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Input Output Analysis

Input-output analysis is a framework developed by Wassily Leontief to analyze interindustry relationships within an economy. It involves constructing a matrix using observed economic data that shows the flows of goods from producing sectors to purchasing sectors. Each row shows the distribution of outputs from one sector throughout the economy, while each column shows the inputs required by a sector for production. This framework models an economy as a system of linear equations and can be represented using matrix algebra.

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157 views

Input Output Analysis

Input-output analysis is a framework developed by Wassily Leontief to analyze interindustry relationships within an economy. It involves constructing a matrix using observed economic data that shows the flows of goods from producing sectors to purchasing sectors. Each row shows the distribution of outputs from one sector throughout the economy, while each column shows the inputs required by a sector for production. This framework models an economy as a system of linear equations and can be represented using matrix algebra.

Uploaded by

Bhargav Reddy
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Input–output analysis is the name given to an analytical framework developed by

Professor Wassily Leontief in the late 1930s, in recognition of which he received the
Nobel Prize in Economic Science in 1973. Input–output has been a part of an
integrated framework of employment and social accounting metrics associated with
industrial production and other economic activity, as well as to accommodate more
explicitly such topics as international and interregional flows of products and
services or accounting for energy consumption and environmental pollution associated
with interindustry activity.

1 Input–Output Analysis: The Basic Framework


The basic Leontief input–output model is generally constructed from observed
economic data for a specific geographic region (nation, state, county, etc.). One is
concerned with the activity of a group of industries that both produce goods
(outputs) and consume goods from other industries (inputs) in the process of
producing each industry’s own output. In practice, the number of industries
considered may vary from only a few to hundreds or even thousands. For instance, an
industrial sector title might read “manufactured products,” or that same sector
might be broken down into many different specific products.
The fundamental information used in input–output analysis concerns the flows of
products from each industrial sector, considered as a producer, to each of the
sectors, itself and others, considered as consumers. This basic information from
which an input– output model is developed is contained in an interindustry
transactions table. The rows of such a table describe the distribution of a producer
’s output throughout the economy. The columns describe the composition of inputs
required by a particular industry to
produce its output. These interindustry exchanges of goods constitute the shaded
portion of the table depicted in Figure 1.1. The additional columns, labeled Final
Demand, record the sales by each sector to final markets for their production, such
as personal consumption purchases and sales to the federal government. For example,
electricity is sold to businesses in other sectors as an input to production (an
interindustry transaction) and also to residential consumers (a final-demand sale).
The additional rows, labelled Value Added, account for the other (non-industrial)
inputs to production, such as labor, depreciation of capital, indirect business
taxes, and imports.
Figure 1 Input–Output Transactions Table

In its most basic form, an input–output model consists of a system of linear


equations, each one of which describes the distribution of an industry’s product
throughout the economy.

The mathematical structure of an input–output system consists of a set of n linear


equations with n unknowns; therefore, matrix representations can readily be used.

Fundamental Relationships

An input–output model is constructed from observed data for a particular economic


area – a nation, a region (however defined), a state, etc. In the beginning, we will
assume (for reasons that will become clear in the next chapter) that the economic
area
is a country. The economic activity in the area must be able to be separated into a
number of segments or producing sectors. These may be industries in the usual sense
(e.g., steel) or they may be much smaller categories (e.g., steel nails and spikes)
or much
larger ones (e.g., manufacturing). The necessary data are the flows of products from
each of the sectors (as a producer/seller) to each of the sectors (as a
purchaser/buyer);
these interindustry flows, or transactions (or intersectoral flows – the terms industry
and sector are often used interchangeably in input–output analysis) are measured for
aparticular time period (usually a year) and in monetary terms – for example, the
dollar
value of steel sold to automobile manufacturers last year.1
The exchanges of goods between sectors are, ultimately, sales and purchases of
physical
goods – tons of steel bought by automobile manufacturers last year. In accounting
for transactions between and among all sectors, it is possible in principle to record
all exchanges either in physical or in monetary terms. While the physical measure is
perhaps a better reflection of one sector’s use of another sector’s product, there
are
substantial measurement problems when sectors actually sell more than one good
(a Cadillac CTS and a Ford Focus are distinctly different products with different
prices; in physical units, however, both are cars). For these and other reasons,
then,
accounts are generally kept in monetary terms, even though this introduces problems
due to changes in prices that do not reflect changes in the use of physical inputs.

In its most basic form, an input–output model consists of a system of linear


equations, each one of which describes the distribution of an industry’s product
throughout the economy.

The mathematical structure of an input–output system consists of a set of n linear


equations with n unknowns; therefore, matrix representations can readily be used.

One essential set of data for an input–output model are monetary values of the
transactions between pairs of sectors (from each sector i to each sector j); these are
usually designated as zij . Sector j’s demand for inputs from other sectors during the
year will have been related to the amount of goods produced by sector j over that same
period. For example, the demand from the automobile sector for the output of the
steel
sector is very closely related to the output of automobiles, the demand for leather
by
the shoe-producing sector depends on the number of shoes being produced, etc.
In addition, in any country there are sales to purchasers who are more external or
exogenous to the industrial sectors that constitute the producers in the economy –
for
example, households, government, and foreign trade. The demands of these units –
and hence the magnitudes of their purchases from each of the industrial sectors – are
generally determined by considerations that are relatively unrelated to the amount
being
produced. For example, government demand for aircraft is related to broad changes
in national policy, budget levels, or defense needs; consumer demand for small cars
is
related to gasoline availability, and so on. The demand of these external units,
since it
tends to be much more for goods to be used as such and not to be used as an input to
an industrial production process, is generally referred to as final demand.
Assume that the economy can be categorized into n sectors. If we denote by xi the
total output (production) of sector i and by fi the total final demand for sector i’s
product,
we may write a simple equation accounting for the way in which sector i distributes
its
product through sales to other sectors and to final demand:

eqn.1

The zij terms represent interindustry sales by sector i (also known as intermediate sales)
to all sectors j (including itself, when j =i). Equation (1) represents the distribution
of sector i output. There will be an equation like this that identifies sales of the
output
of each of the n sectors:

Eqn .2

Let

eqn-3

Here and throughout this text we use lower-case bold letters for (column) vectors, as
in
f and x (so x_ is the corresponding row vector) and upper case bold letters for
matrices,
as in Z.With this notation, the information in (2) on the distribution of each sector
’s
sales can be compactly summarized in matrix notation as
x = Zi + f eqn.4

We use i to represent a column vector of 1’s (of appropriate dimension – here n).
This is
known as a “summation” vector (Section A.8, AppendixA). The important observation
is that post-multiplication of a matrix by i creates a column vector whose elements
are
the row sums of the matrix. Similarly, i_ is a row vector of 1’s, and
premultiplication of
a matrix by i_ creates a row vector whose elements are the column sums of the matrix.
We will use summation vectors often in this and subsequent chapters.
Consider the information in the jth column of z’s on the right-hand side:

These elements are sales to sector j – j’s purchases of the products of the various
producing sectors in the country; the column thus represents the sources and
magnitudes
of sector j’s inputs. Clearly, in engaging in production, a sector also pays for other
items –
for example, labor and capital – and uses other inputs as well, such as inventoried
items.

Table 2 Input–Output Table of Interindustry


Flows of Goods
All of these primary inputs together are termed the value added in sector j. In
addition,
imported goods may be purchased as inputs by sector j. All of these inputs (value
added
and imports) are often lumped together as purchases from what is called the payments
sector, whereas the z’s on the right-hand side ofequation (2) serve to record the
purchases
from the processing sector, the interindustry inputs (or intermediate inputs). Since
each equation in (2) includes the possibility of purchases by a sector of its own
output
as an input to production, these interindustry inputs include intraindustry transactions
as well.
The magnitudes of these interindustry flows can be recorded in a table, with sectors
of
origin (producers) listed on the left and the same sectors, now destinations
(purchasers),
listed across the top. From the column point of view, these show each sector’s
inputs;
from the row point of view the figures are each sector’s outputs; hence the name
input–output table. These figures are the core of input–output analysis.

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