Lecture 5: Input-Output Models

Prof. Eduardo A. Haddad and Prof. Joaquim J. D. Guilhoto

Input-output analysis

Idea developed by Wassily Leontief (awarded Nobel

Prize in Economics in 1973)

Employed in all countries – no matter what their

political sentiments

Part of National Income and Product Accounts

Extend ideas of the economic base model by

disaggregating production into a set of sectors

Can be extended to explore issues of income

distribution, tax policy, development strategies etc.

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Input-output analysis

Imagine a region with m firms, producing a whole array

of goods and services from agriculture, food processing,
manufacturing, personal and business services and
government.

Firms are assigned to n broad sectors based on their

principal product.

The number of sectors, n, ranges from 50 to several

hundred and the allocation conforms to the Standard
Industrial Classification (SIC).

For this presentation, only two sectors will be shown to

facilitate the analysis and to avoid getting bogged down
in details.
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 Input-output flows

Final Demand

Output Capital Households Exports Government

Are Supplied to:

Imported
Domestic Goods
Goods
Are demanded from:

Domestic Imported
Labor Capital Land
Inputs Inputs
Primary Inputs
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Input-output table

The Input-Output Matrix

Demanda Final
Produção SectorFormação Consumo Final Governo e out.
Exports
i Sector j Exportações Households
corrente de capital das famílias Governmentdemandas
Investments
Buyng Sectors Stocks

São ofertados para:

Sector i
Intermediate Final
Produtos Total
Produtos domésticos
Selling
Sectors Consumption Demand
importados Outp.
Sector j São demandantes de:

Imports Imports
Insumos
Imports
Insumos
Trabalho Capital Terra
domésticos Sales Taxes Sales Taxes
importados

Comp. Emp.
Value Insumos
Added primários Selling
GOS
Total Output Buying

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Numerical example

IO Matrix S1 S2 Y X
S1 150 500 350 1000
S2 200 100 1700 2000
W 650 1400
X 1000 2000
Employment 300 800

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Input-output flows

The transactions between these sectors are arrayed in a matrix (n

rows and n columns), as shown in the table.

Looking across the rows, the sales made by the firm at the left can
be traced to firms listed at the top of the column.

Thus sector 2 sells $200 to sector 1, and $100 to sector 2.

The columns provide complementary information of the source of

purchases made by the sector at the top of the column from all
other sectors.

Again, following sector 2, note that it buys $500 from sector 1, and
$100 from sector 2.

This part of the input-output table is referred to as the

interindustry transactions; it provides an economic photograph of
the ways in which one sector is linked to another sector.

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Input-output flows

However, sectors also make sales to other sets of activities

– consumers, government and to customers located outside
the region (exports).

In addition, firms also make purchases of labor (wages and

salaries), returns to capital (profits and dividends) and
imports.

These are shown in the rest of the table.

The column Y is referred to as final demand; row W is

referred to as primary inputs.

The sum of wages and salaries and profits and dividends

(returns to labor and capital) are referred to as value
added.

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Input-output model

The input-output table is basically an accounting

system – a double entry one similar to that prepared
for a business in which sales and purchases or assets
and liabilities will be shown but, in this case, for an
economy.

The next step is to prepare an economic model so

that we can trace the impact of changes in one sector
on the rest of the economy.

We do this because the nature of interdependence

among sectors varies.

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Input-output model: key assumptions

We assume that each sector produces goods and

services according to a fixed recipe (formally known
as a production function)

zij
aij  , i , j  1,..., n
xj
 Fixed technical coefficient

 Constant returns to scale

 Sectors use inputs in fixed proportions

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Input-output model: key assumptions

Inputs are expressed in monetary terms since it would

be difficult to combine tons of iron ore with megawatts
of electricity, or hours of labor in some consistent
fashion.

This fixed recipe enables us to express the transactions

in proportional form, also known as direct coefficients;
these are shown in the first example in the Excel
file.

The final assumption is that the economy is driven by

signals emanating from final demand (consumers,
government, exports); this is the exogenous part of the
economy, while the interindustry transactions respond to
these signals and are therefore endogenous.

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Basic relations

Buying Sectors

Selling Final Total

Sectors Intermediate Consumption
Demand Output

Imports (M) M

Sales Taxes on Inputs (T) T

Value Added
Total Output

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Basic relations

n
 zij  yi  xi , i  1,..., n
j 1

zij
aij  , i , j  1,..., n
xj

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Production function

 z1 j znj 
x j  f z1 j ,..., znj ,W j , M j  x j  min 
a
,..., 

 1 j a nj 

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The Leontief model

a
j 1
ij x j  y i  xi i  1,..., n

Ax  y  x
x   I  A y
1

B  I  A
1

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The power series approximation of I  A
1

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Leontief matrix

I  A1 is known as the Leontief inverse matrix and is

shown in the table below:

The entries reveal the direct and indirect impacts on a

sector when final demand in the sector at the top of the
column changes by $1 (or $1 million or $100 million).

Note that the entry on the principal diagonal is always >1;

the unit value represents the increase in final demand in
that sector. The remaining portion is the direct and indirect
impact of expansion.

(I-A) -1 1 2
1 1,254 0,330
2 0,264 1,122
Total 1,518 1,452
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Leontief matrix

At the bottom of the multiplier table there is a row labeled

total

Note that these values vary from 1.45 (sector 2) to 1.52

(sector 1)

How should these entries be interpreted?

They provide information on the impact on the rest of the

economy (including the sector in question) of a unit change
in final demand in any sector.

The value 1.45 for sector 2 tells us that for every increase
of $1 in that sector an additional 0.45 worth of activity is
generated for a total value of production of 1.45.
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Leontief matrix

Why do these values vary?

 They reflect the degree to which a sector is dependent on

other sectors in the economy for its inputs and as a source
of consumption for its products.
 They depend on the structure of production (the recipe).

It would be incorrect to assume that a sector’s importance in the

economy is directly related to the size of the multiplier

 While true in part, a sector with a large volume of

production but a modest multiplier may generate a greater
volume of activity in the region than the sector with the
largest multiplier but a smaller volume of production.

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Multipliers and generators

There are several additional multipliers that can be

calculated

When a sector expands production, it will increase

payments to labor generating additional wages and
salaries that will be spent in the region. Further, other
industries whose production has to expand to meet
these new demands will also spend more on wages
and salaries. Thus, we may generate an income
multiplier that reveals the relationship between
direct income generation and total income (in similar
fashion to output).

We could also transform the analysis into

employment terms.
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Multipliers and generators

Vj
Coefficient C vj 
Xj

n
G   civ bij
v
j
i 1

Generator G v  C v B  1xn
or
G v  Cˆ v B  nxn

G vj
Multiplier M vj 
C Vj

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Impact analysis

X  I  A Y
1

X  I  A Y
1

ˆ
V  C X
v

ˆ
V  C BY
v

v ˆ
G C B v

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Closing the IO model to households

Households earn incomes (at least in part) in

payment for their labor inputs to production
processes, and, as consumers, spend their income in
rather well patterned ways.

One could move the household sector from the final-

demand column and labor-input row and place it
inside the technically interrelated table, making it one
of the endogenous sectors.

X  W  Y
(Second example in the Excel file)
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Closing the IO model to households

A Hc  Y*   X 
A Y  *  X  
H r 0  Yn 1   n 1 
X

Y  Y Y
* h

X  BY

B  ( I  A ) 1

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Regional IO models

Buying Sectors

Selling Final Total

Sectors Intermediate Consumption
Demand Output

Imports from the rest of the Country (MC) MC

Imports from the rest of the World (MW) MW

Sales Taxes on Inputs (T) T

Value Added
Total Output
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 Interregional IO models

Buying Sectors Buying Sectors

Region L Region M

Selling sectors FD FD TO
Interindustry Inputs Interindustry Inputs
Region L LL LM LL LM L

Selling sectors Interindustry Inputs Interindustry Inputs FD FD TO

Region M ML MM ML MM M

Imports from the World Imports from the World M M M

Sales Taxes Sales Taxes T T T

Value Added Value Added

Total Output L Total Output M

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Interregional IO models

Final Demand s Final Demand t

Exports, Cons. households,... Exports, Cons. households,...
Sector j reg s Sector j reg t

Sector i reg s

Large amount of data

Sector i reg t

Problem?!

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Interregional IO models

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Estimation of regional models

Early studies:

p Rj 
X R
j  E Rj 
X R
j  E Rj  M Rj 
where:
X Rj is the total output of good j in region R;

E Rj is the total exports of good j from region R;

M Rj is the total imports of good j by region R.

 
1
ˆ
A  PA
R R ˆ
X  I  PA YR
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Estimation of regional models

Example:

(Third example in the Excel file)

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Regional coefficients

Regional coefficients:

zijLL
aijLL 
X Lj

Regional production:

X  I  A
L LL 1
 YL

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Interregional IO models

Interregional flows – intermediate consumption:

 Z LL Z LM 
Z   ML MM 
Z Z 

Total output:

X i  z i1  z i 2  ...  z ii  ...  z in  Yi

X 1L  z11LL  z12LL  z11LM  z12LM  Y1L

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Interregional IO models

Interregional coefficients:

zijLL zijLM
aijLL  aijLM 
X jL X jM

zijML zijMM
a ijML  a ijMM 
X jL X jM

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Deriving the interregional IO model

 A LL  A LM  Y L  XL
A     Y   X 
 A ML  A MM  Y M   X M 


  I  0   A LL
 A LM
 
  X L
 Y L 
             

 0  I  
  A ML
 A MM
 
  X M
 Y M 

(I  A) X  Y ,

X   I  A Y
1

(Fourth example in the Excel file) 34

Multipliers in (inter)regional IO models

Multipliers vary not only across sectors but also across regions.

A small regional economy, with a modest representation of

industry, may not be able to provide all the necessary inputs
required by local industry. Thus, there will be considerable
importation of inputs (sometimes referred to as leakages).

In general, the larger the value of the imports, the lower the
value of the multiplier.

We would expect multipliers to decrease as we move from the

country as a whole to a macro-region, an individual province, a
metropolitan region and finally to a municipality.

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