross domestic product of a country Total number of population is all population of a country GDP per capita is a very reliable indicator of a country's performance. According to Madsen when GDP per capita increase the economy of a country will grow. GDP per capita serves as a monitor in the development of the economy through time. Decrease in GDP per capita means a decline in the economy. 8 Figure 1 GDP per capita, current price US$ As is seen in the graph the latest value of GDP per capita in Albania was 4,781.23 US $ in 2014. Over the years this value has fluctuated between 819.25 US $ in 1985 to 4,781.23 US $ in 2014. Assuming that different exogenous factors have an impact on GDP per capita growth in Albania, we can express the subsequent model: Ec Gr Rate=β0 + β1 pop Tot + β2 G pop Urb + β3 B Rate + ε Ec Gr Rate = economic growth rate (based on GDP per capita) pop Tot = annual average growth rate of total population in Albania G pop Urb = annual average growth rate of urban population B Rate = number of live births per 1000 habitants in Albania From this formula we can say that increase in population will increase participation in work force so the coefficient of population growth will have a positive sign. Fertility decline leads to improving the health of children by consumption and by education. So that the birth rate 9 coefficient will have a positive sign. Also, the higher the rate of urban growth and the level of urbanization, the higher the per capita GDP growth rate would be. Urbanization in Albania was done without proper planning, and this leads to reduced quality of life. Because urban population growth becomes uncontrolled it slows economic growth. So the coefficient of the growth rate of urban population will have a negative sign for Albania. 1.3 Savings In the world that we live today can be found significant differences in saving rate between countries. This difference is rising not only between poor and rich countries but even between rich countries. According to Keynesian saving is the amount left over when the cost of a person's consumer expenditure is subtracted from the amount of disposable income that he or she earns in a given a period of time. Gross savings are calculated as gross national income less total consumption plus net transfers. Figure 2 Gross Saving in Albania from 1985-2014 (% of GDP) Source: www.opendataforafrica.org As is seen from the graph gross saving in Albania fluctuates every year but comparing with the year 1985 it is decreased by 10%. Albanian families who have lower incomes and older households increase saving rates because of low income that they receive. As shown in the graph 10 since 2010 saving rates are increasing this because unemployment is increasing, unemployment is in proportional with the savings rate, increased unemployment leads to increasing the rate of saving. But by comparing Albania to Japan, the Japanese have the highest rate of savings with any other country. 1.4 Net taxes on products Net taxes on products (net indirect taxes) are the sum of product taxes less subsidies. Product taxes are those taxes payable by producers that relate to the production, sale, purchase of the goods and services. Subsidies are grants on the current account made by general government to private enterprises and unincorporated public enterprises. The grant may take the form of payments to ensure a guaranteed price or to enable maintenance of prices of goods and services below cost of production and other forms of assistance to producers. Figure 3 Net taxes on products (US$) http://www.tradingeconomics.com Net taxes on products in Albania were last measured at 61787000000 in 2013, according to the World Bank. Figure shows that net tax has been rising from 1995 to 2013. Albania is country 11 that has less tax on product comparing with the other countries, US remains higher than other countries in net tax on products. 2. Regression Analysis In Appendix are data for final consumption expenditure, GDP per capita, Gross Savings and Net taxes on products, all are in US$ from 1985-2013. Dependent variable: Final Consumption Expenditure, it measures the market value of all goods and services, it is in US$. Independent variable: o GDP per capita-is a quantitative variable measured by getting the total output of the country, GDP, divided by the population of the country, measured in US$. o Gross Savings, is a quantitative variable that is calculated as GDP less Final Consumption Expenditure. o Net Taxes on Products, are the sum of product taxes less subsidies. Product taxes are those taxes payable by producers that relate to the production, sale, purchase of the goods and services. Since there are three independent variables and one dependent variable, the model is a multiple regression model. The model will be estimated with the given equation: y= 591528720.65 + 1879288.49(x1)-0.63(x2) + 2.64(x3) P value indicates if the independent variable is significant enough to influence the dependent variable and this will be explain below. 12 Intercept Table 1 Regression Analysis for coefficients of correlation Regression Statistics Multiple R 0.997124635 R Square 0.994257538 Adjusted R Square 0.993568443 Standard Error 320282065.6 29 Observations R squared measures the goodness a fit of the model. The nearer it is to 1 the better it is. R Square = 0.9942 this means that these three variables explain 99% of the variation in the dependent variable that is final consumer expenditure. Table 2 Data of Regression Analysis for Residual and Regression ANOVA df Regression Residual Total SS MS F 4.44024E+20 1.48008E+20 1442.844529 2.56452E+18 1.02581E+17 4.46588E+20 3 25 28 Significance F 3.99E-28 Our degrees of freedom are k=3 P value is = 3.99E-28 Table 3 Data of Regression Analysis of coefficients X1, X2 and X3 Coefficients 591528720.7 Standard Error 114837437.4 t Stat 5.151009412 P-value 2.52277E-05 13 Lower 95% 355016593.1 Upper 95% 828040848.2 Lower 95.0% 3.55E+08 Upper 95.0% 8.28E+08 X1 Variable(GDP per capita) X2 Variable (Gros Savings) X3 Variable (Net taxes on products) 1879288.497 0.632955829 2.643661448 459555.815 0.000393725 0.391367834 4.089358539 1.617291392 2825761.407 932815.6 2825761 0.118365245 932815.5862 1.438992964 0.173081306 -1.43899 0.173081 0.757191463 3.491404193 0.001803957 1.084196452 4.203126445 1.084196 4.203126 From the coefficients we can see that there is a positive relationship between GDP per capita and final consumption expenditure, the dependent variable. For each unit increase in GDP per capita there is an increase in final consumption expenditure by 1879288 units. It has a negative relationship between gross savings and final consumption expenditure, for each unit increase in gross savings there is a decrease in final consumption expenditure by 0.6 units, as increase in saving leads to decline in final consumption expenditure. It has a positive relationship between net taxes on products and final consumption expenditure. For each unit increase in net taxes there is an increase in final cons expenditure by 2.6 units. In order for us to accept that there is a relationship between the dependent variable and the independent variable we need to see the P values for each variable. The P-value has to be lower than 0.025 for each variable. GDP per capita P value= 0.000393725 that is smaller than 0.025 so the relation is significant. For gross savings P value=0.118365245 and that is not lower than 0.025 se we cannot say that the relationship is significant. In the third case the P value for net taxes is 0.001803957 in this case it is lower than 0.025 se the relationship is significant. 14 3. Conclusion Expenditure on consumption contributes as a portion of the Gross Domestic Product that is also known as the income of the country. Consumption is established to be very influential in evaluating the growth of a country; also consumption is a function of national income. The aim of this paper was to define how GDP per capita, gross savings and net taxes affect an important economic factor as final consumption expenditure. To test the relationship is needed a statistical analysis to determine how these variables affect the overall consumption of Albania gathering data from 1985-2014. Model represent three independent variables: GDP per capita, gross savings and net taxes on product and one dependent variable which is final consumption expenditure. Paper shows how certain economic activities have e impact in hoe a country spends for final consumption. Regression indicates that with the increase of GDP per capita and net taxes on product results to increase on final consumption expenditure. For each unit increase in GDP per capita there is an increase in final consumption expenditure by 1879288 units. It has a negative relationship between gross savings and final consumption expenditure, for each unit increase in gross savings there is a decrease in final consumption expenditure by 0.6 units, as increase in saving leads to decline in final consumption expenditure. It has a positive relationship between net taxes on products and final consumption expenditure. For each unit increase in net taxes there is an increase in final cons expenditure by 2.6 units 15 4. 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