Managerial Economics

Term I Project
Fitting of Engel Curve: Urban Kerala

Submitted to:
Prof. Kaushik Bhattacharya,
Associate Professor,
Business Environment Group, IIM Lucknow

Alok Chandra (PGP26072)

Ankur Dutt (PGP26076)
Arjun H(PGP26080)
Joydeep Barman (PGP26092)
Nikhil RC 1
(PGP26109)
Shiv Kumar Seth (PGP26119)
Shravan Mukhopadhyay(PGP26120)
ABSTRACT

Fitting of Engel Curve: Urban Kerala aims at understanding the trends of food consumption
in households with changing income levels. The input data that is used for this purpose has
been extracted from The National Sample Survey on Household Consumer Expenditure (NSS
63rd Round) which was conducted from July 2006 and June 2007.
The region that has been chosen for the purpose of this analysis is Urban Kerala. The
objective is achieved by plotting an Engel Curve and subsequently analyzing the pattern
observed. Ideally, the Engel curve is plotted between Income of the Consumer and the
Quantity Consumed. But since Income is directly proportional to the expenditure of a
household, we have plotted the Engel Curve between Income expenditure of a Household and
Expenditure of food items consumed by the household. We also have considered some other
factors that affect Income.

2
INTRODUCTION

Engel Curves
Definition: Engel curve shows how the quantity demanded of a good or service changes as
the consumer's income level changes.

Named After: It has been named after the 19th century German statistician Ernst Engel.

Description: An Engel curve describes how a consumer’s purchases of a good like food

varies as the consumer’s total resources such as income or total expenditures vary. Engel
curves may also depend on demographic variables and other consumer characteristics. A
good’s Engel curve determines its income elasticity, and hence whether the good is an
inferior, normal, or luxury good. Empirical Engel curves are close to linear for some goods,
and highly nonlinear for others. Engel curves are used for equivalence scale calculations and
related welfare comparisons, and determine properties of demand systems such as
agreeability and rank.

Representation: Engel curve is represented in the first-quadrant of the Cartesian coordinate

system. Income is shown on the Y-axis and the quantity demanded for the selected good or
service is shown on the X-axis.

Normal goods: The Engel curve has a positive gradient. That is, as income increases, the
quantity demanded increases. Amongst normal goods, there are two possibilities. Although
the Engel curve remains upward sloping in both cases, it bends toward the y-axis for
necessities and towards the x-axis for luxury goods.

Inferior goods: The Engel curve has a negative gradient. That means that as the consumer
has more income, they will buy less of the inferior good because they are able to purchase
better goods. Example of Inferior Goods and Services: Scooters, Road side food joints etc.

Graph:

3
DATA COLLECTION

The National Sample Survey

The National Sample Survey (NSS), set up by the Government of India in 1950 to collect
socio-economic data employing scientific sampling methods, started its sixtieth round from
1st January 2004. The sixtieth round of the NSS annual survey contains data on consumer
expenditure, employment-unemployment situation and morbidity and health care. 

Geographical coverage: The survey covers the whole of the Indian Union except (i) Leh
(Ladakh) and Kargil districts of Jammu & Kashmir, (ii) interior villages of Nagaland situated
beyond five kilometres of the bus route and (iii) villages in Andaman and Nicobar Islands
which remain inaccessible throughout the year.

Period of survey and work program: The period of survey was of six months duration
starting on 1st January 2004 and ending on 30th June 2004.

Sample Design:
A stratified multi-stage design was adopted. The first stage units (FSU) were the 1991 census
villages in the rural sector and Urban Frame Survey (UFS) blocks in the urban sector. The
ultimate stage units (USU) were households in both the sectors. (In case of large
villages/blocks requiring hamlet-group (hg)/sub-block (sb) formation, one intermediate stage
was the selection of two hgs/sbs from each FSU.)

Strata formation (District Level):

For Urban Sector, Two special strata were formed at the State/ UT level, viz.
Stratum 1: all FSUs with population between 0 to 50 and
Stratum 2: FSUs with population more than 15,000.
Special stratum 1 was formed if at least 50 such FSUs were found in a State/UT. Similarly,
special stratum 2 was formed if at least 4 such FSUs were found in a State/UT. Otherwise,
such FSUs were merged with the general strata. From FSUs other than those covered under
special strata 1 and 2, general strata was formed and its numbering started from 3.

Sub Samples
From each stratum, two subsamples were randomly chosen for the purpose of the survey.
These sub-samples are nothing but Northern and Southern Regions and have been named Sub
Sample 1 and Sub Sample 2.

4
 KERALA
URBAN RURAL

NORTHERN SOUTHERN

SUB SAMPLE 1 SUB SAMPLE 2

SECOND
SECOND STAGE STRATA 1 STAGE
STRATA 2

SCHEDULED SCHEDULED
TYPE 1 TYPE 2
(HOUSEHOLD (HOUSEHOLD
LEVEL) LEVEL)

5
1. Fitting of Engel Curve: Urban Kerala

Introduction
The Indian economy has been growing at a very healthy rate over the past decade or so. This
stupendous growth has led to rapid urbanization, increasing income levels and changing
lifestyle patterns of its citizens. As a result of this and the increase in population, the demand
for food in India is increasing rapidly and a study of food consumption patterns has thus
become of utmost importance to policy makers. Analysis of food consumption patterns and
their correlation with changes in income levels and other behavioral patterns is essential to
assess the food security-related policy issues in our country.
The present study is aimed at studying the food consumption patterns in Urban Kerala by
establishing the relationship of total household expenditure to the expenditure on food items
for urban Kerala. The study uses data from 63 rd round of the consumer expenditure survey of
the National Sample Survey [NSS] conducted between July 2006 and June 2007. Multiple
regressions were carried out and the results obtained have been presented in the form of
Engel Curves.

Engel curve is plotted between the expenditure on food consumption and total expenditure of
each household. The five factors that influence the food expenditure considered are
household size, dwelling unit, social group, land holding size and seasonality. Three
functional forms of Engel Curves have been considered and graphs have been arrived for
each sample population. The correlation between the expenditure and each of the input
parameter has been analyzed.

Three different functional forms linear, double log and semi log have been used to estimate
the Engel Curve and the elasticity estimates have been calculated for each one of them. Two
Engel Curves have been estimated for each sub sample of the population considering the
factors household size, dwelling unit, social group, land holding size and seasonality of the
household in three different functional forms. In all, Engel curves have been estimated
varying one of the five factors and constructing each curve for a sub sample of the
population.

The study consists of four chapters. In the present chapter, we have already discussed the
fundamental objectives of this study. The second chapter presents a review of the theory of
Engel curves and Engel functions and their implications. It also briefly discusses published
literature which is relevant to the study. The third chapter analyzes and discusses the results
of the study. The final chapter presents the main findings and conclusions of the study.

A detailed analysis must consider various parameters such as the impact of real household
income, seasonal factors, social group and the community of the population. Also there is a
need to estimate the demand for various food items and also the demand elasticities of food
items in order to quantify the influence of income on consumption. This analysis and thus
arriving at a realistic estimate for the demand for food is very important in order to achieve a
smooth and more importantly a planned development.

This study attempts to construct Engel curves between the expenditure on food and the
monthly household expenditure (this is considered as a proxy for income) for two subsamples
of population in urban Kerala.

6
Literature Review

Engel Curve
Engel Curves were developed and first used by the German statistician and economist Ernst
Engel to describe how a consumer’s purchases of a good like food vary with the consumer’s
total resources such as income or total expenditures.
Engel curves may also depend on demographic variables and other consumer characteristics.
A good’s Engel curve determines its income elasticity, and hence whether the good is an
inferior, normal, or luxury good. Empirical Engel curves are close to linear for some goods,
and highly Non-linear for others.
For normal goods, the Engel curve is an upward sloping curve and hence suggests that the
quantity demanded for such a good or a service increases as the income of the individual
increases.
On the other hand, for inferior goods, the Engel curve is a negatively sloped curve i.e. it has a
decreasing gradient. In this case, as the income of the individual increases, he/she will
decrease the consumption of the inferior goods and switch to better goods.
The Engel Curve can be constructed in various functional forms. Following functional forms
have been considered for this study:

1. Linear Function
2. Double-Log Function
3. Semi-Log Function

Survey Methodology Review

The National Sample Survey Organization (NSSO), a permanent survey organization, set up
in the Department of Statistics of the Government of India in 1950, collects data on various
facets of the Indian economy through nationwide large-scale sample surveys to assist in
socio-economic planning and policy making.

The NSSO has been carrying out Consumer Expenditure Surveys once in every five years
since 1972-73. The data used in this study has been obtained from the 63 rd round of the NSS
survey that was conducted between July 2006 and June 2007. The subject of the household
survey was household consumer expenditure.

In the NSS surveys, not only the average levels of consumption but also the distribution of
households and persons over different ranges of consumption level are presented, separately
for rural and urban areas of different States of the country.
A stratified multi-stage design was adopted for the 63 rd round survey. The first stage units
(FSU) were the 2001 Census villages (Panchayat wards in case of Kerala) in the rural sector
and Urban Frame Survey (UFS) blocks in the urban sector.

SAMPLE DESIGN
A stratified multi-stage design was adopted for the 63rd round survey. The first-stage units
(FSU) were the 2001 Census villages in the rural sector and Urban Frame Survey (UFS)
blocks in the urban sector. In addition, for the newly declared towns and outgrowth (OGs) in
Census 2001 for which UFS had not been done, a separate list was prepared and used as a
frame for such towns and OGs in the urban sector. For these towns and OGs the whole

7
town/OG was considered as an UFS. The ultimate stage units, in both sectors, were
households. In the case of large villages/blocks requiring formation of hamlet-groups (hg)/
sub-blocks (sb), the selection of two hg’s/ sb’s from each FSU formed an intermediate stage
of sampling.

STRATIFICATION
Two basic strata were formed at the State/ UT level, viz., (i) rural stratum comprising all rural
areas of the district and (ii) urban stratum comprising all urban areas of the district. However,
if there were one or more towns with population 10 lakhs or more as per population census
2001 in a district, each of these also formed a separate basic stratum and the remaining urban
areas of the district was considered as another basic stratum.

METHODOLOGY
Using the data from the 63rd round of the NSS Survey, Engel curves for urban Kerala have
been obtained. Each Engel curve gives us a relationship between the income and food
expenditure. Each household has a number of characteristics out of which only an important
few have been selected. The parameters which have been selected are
1. Social Group
2. Land possessed
3. Dwelling Unit
4. Season
5. House hold size
The other parameters have been ignored as they are not that significant. E.g we have ignored
the religion data as it doesn’t significantly contribute to expenditure pattern.

Assumptions
The following assumptions have been made while using the data and determining the Engel
curves.
1. Total expenditure has been used as an approximation of income since the income data
was not available
2. The total food expenditure has been arrived at by summation of various food
expenditures given in Level 4.

Data Retrieval
The survey data by NSS was presented in a crude text format. With the help of . This was
absolutely necessary to carry out any further analysis. The data was classified into various
headings based on the information provided by the layout files.
To check the efficacy and reliability of the data NSS divide the total data collection into two
sub samples.
 Sub sample 1
 Sub sample 2
So, we have plotted three sets of regression analysis for two set of data presented under Sub
sample 1, sub sample 2 and combined data of sub samples.

Regression Analysis
The household expenditure data collected is a function which can be summarized as below:
X = f (Y, a, b, c, d, e)

8
where,

X: Food expenditure per capita

Y: Total expenditure per capita

a: Sub round
b: Land possessed
c: Social group
d: House hold size
e: Dwelling unit

In the course of the study, since there was no direct information captured about “income” in
the National Sample Survey, the following 5 factors were considered to provide an accurate
representation of income –
(i) Total expenditure of the household
(ii) Sub round of the data which represents the seasonality. The season in which the
survey was conducted – to account for any seasonal anomalies. The survey was
conducted in 4 seasons:
a) Sub round 1
b) Sub round 2
c) Sub round 3
d) Sub round 4
(iii) Sizes of the land holding of the household are broken down on a scale from 1 to
10, increasing in that order.
(iv) Caste – A “social” factor which has a positive correlation with economic strata to
which the household belongs. We have used 4 dummy variables to assign social
group to a particular household/ person in measuring Food expenditure.
(v) Household size: the number of persons is a significant factor to the expenditure as
a whole of the household.
(vi) Dwelling unit: the kind of residence of the person is also a characteristic of their
well being. We have considered dummy variables in this context.

This is a problem of multiple linear regressions. We used various online tools

(http://www.wessa.net) to arrive at the best it for the equation. We have done both direct and
double-log regression to analyze and derive elasticities of Engel curves. We have then
compared the elasticities of sub-sample 1, 2 and combined data of both the samples. The
following graphs show the regression analysis.

9
ANALYSIS OF THE RESULTS

10