Welfare implication of determinants affecting aggregate consumption expenditures in Rwanda

3.Scope and period of the study

This study is addressing on assessment on welfare implication of determinants affecting aggregate consumption expenditure in Rwanda. We normally assessed the level of aggregate consumption as a function of income, interest rate, inflation rate and exchange rate as well such the Rwanda, after 1994 Genocide, the economy was really in recessionary period so that it was not easy for the community to produce and consume. The research dated from 15^st March 2016 and ended on 15^th August, 2016 and then presented on September 06^th, 2016.

4.Problem statement

Rwandan economy is struggling for balance of payment deficit because of high level of imports and lower level of export, the Rwanda currency which is depreciating day to day, a continuous increase of prices as well as the high level of lending interest rate. The level of income is normally lower because of lower level of return of wages and many other factors. This study, therefore, aims at finding out the trends of key macroeconomic variables that determine aggregate consumption expenditure in Rwanda from 1995 to 2015. The theory underpinning this study stems from the nature and relationship between consumption and income. The most undeniable attention to what has come to be called the consumption function was first well thought out by John Maynard Keynes. In less developed counties (LDC) like Rwanda, consumption expenditures are based on actual income, not full employment or equilibrium income, important savings and investment determinants include income, expectations, and other influence beyond the interest rate. These assumptions imply that the economy can achieve a short-run equilibrium at less than full-employment production. According to Keynesian theory, changes in aggregate demand, whether anticipated or unanticipated have their greatest short run impact on real output and employment, not on price. Rationalizing rigid prices is hard to do because according to standard microeconomics theory, real supplies and demands do not change if all nominal prices rise or fall proportionally. If government spending increases, for example, all other components of spending remain constant, then output will increase. Therefore, J.M Keynes's absolute income hypothesis didn't give account. Milton Friedman emphasized that consumers smooth their expenditure by borrowing and

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lending. He posited that consumption is determined by long term expected income rather than current level of income. He argued that consumption in one day is determined not by income received on that day but on the average daily income received for a period. Income consist of a permanent (anticipated and planned) component and a transitory (windfall gain/unexpected) component (Anyanwu, 1993). Milton Friedman noted that permanent income or expected long average income is earned from both human and non-human wealth consisting of labor income, saved money, debentures, equity shares, and real estate and consumer durables goods like cars, refrigerators, air conditioner, TV sets etc. This theory made an important contribution by laying stress on changes in interest rate and wealth as well as the desire to add to one's wealth (Forgha, 2008). Many economists have posited that consumption depends on a person's lifetime income. Franco Modigliani emphasized that income varies systematically over people's lives and savings allow consumers to move income from the time in life when income is high to low income lifetime period in order to smoothen consumption. The life cycle hypothesis is based on household utility maximizing behavior defined on present and future consumption subject to a lifetime resources constraint. It assumes that price is constant, interest rate is stable and consumers do not inherit any asset and as such the wealth owned by a consumer are his own. It also indicates that consumption in a period depends on the total resources (wealth) one has to spend over his remaining lifetime which composes of initial wealth and expected earnings at late stage in life^. (Onuchuku, 1998).

Keynes in his book «The General Theory of Employment, Interest rate and Money» published in 1936 laid the foundation of modern consumption theories. Keynes mentioned several subjective and objective factors which determine the consumption of a society. However, of all factors, he posited that the level of income determines the consumption of an individual and the society. He laid stress on the absolute income of an individual as the major determinant of consumption and as such, his theory was regarded as the absolute income hypothesis. His theory centered on the relationship between the Marginal Propensity to Consume (MPC) and Average Propensity to Consume (APC).

Further, Keynes put forth the fundamental «psychological law of consumption» according to which he propounded that as income increases, consumption increases, though not by as much as the increase in income. In other words, the marginal propensity to consume is less than 1, means that 0<MPC<1.

Keynes made 3 salient points from his proposition. First, consumption expenditure depends mainly on absolute income of the current period. Second, consumption is a positive function of absolute level of current income and third, the more income derived, the more the consumption expenditure in that period (Jhingan, 2002).

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Keynes posited that interest rate does not have an important role in influencing consumption decision. This stood in stark contrast to the classical economist who believed that a higher interest rate encourages savings and discourages consumption (Blare, 1978). Based on conjectures, Keynesian consumption function is given as C= C0 + bY^d, a>0, where C is the consumption, Y^d is disposable income; C0 is consumption when income is zero (autonomous consumption) and b is the rate of change of consumption due to change in income called the marginal propensity to consume (MPC). While this theory has success modeling consumption in the short run, attempt to apply this model over a long time frame proved less successful. This led to the emergence of other consumption theories put forth by several economists based on other key factors which is believed to determine consumption other than income. From all the reason above the researcher has to conduct this study basing on the following two questions:

? What is the status and trends of gross consumption expenditure, income, interest rate, inflation rate and exchange rate from 1995 up to 2015 in Rwanda?

? Is there any relationship between consumption, income, interest rate, inflation rate and exchange rate from 1995-2015 in Rwanda?