CHAPTER 1 INTRODUCTION

Background of the Study

Income and expenditures are the foundation of any business. Understanding this enables companies to record financial data in more accurate passion. Now a days a there are a lot of business occurring, some business also tends to close because costumers are diminishing. This is because current economic policies are not enough or violated by the locals and it interrupts the improvement of a certain locality. Hence, it increase poverty incidence. In the Philippines poverty is generally widespread. Income distribution is significantly unequal. Distribution of expenditure in the Philippines is somewhat less inequitable or biased than that of income. Studies are conducted to improve the economic growth of our country for as to go along with the improvements of our neighboring countries. According to John Maynard Keynes, if national income would adjust it will restore the equilibrium in the society. An increase in the government expenditure means imbalanced in the society. Keynes argued that relying in markets for employment was not a good idea. He believed that the economy could settle at any equilibrium and there are no automatic changes in the market to correct the situation. It is a step by step improvement in a certain locality. In the Philippines, the Family Income & Expenditure Survey (FIES) is the main source of income and expenditure data in the Philippines. It is a nationwide survey of households conducted regularly by the National Statistics Office (NSO). This undertaking aims to accomplish the following objectives: (1) to gather data on family income and family living

expenditure and related information affecting income and expenditure levels and patterns in the Philippines; (2) to determine the sources of income and income distribution, levels of living and spending patterns, and the degree of inequality among families; (3) to provide benchmark information to update weights in the estimation of consumer price index (CPI); and (4) to provide inputs in the estimation of the countrys poverty threshold and incidence.

The examination of the relationship between public expenditure and national income is hardly a new area of exploration in the economics and public finance literature. However, future research work on this area is of paramount important as it is directly related to the modeling and assessment of the effectiveness of fiscal policies. Many researchers have examined the relationship between expenditure and income and other economic indicators the results are significantly inconsistent.

Theoretically, there are two competing school of thought defining this causal relationship. First, Wagner (1890) postulated that public expenditure is an endogenous variable and grows faster than national income. Endogenous variable is a dependent variable generated within a model and, therefore, a variable whose value is changed (determined) by one of the functional relationships in that model. Moreover, public expenditure is a consequence rather than cause of national income. Therefore, Wagners law viewed that public expenditure plays no role in generating national income; hence the causality direction runs from national income to public expenditure. However, Keynes (1936) argued that public expenditure is an exogenous variable and can be used to generate national income. Exogenous Variable is exogenous variable is an Independent variable that affects a model without being affected by it, and whose qualitative characteristics and method of generation are not specified by the model builder. For this reason,

public expenditure is a cause rather than effect of national income. Therefore, the causal relationship should run from public expenditure to national income (Tang 2009).

The tie between public expenditure and national income has been the focus of many public finance studies both at theoretical and empirical levels. The focus has been mainly on two approaches, first, Wagners law approach (1883), which states that national income causes public expenditure and second, Keynesian approach (1936), which states that public expenditure causes national income. In both approaches the focus is only to the unidirectional causal link between the public expenditure and national income (Jamshaid, 2010), the effect of expenditure to income or the effect of income to expenditure. Moreover, according to Keynesians, public expenditure is the real tool to boost the economic activities in the economy and also a tool to bring stability in the short run fluctuations in aggregate expenditure (Singh and Sahni, 1984). Furthermore, the role of fiscal policy in boosting the rate of economic growth has also been the part of literature of endogenous growth that government spending directly affecting private production functions (Barro, 1990). In contrast, according to Wagnerians approach public expenditure growth is a natural consequence of economic growth. The empirical evidences on these views are reported in detail in the studies and the issues related to interpretation of Wagners Law and Keynesian approach have been discussed in detail by Peacock and Scott (2000).

This paper proposes to model the relationship between income and expenditure. And to test if income has an effect on expenditure as stated by Wagners Law. Aside from simple linear regression a new method is introduced. This method is called spline regression.

Regression analysis is a statistical tool for the investigation of relationships between variables. Usually, the investigator seeks to establish the causal effect of one variable upon

anotherthe effect of price increase upon demand, for example, or the effect of changes in the money supply upon the inflation rate. To investigate such issues, the investigator assembles data on the necessary variables of interest and employs regression to estimate the quantitative effect of the causal variables upon the variable that they influence. The investigator also typically assesses the statistical significance of the estimated relationships, that is, the degree of confidence that the true relationship is close to the estimated relationship. The common forms of regression are Simple Linear Regression and Polynomial Regression. These models are simple but unsuited for most situations. Linear regression fails to capture the linear dependency between the dependent and the dependent variables while polynomial regression of higher degree encounter the problem of multicollinearity among the terms. A new method is used to explain all the variation. This method is called Spline Regression. Spline regression is a method in which it avoids the inappropriate jump (break) in joining two regression lines. A spline knot is representing a turning point in a spline model which connects the downward regression line to the upward regression line. Spline regression models have greater flexibility than linear regression model and polynomial regression model in higher dimensions and are generally less likely to generate perfect multicollinearity in higher dimensions. Spline regression models provide better fit than that of linear and polynomial regression models employing simple linear relationship. Spline regression is a new method, where there is an abrupt change in the trend of data. (Marsh and Cormier)

Objective of the Study This paper aims to: 1. introduced the concepts of splines and knots. 2. apply the method of Spline Regression to FIES data 3. compare the efficiency of the following models from the FIES data 3.1. as polynomial regression i. Simple linear regression 3.2. as spline regression i. Linear spline regression

Statement of the Problem The study aims to answer the following question: a. Does income affect expenditure in the Philippines? b. Is there a significant relationship between income and expenditure?

Significance of the Study This study is useful in fitting models when there is an abrupt change in the tread of the data. It provides alternative ways to the users on what tool to use in data modeling. It also gives insights to the readers on some concepts and ideas about spline regression. The outcome of this

study will give insight to the government and other social organization in making policies and implementing them to diminish poverty incidence in our country.

Scope and Delimitation of the Study The study focused only on the average family income and expenditure in the Philippines. The scope of the study is delimited only in 105 municipalities and 22 provinces in the Philippines for the year 2000. Provinces excluded key municipalities that are considered as domains. The data gathered are from the FIES (Family Income and Expenditure Survey) conducted by the NSO (National Statistic Office). It also focuses in using spline regression in fitting models. Definition of Terms Income - is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms.

Expenditure - cash or a cash equivalent paid in exchange for goods and services

Multicollinearity - is a statistical phenomenon in which two or more predictor variables in a multiple regression model are highly correlated.

Average income and expenditure It is the daily income and expenditure of a person for the year 2000

CHAPTER 2 REVIEW OF RELATED LITEARTURE AND STUDIES

Related Literature Splines are lines or curves, which are usually required to be continuous and smooth. Univariate polynomial splines are piecewise polynomials in one variable of some degree d with function values and first d-1 derivatives that agree at the points where they join. The join points (or abscissa values) that mark one transition to the next are referred to as break points, interior knots, or simply knots (Poirier, 1976, Eubank, 1999). Knots give the curve freedom to bend and more closely follow the data. Splines with few knots are generally smoother than splines with many knots; however, increasing the number of knots usually increases the fit of the spline function to the data. (Hansen and Kooperberg, 2002). Splines are a useful function-type to use in Regression when the relationship between a response and a set of covariates is not known a priori. In particular, they share many of the nice mathematical properties of polynomials, without the global behavior that can be problematic when fitting a regression model. The use of splines within the regression framework has been largely influenced by the work of Hastie and Tibshirani (Hastie and Tibshirani 1986,1990) on Generalized Additive Models (GAMs). Also, Spline regression Models are more complex compared to the traditional regression models due to polynomial terms. Hence, a simpler model is recommended. We use least square procedures for estimating parameter in spline regression models which involves minimizing the sum of squares of deviations (of observed values from predicted values). The method of least squares assumes that the best-fit curve of a given type is the curve that has the minimal sum of the deviations squared (least square error) from a given set of data.

(http://www.efunda.com/) Such estimators are unbiased whenever the means of the error terms are independent and jointly distributed as multivariate normal having minimum variance. As such, least squares estimators are viewed as optimal in the multi-normal case. In addition spline methods tend to be easier to use with standard packages such as SPSS. . SPSS is a computer program used for survey authoring and deployment (IBM SPSS Data Collection), data mining (IBM SPSS Modeler), text analytics, statistical analysis, and collaboration & deployment.( http://en.wikipedia.org) SPSS is a comprehensive and flexible statistical analysis and data management solution.

Related Studies

In the study conducted by Bartosova Jitka, and Novak Michal, in the year 2010 entitled Income and Expenditure of Czech households they concluded When analyzing the total income and total expenditure of households from HBS in 2007 they learned that the total income of Czech households have been higher this year than the total expenditure. This confirms the fact that in 2007 there was a higher growth of total savings than thegrowth of household debt

In the study conducted by Noorhaslinda Kulub, Abd. Rashid, Aslina Nasir, Nik Hashim Nik Mustapha and Nik Fuad Kamil in the year January 2011 entitled Analysis of Income and Expenditure of Households in the East Coast of Peninsular they concluded that it is very important to highlight the household income and expenditure in order to know how their spending pattern in the context of nowadays. From the expenditure items that mentioned before this, all Malaysian especially among the household should have good information and knowledge to manage their money and to put the priority expenses of the total expenditures. The

following below are the steps or guidance in thrift spending: Get to know the thrift store shopping to avoid losing money, Make a budget and Limited Promotion and Unbeneficial Advertisement.

In the study conducted by Chaido Dritsaki and Melina Dritsaki in the year 2010 entitled Government Expenditure and National Income: Causality Tests for Twelve New Members of E.E. it was concluded that causal link runs from real per capita income to real per capita government expenditure. The Granger causality tests indicate that the reverse hypothesis is supported only by the Bulgarias and Cyprus data, suggesting that the direction of causality is from government expenditure to national income. It was also concluded that also indicate that government expenditures do not play a significant role in promoting economic growth in the four countries in our study (the Bulgaria and Cyprus is the exception). This is surprising because it is widely believed that government has played an important role in the development of these countries.

In the study conducted by Deborah Hurley, James Hussey, Robert McKeown, Cheryl Addy, entitled An Evaluation of Splines in Linear Regression they conclude in general, the sample size is not particularly important in determining which modeling method works best. All models generally did better with an increase in sample size, as we might expect, but the ordering of models from best to worst remained constant as the sample size changed. Complex spline models, though useful for some defined data structures, are not appropriate for all situations. While they perform well when used to smooth a series of data, they may not perform well if used in a regression setting where prediction is of interest. This agrees with the well-known phenomenon of decreased precision when adding any unnecessary term to a regression model.

Thus, users should exercise caution in the application of such models, and not assume that they will be appropriate in any modeling situation. In the study conducted by Eugene Brusilovskiy entitled The Piecewise Regression Model as a Response Modeling Tool it was concluded that as the accuracy of the solution depends on the ratio of we can obtain the exact solution when the ratio is close to

one, or when the knots are known. A three step heuristic approach is suggested for the situation when the data are significantly contaminated and/or the knots are unknown.

In the study conducted by Chan Hee Jo, Little Rock, AR Jeff Gossett and Pippa Simpson, in the year 2007 entitled Regression Splines with Longitudinal Data it was concluded that semi-parametric model, with parameters of fixed and random components, clinical longitudinal data. It allows one to compare the sub groups in these outcomes. It offers an easy way to test various covariance structures and select an appropriate one. Simulation using SAS IML can be a valuable tool for showing the effect that missing data can have on inferences made from repeated measures models.

In the study conducted by Qingzhi Guo and Ralph E. White in the year 2005 entitled Cubic Spline Regression for the Open-Circuit Potential Curves of a Lithium-Ion Battery it was conclude The cubic spline regression model presented here is useful for fitting complicated profiles such as the experimental OCP curves of intercalation electrodes. Even though a few intervals need to be defined and the model equation has a form varying from one interval to another, the model predictions are smooth within the entire range of the experimental data points

because the dependent variable, and its first and second derivatives, are all continuous within that range. Round-off error can be avoided in cubic spline regression by choosing the first regression interval away from a steep portion of an OCP curve. In general, using a high-order polynomial equation to fit an OCP curve of an intercalation electrode is not recommended because such a fit does not provide the accuracy needed.

CHAPTER 3 METHODOLOGY

Data Gathering Procedures

The researcher asks permission from the National Statistics Office to gather the data for the average family income and expenditure for the year 2000.

Data Analyses

A. Original Data 1. Draw the graph of the data using Scatter Plot. The graphical representation allows you to determine the trend of the data. Ii also estimates the number of segments and the location of knots (breakpoints) or the points where changes in its trend occur. 2. Determine the number of segments or intervals on the graph. For each n segments, there is a corresponding n 1 knots. Accordingly, two (2) interior knots is the standard starting point. If the fit appears rough, knots are added. If the fit appears overly nonlinear, knots are subtracted. Two (2) or three (3) interior knots are sufficient for most applications. 3. Identify the location of the knots. It can be accomplished by some methods: i) Natural Division Points

ii) Visual Inspection iii) Proposed Sign-Slope Procedure 4. Fit the Linear Spline Regression to the original data using the formula Y = b0 + b1X + b2(X-c1)+ + b3(X-c2)+ + + bN+1(X-cN)+ where (X-ci)+ = X-ci if X-ci > 0 and (X-ci)+ = 0 if X-ci 0. This formula represents N + 1 separate simple linear regression equations that correspond to the N + 1 segments of the time series. The estimated parameters are evaluated by using the least squares method. 5. Once a model has been constructed, check the underlying assumptions for regression analysis. Use RMSE and AIC for the goodness of fit. Apply F-test and t-tests for the statistical significance of the overall fit and estimated parameters, respectively.