U.S. Disposable Income and U.S.

¶ … U.S. disposable income and U.S. imports. In other words, we are trying to establish a link between the two to understand how fluctuations in the former can cause the latter to increase or decrease. The topic is important because over the years we have seen increasing dependence of U.S. On foreign products as its imports have been on the rise. This is not exactly a desirable situation because it shows weakening local production capacity.

The imports in the area of crude oil have noticeably increased almost touching 74% since 1985 when domestic production was at its highest. We need to explore the factors which may be affecting imports including income. When disposable income increases, people have greater purchasing power which means they demand more. This demand however may not always be met with equally enthusiastic response from the production side due to capacity restrictions. This is when a country has to depend on imports.

While every country would want to see an increase in the income of its people, it doesn't want this to correspond with rapidly increasing imports and shrinking local production capacity. But this appears to be the trend in the U.S. where production has not been able to keep up with increase in income. The topic is important because over the last few decades, there has been a significant change in disposable income of Americans and U.S. imports have likewise increased in some areas and decreased in others.

It is thus very critical for correct determine of income elasticity to study the effects of changes in income on U.S. imports. While it is generally believed that income changes would result changes in import levels but the kind of changes that occur may be drastically different from one country to another. In the U.S.

For example, it was noticed that income increases led to an increase in imports but a relatively slower growth rate compared to Japan where increase in income led to a decrease in imports and a much higher growth rate. Thus came the concept of income elasticity into play. We must understand income elasticity to be able to understand what happens to import levels when income changes and how it affects different countries differently.

Income elasticity for demand for imports refers to the degree of change in import level as income changes. Overall a change is noticed in world trade (imports and exports) as world income changes. This phenomenon then affects each individual country as well though not in the same manner. There are several interrelated concepts in this argument which must be clearly understood such as comparative advantage, income elasticity in developing countries compared to developed ones and the role of higher income groups in determining demand and income's effect on consumption etc.

Comparative advantage theory suggests that when a country has comparative advantage in one area, income changes will lead to higher exports in that area and lower imports. For example U.S. have a comparative advantage in production of services compared to production of goods. OECD Economic Outlook 2004 explained, "…the United States has more of a comparative advantage in the production of services, particularly new economy services, than goods. If this is true then further liberalization of trade in services, together with deeper investment in new economy services by U.S.

trading partners, would increase the size of this sector within U.S. trade and thus narrow the overall asymmetry." (p. 163) Income elasticity also affects countries differently depending on variety of factors including their level of development and labor prices. "….the deceleration of the growth of manufactured imports from the developing countries can be attributed to the decline in GNP growth rates in the developed countries rather than to increased protection.

In fact, the apparent income elasticity of demand for manufactured goods imported from the developing countries (the ratio of the rate of growth of these imports to that of GNP) continued to increase…" (Balassa, p.9) For this paper, we have studied two articles titled "Inequality and the U.S. import demand function" by Magarita Katsimi and "Relationship between GDP, imports and U.S. production of crude oil" by Imad Jabir. The two articles are connected with our chosen topic and show how income affects imports.

The first paper by Katsimi uses a specific model of trade to see how U.S. income inequality has a significant effect on U.S. demand for imports. They chose vertically differentiated products to study trade and income. They found that U.S. income disparities do have a significant effect on U.S. imports using their trade model but also could offer alternative explanations for the finding.

Their main argument surrounds around the assumption that the country can domestically produce very high quality of the differentiated product while it imports low quality version of the item from other countries due to the demand in lower income groups. When we say differentiated products, it means that while the product is the same, different income groups would demand different qualities of the same item. In other words income determines quality demanded.

So while the country itself has enough of the high quality version, it doesn't have the same item available in low quality and hence needs to import. Based on their findings, the hypothesis is proven correct as they explain, "…according to our range of estimates (0.8-1.2), had inequality in the U.S. remained at its 1975 level, imports in 1996 would have been lower between 12 and 19% of the fitted value (which is close to the actual value).

The further rise in inequality since 1996 implies that had inequality in 2004 been at its 1975 level, the percentage decline in U.S. imports in 2004 would have been even larger than in 1996, thus implying a very large improvement in the U.S. current account deficit." They researchers also investigated the relationship between aggregate imports, income relative process and inequality in the long run and found them to be closely linked.

They also discovered that "the influence of inequality is quantitatively very important as well." In the second article studied for this paper, the author Imad Jabir focused on the exploration of a relationship between oil imports, GDP and domestic crude oil production. They found that increase in GDP leads to higher crude oil imports and while it was previously believed that the latter had a positive impact on the former, Jabir found that it was the other way around because higher GDP is directly connected with high oil imports.

The country chooses to import more and needs to import more too to increase production in different industries and meet the demand for various products. But there is also an important factor which cannot be ignored. According to the article, the level of domestic oil production together with GDP determines the level of oil imports. Based on these articles we find that income has a connection with imports but there are other.