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This paper investigates the effects of underground economy on the Iran’s imports demand for intermediate, consumption and capital goods during 1971-2011. In this study, the size of the underground economy of Iran has been estimated by using fuzzy logic and demand for imports has been analyzed within intermediate, capital and consumption goods separately. Our findings show that the average size of the underground economy of Iran is 20.64 % of Gross Domestic product(GDP) for 2001-2011 period, and the effect of the underground economy on the demand for imports of intermediate goods is negative, but underground economy affects positively the demand for imports of capital goods and consumption groups. In addition, import demand for intermediate goods with respect to the underground economy is less elastic and negative-signed, while import demand for capital goods and consumption goods with respect to the underground economy is less elastic and positive-signed.

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Underground economy is considered as an important economic component among the world countries, and in particular developing countries. It creates a serious consequence in the economy and could lead to a deviation from the correct diagnosis of economy status and as a result prescription of the mistaken policies. Therefore, identifying the size of underground economy and using corrective measures to reduce and control it is the main concern of policymakers. Financial development is among factors affecting the performance of underground economy. It reduces the cost of credit and decreases the incentives of agents in the underground sector. This study aims to investigate how to financial development affect underground sector. To this end, it uses structural equation modeling and multiple indicators – multiple causes (MIMIC) approach. The results suggest that the average ratio of the underground economy to GDP is equal to 20.68% during 1973-2012. For one unit increase in financial development, on average, the size of the underground economy decreases by 0.05 percent.