Background of the study
In developing countries, detailed knowledge of the relationship between expenditure shares and total household expenditure plays a significant role in household welfare analysis. Food and nutritional programs, poverty reduction strategies as well as tax reforms, all require information on how expenditure share respond to changes in household total expenditure for effective formulation and implementation. Knowledge of how expenditure shares respond to changes in household total expenditure, however, is often ascertained through Engel curve analysis. Engel curves as noted in Girma and Kedir (2007) describe the relationship between household expenditure on particular items and household total expenditure. The most studied Engel curve is food Engel curve which describes how food expenditure increases as total expenditure increases. Such studies often show that household food consumption increases less than proportionally with income, and food expenditure as a share of total expenditure decreases as income increases (Girma and Kedir, 2007; Banks et al., 1997; Deaton and Muellbauer, 1980; Engel, 1857). This relationship is known as the Engel’s law.
For a developing country such as Ghana, knowledge of food Engel curve is important for a number of reasons. First, food Engel curve is important in welfare analysis. For poorer household food expenditure share is high but it decreases as the household income increases. Therefore, high food expenditure share can be used as indicator of poverty levels while decreases in food share can be associated with rising incomes. Second, since food Engel curve shows the relationship between food share and income, it can be used to predict how food expenditure will change as income changes. These predictions can be used to simulate the impact of tax policies on consumers as well as the local economy. The food Engel curve reveals important information about aspects of consumer behavior which has relevant policy implications (Deaton and Muelbauer 1980). For instance, food Engel curve may indicate proportionately the burden of tax imposed on food items consumed by the poor. Third, aside from it (food Engel curve) showing how food share responds to changes in income, the food Engel curve also reveals the income elasticity of food and thus, shows if food is a normal good, inferior good or luxury good.