ECN 453: THE HARROD-DOMAR MODELS – ADEBISI, A.A.

PhD

Economic growth may be defined as the increase in the real national product or output over time- (Y/Y). Be it no

(a) Domar’s Growth Model:

Domar builds his model on the assumption of a constant marginal propensity to save () and a constant marginal o

Equilibrium:

The Equilibrium rate of economic growth is that rate at which the increase in the aggregate
demand equals the increase in the total productive capacity of the economy.

The left hand side of this equation shows the supply (potential) while the right hand side of both
these equations shows the demand (required). For full employment to be maintained in the
economy, the increase in the potential capacity has to be equal to the required increase in
demand. This gives us what Domar call his “fundamental equation” and which has been solved
by Domar. – By multiplying both sides by α and dividing both sides by In.
όIn = In/ό α

Divide both sides In;

= In/ In = ό

To keep the economy fully employed, the rate of growth of net investment must be equal to (α)
K/Y (MPS times the output – capital ratio). The rate of growth of income must be the same.

Hence, Output, Investment and Income must grow rapidly enough otherwise excess capacity will
result in the economy.

Harrod’s Growth Model:

In Harrod’s dynamic system:

Note: to avoid too much or too little; production income must rise at an increasing rate.

(i) A slight deviation from the warranted growth rate path tends to be “self sustained and
possibly self aggravating”. When there is even a slight deviation from the path of
warranted rate of growth – the model becomes a “razor edge” model.
When AD < I or I > AD

Warranted Rate of Growth:

It is that rate of growth at which producers will be content with what they are doing – behavior
of entrepreneurs. It is the entrepreneur’s equilibrium. It is the line of advances which if achieved,
will satisfy profit takers that they have done the right thing. Harrod has discussed this in terms of
the aggregate business behavior. Harrod’s equation for the warranted rate of growth is GwCr = s

i.e. δK/δY = In/ δY

The theory focuses our attention on the important fact that over – investment will cause capital
scarcity while under – investment will lead to excess capacity.

Actual Rate of Growth:

Gc = s; G = (Y/Y); C = In
/ Y; s = Mps or S/Y. That is expost saving (s) equals expost investment (
In) in any period.

Gc = s-k where, k is the proportion between autonomous investment and net income (In/Y).

Harrod – Domar Theory: Synthesize

The Harrod – Domar growth model evolved from the works of J. M. Keynes that focused on the
short run aspect of investment. Roy Harrod and Evsey Domar both working separately and
independently formulated what has become the most widely applied growth model in economic
history. However, in spite of close to a half century of its application the model having been
meant for short term investment analysis, based on unsustainable assumptions and drawing from
a differing environment, has been rendered in effectual in developing economies as attested. The
resulting Harrod – Domar Model focused on “dynamic theory on the relations between savings,
investment and output”. Essentially, the model argued that the national savings rate (the fraction
of income saved) had to be equal to the product of the capital – output ratio and the rate of
growth of the effective labor force if the economy was to keep its stock of plant and equipment
in balance with its supply of labor so that the steady growth could occur.

Harrod and Domar tried to put together two of the key features of the keynessian economics i.e.
the multiplier and the accelerator in one model that explained the courses of long run economic
growth. The model rose out of necessity of ensuring long term full employment equilibrium in
developed economies. Both of them mere interested in discovering the rate of income growth
necessary for a smooth and uninterrupted working of the economy. In their analysis they
assigned a key role of investments in the process of economic growth. They did consider capital
accumulation a dual role to play in investments. First investments creates incomes and secondly
it auguments the existing productive capacity by increasing its capital stock i.e demand and
supply effects.

However, for enhancing a full employment equilibrium level of income from year to year, it is
necessary that both real income and output should expand at the same rate, at which the
productive capacity of the capital stock is expanding. The required rate of income growth is
what they call the warranted rate of growth rate.

A necessary condition of economic growth is that the new demand or spending must be adequate
enough to absorb the output generated by increase in capital stocks or else there will be idle
production in capacity. The conditions should be fulfilled year in year out in order to enhance
full employment and to achieve steady economic growth in the long run (Central theme of the
Model).

To illustrate the Harrod – Domar model let’s assume that there are two factors of production i.e. labour and capi
Ќ = I – δK

Ќ = SY – δK (1)

A dot above variable indicates differentiation with respect to time and so dividing both sides
equation (I) K gives the growth rate of capital stock.

Ќ = SY – δK (2)

K K K

Taking V as the capital – output ratio and assuming no depreciation (ie – δ=0) allows slight
modification of equation 2 to give the well known, Harrod- Domar Equation for the so called
warranted growth rate gw

Ќ =S

Gw = S

Because of the assumption of fixed coefficients in production, the warranted rate of growth is an
upper bound for the rate of output growth. Likewise the growth of the labor force, known as the
natural growth rate (gn) also limits the growth rate of output. Most early development
economists shared Domar’s view that unskilled labor was in abundant supply and so it was the
warranted rate that would act as the brake to growth. The shortfall of investment (savings)
below that required to satisfy the Harrod- Domar consistency condition (gw = gn) became known
as the ‘financing gap’. Before the advent of significant international capital flows, or attract
foreign aid to fill any existing gap. Today governments are perhaps more likely to look towards
portfolio and direct foreign investment.

The major stumbling block of the Harrod- Domar model is that long run equilibrium growth can
only be attained if the warranted and natural rates are equal. If this is not the case of economy
will be subject to prolonged periods of escalating unemployment (gn < gw). However, S, v, n
and & are all exogenous to the model and there is little reason to believe that they will just
happen to all take the necessary values so that gw and gn will equate.

The limitations of the “Harrod – Domar model”

The Harrod Domar models of economic growth are based on the experiences of advance
economies and are primarily addressed to an advanced capitalist economy in an attempt to
analyze the requirements of steady growth in such economy.

Basically both Harrod and Domar are interested in discovering the rate of income growth
necessary for a smooth and uninterrupted working of the economy. Here investment is treated as
a significant factor in the process of economic growth.
However due to certain crucial assumptions made by Harrod, these models have been made
weak and unrealistic in a number of ways. The propensity to save (< or s) and the capital output
ratio (0) are assumed to be constant which is not so actual sense. In the long run these are likely
to change, thus modifying the requirements for steady growth which can, however, be
maintained without the assumption.

Harrod and Domar also make the untenable assumption that labor and capital are used in fixed
proportions. Generally labor can be substituted for capital and the economy can move more
smoothly towards a path of steady growth. In fact, unlike Harrod’s mode, this path is not so
unstable that the economy should experience chronic inflation or unemployment if the rate of
growth of output in given period of time does not coincide with the warrant rate of growth of
output does not coincide with the ‘warrant rate of growth’ or the full capacity rate of growth of
income.

No consideration is made by this model of the changes in the general price level, price changes
always occur overtime and may stabilize otherwise unstable situations. This assumption that
there are no changes in interest rates is irrelevant to the analysis rates change and affect
investment. A reduction in interest rates during periods of overproduction can make capital
intensive processes more profitable by increasing the demand for capital and thereby reducing
excess supplies of goods.

Harrod- Domar models ignores the effect of government programs on economic growth. In case
of the government undertaking a program of development, no casual or functional relationship is
provided by this analysis, which is quite unrealistic.

The entrepreneurial behavior actually determines the warrant growth rate in the economy and
this is conspicuous reflected by the model. This further makes the concept of the warrant growth
rate unrealistic. In addition, the Harrod- Domar model clearly fails to make a distinction
between capital goods and consumer goods, earning them very sharp criticisms from various
quarters. Professor Rose, states that the primary source of instability is Harrods system lies in
the effect of excess demand or supply on production decisions and not in the effect of growing
capital shortage or redundancy on investment decisions.

Harrod - Domar analysis was evolved under different set of conditions. It was meant to prevent
and advanced economy from the possible effect of secular stagnation. It was never intended to
guide industrialization programmes in underdeveloped economies. This limits the application of
these models in the latter.

Another limitation with these growth model, is that they are characterized by a high saving ratio
and a high capital output ratio, while it is crystal clear that decisions to save and invest are
generally undertaken by the same group of persons in underdeveloped economies. The vast
majority of the people live on the margin of subsistence and thus very few are in a position to
save.

According to Professor Kurihara, this model fails to solve the problem of structural
unemployment found in underdeveloped countries. It can tackle the problem of keyesian
unemployment arising out of deficiency of effective demand or under- utilization of capital. But
when population grows faster than accumulation of capital in underdeveloped country, structural
unemployment will arise due to lack of capital equipment.

The Harrod- Domar models are based on the assumption that there is no government intervention
in economic activities which is not applicable to underdeveloped countries, which cannot
develop without government help. In such countries, the state plays the role of “pioneer
entrepreneur in starting large industries and regulating and directing private enterprise.

Whereas the Harrod Domar models are based on the assumption of a closed economy,
underdeveloped countries are open rather than closed economies. Foreign trade and aid play
very crucial roles in their economic development and hence are the bases of their economic
progress.

Institutional factors have been assumed to be given in these models. But the reality is that
economic development is not possible without institutional changes in such countries.
Consequently, these models fail to apply in underdeveloped countries.

It is therefore, prudent to categorically conclude that the Harrod- Domar models based as they
are on unrealistic assumptions have little practical application in underdeveloped countries. But
despite all these limitations, these models are purely laissez – faire, based on the assumption of
fiscal neutrality and designed to indicate conditions of progressive equilibrium for an advanced
economy.

TOPIC 2: INPUT – OUTPUT ANALYSIS

Economic growth and development usually has economic plans relating to it and these plans are
always established in accordance with some particular mathematical or statistical models. These
models try to take into account the structural conditions existing within a given economy during
a proposed planning period.

Input – Output analysis helps us to understand inter sectorial linkages. They indicate, via the
sales and purchases of commodities, the ways in which individual economic units are dependent
on one another. It is used to analyze inter-industry relationship in order to understand the inter-
dependencies and complexities of the economy and thus the conditions for maintaining
equilibrium between supply and demand. This is often called inter industry economics or the
Leontief system. Input-output is a novel technique invented by Prof. Wassily W. Leontief in
1951. It is used to analyse inter-industry relationship in order to understand the inter-
dependencies and complexities of the economy and thus the conditions for maintaining
equilibrium between supply and demand. It is also known as “inter-industry analysis.”

Before analysing the input-output method, let us understand the meaning of the terms, “input”
and “output”. According to Prof. J.R. Hicks, an input is “something which is bought for the
enterprise” while an output is “something which is sold by it.” An input is obtained but an output
is produced. Thus input represents the expenditure of the firm, and output its receipts. The sum
of the money values of inputs is the total cost of a firm and the sum of the money values of the
output is its total revenue.
The input-output analysis tells us that there are industrial interrelationships and inter-
dependencies in the economic system as a whole. The inputs of one industry are the outputs of
another industry and vice versa, so that ultimately their mutual relationships lead to equilibrium
between supply and demand in the economy as a whole. Coal is an input for steel industry and
steel is an input for coal industry, though both are the outputs of their respective industries. A
major part of economic activity consists in producing intermediate goods (inputs) for further use
in producing final goods (outputs). There are flows of goods in “whirlpools and cross currents”
between different industries. The supply side consists of large inter industry flows of
intermediate products and the demand side of the final goods. In essence, the input output
analysis implies that in equilibrium, the money value of aggregate output of the whole economy
must equal the sum of the money values of inter-industry inputs and the sum of the money values
of inter industry outputs.
Main Features. The input-output analysis is the finest variant of general equilibrium. As such, it
has three main elements:
First, the input-ouput analysis concentrates on an economy which is in equilibrium. It is not
applicable to partial equilibrium analysis.
Secondly, it does not concern itself with the demand analysis. It deals exclusively with technical
problems of production.
Lastly, it is based on empirical investigation.
Assumptions. This analysis is based on the following assumptions:
(i) The whole economy is divided into two sectors—’’inter-industry sector” and “final demand
sector,” both being capable of sub-sectoral division.
(ii) The total output of any inter-industry sector is generally capable of being used as inputs by
other inter industry sectors, by itself and by final demand sectors.
(iii) No two products are produced jointly. Each industry produces only one homogeneous
product.
(iv) Prices, consumer demands and factor supplies are given.
(v) There are constant returns to scale.
(vi) There are no external economies and diseconomies of production.
(vii)The combinations of inputs are employed in rigidly fixed proportions. The inputs remain in
constant proportion to the level of output. It implies that there is no substitution between
different materials and no technological progress. There are fixed input coefficients of
production.
The input-output analysis consists of two parts: the construction of the input-output table and the
use of input-output model.
USE OF INPUT-OUTPUT MODEL IN PLANNING
The input-output table relates to the economy as a whole in a particular year. It shows the value
of the flow of goods and services between different productive sectors especially inter-industry
flows. For understanding, a three-sector economy is taken in which there are two inter-industry
sectors, agriculture and industry, and one final demand sector.
Table 1 provides a simplified picture of such economy.
In this table, the total output of the industrial, agricultural and household sectors is set in rows (to
be read horizontally) and has been divided into the agricultural, industrial and final demand
sectors. The inputs of these sectors are set in columns. The first row total shows that altogether
the agricultural output is vauled at Rs. 300 crores per year. Of this total, Rs 100 crores go
directly to final consumption, that is, household and government, as shown in the third column of
the first row. The remaining output from agriculture goes as inputs; 50 to itself and 150 to
industry. Similarly, the second row shows the distribution of total output of the industrial sector
valued at Rs. 500 crores per year.

Table 1. Input-Output Table:

(in Value Terms : Rs. Crores)
PURCHASING SECTORS

1. Inputs to 2. Inputs 3. Final Total

Agriculture to Deman Output
Industr d or Total
y Revenue

Sectors Agriculture 50 150 100 300

Industry 100 250 150 500

SELLING Value 150 100 0 250

Added

SECTOR Total
S output
(OR)

Total cost 300 500 250 1050

* Value added refers to payments to the factors of production.

Columns 1, 2 and 3 show that 100 units of manufactured goods go as inputs to agriculture, 250 to
industry itself and 150 for final consumption to the household sector.
Let us take the columns (to be read downwards). The first column describes the input or cost
structure of agricultural industry. Agricultural output valued at Rs .300 crores is produced with
the use of agricultural goods worth Rs. 50, manufactured goods worth Rs. 100 and labor or/and
management services valued at Rs. 150. To put it differently, it costs Rs. 300 crores to get a
revenue of Rs. 300 crores from the agricultural sector, Similarly, the second column explains the
input structure of the industrial sector (i.e., 150+250+100=500). Thus “a column gives one point
on the production function of the corresponding industry.” The ‘final demand’ column shows
what is available for consumption and government expenditure. The third row corresponding to
this column has been shown as zero. This means that the household sector is simply a spending
(consuming) sector that does not sell anything to itself. In other words, labor is not directly
consumed.
In input – output accounting, two matrices used - the transactions matrix and the input
coefficients matrix.

(i) Transactions matrix

This is also called the base-year flows matrix and it uses the following notation:
Xi = gross output of industry i, = 1, 2, ………….n;

Xij = intermediate demand for the ith industry’s output by the jth industry; I, j = 1, 2,

……,n;
Xi = final demand by consumers for the ith industry’s output, i = 1, 2, ……n.

The two sources of inputs for the jth industry are:

Oj = input of primary factor, labor;

aij = input of intermediate product from ith industry to the jth industry

Hence, it is assumed ; the number of industries equals number of commodities – each

industry produces only one product and no changes occur in the inventories of the
commodities.

The gross output of industry is:

xi = xi=¿ Z xij + xi, I =1, …..,n.

(ii). Input coefficients matrix

Assume constant proportions among inputs and outputs for each industry. This gives fixed-
proportions production functions, so there is no factor substitution. The ratios between input and
output in each industry are then

aij = xij/Xj, i, j = 1, 2, …………..,n

Here aij are the input coefficients. They can be arranged in a matrix form:

Using industries

1 2 3

Producing 1 a11 a12 a1n

industries
 2 a21 a22 a2n

. .

. .

N an1 ann

Primary input a01 a02 a0n

The ratios between labor input and the output of the industries are

aoj = Oi/Xj, I = 1, 2, …………….n

These are the employment coefficients, the last row of the input coefficients matrix.

(ii) Gross outputs required for producing given final outputs

xij = aijXj, I, j = 1, 2, …………n’
Substituting these xij into this equation: Xi = Zxij + xi, I =1, …..,n.
Zaij.xj + xi = x, I = 1 …………………n

If X = column vector of Xi,

X = column vector of Xj,
A = n x n matrix of input coefficients aij,
Then using matrix notation, equation stated last becomes:
AX = X
X = AX = 0

FEASIBILITY AND CONSISTENCY OF THE PLAN

An economy behaves and assumes a certain pattern of flows of resources in two ways. They are:
(a) the internal consistency or balance of each sector of the economy, and (b) the external
stability of each sector or inter-sectoral relationships. Leontief calls them the “fundamental
relationship of balance and structure.” When expressed mathematically they are known as the
“balance equations” and the “structural equations.”
If the total output of say Xi of the ith industry be divided into various number of industries, 1, 2,
3, n, then we have the balance equation: and if the amount say Yi absorbed by the “outside
sector” is also taken into consideration, then the balance equation of the ith industry becomes Yi.
It is to be noted that Yi stands for the sum of the flows of the products of the ith industry, to
consumption, investment and exports, net of imports, etc. It is also called the “final bill of goods”
which it is the function of the output to fill. The balance equation shows the conditions of
equilibrium between demand and supply. It shows the flow of outputs and inputs to and from one
industry to other industries and vice versa. The system of balance equations in the analysis
presents the conditions of internal consistency of the plan.
The plan would not be feasible without them because if these equations are not satisfied, there
might be excess of some goods and deficiency of others. Since xi2 stands for the amount
absorbed by industry 2 of the ith industry it follows that xij stands for the amount absorbed by
the jth industry of ith industry. The “technical coefficient” or “input coefficient” of the ith
industry is denoted by: where, xij is the flow from industry i to industry j, Xj is the total output of
industry j and aij, as already noted above, is a constant, called “technical coefficient” or “flow
coefficient” in the ith industry. The technical coefficient shows the number of units of one
industry’s output that are required to produce one unit of another industry’s output. Equation (3)
is called a “structural equation.” The structural equation tells us that the output of one industry is
absorbed by all industries so that the flow-structure of the entire economy is revealed. A number
of structural equations give a summary description of the economy’s existing technological
conditions.
Technology Coefficient Matrix A
These input coefficients have been arrived at by dividing each item in the first column of Table1
by first row total, and each item in the second column by the second row, and so on. Each
column of the technological matrix reveals how much agricultural and industrial sectors require
from each other to produce a rupee’s worth of output. The first column shows that a rupee’s
worth of agricultural output requires inputs worth 33 paise from industries and worth 17 paise
from agriculture itself.
The matrix of technical coefficient of production for any input-output table with n sectors would
consist of n x n elements. There being two sectors in our example, 2 x 2 technical coefficients of
the matrix would be arranged symbolically as follows:

Table 2: Technology Matrix A

Agriculture Industry

Agriculture All aI2

Industry aI2 a22

THE LEONTIEF SOLUTION*

The table can be utilised to measure the direct and indirect effects on the entire economy of any
sectoral change in total output of final demand.

Cross multiplying. xij = aij. Xj

By substituting the value of xij in the matrix equation and transposing terms, we obtain the basic
input-output system of equations
In terms of our two-sector economy, there would be two linear equations that could be written
symbolically as follows:
x1 – a11x1 – a12x2 = Y1
x2 – a21x1 – a22x2 = Y2
The above symbolic relationship can be shown in matrix form:
X – [A] X = Y
X [I–A] = Y
where matrix (I–A) is known as the Leontief Matrix
and I, the identity matrix =………………………..
Hence
* Ordinary students may omit this portion.
Numerical Solution. Our technology matrix as stated thus:
The value of determinant = .9(.5) – (–.3)(–.3)
= .45 – .09 = .36
Hence
The total output of agriculture sector (x1)
The total output of industrial sector (x2)

EXAMPLE: Given Technology Coefficient Matrix A

Agriculture Industry

Agriculture 50/300 150/500 = 30

Industry 100/300 250/500 = 50

A = .1 .3 and X = 100

.1 .3.3 .5 100 150

(I –A) = .9−3.3−.5

The value of inverse = Adjoint/Determinant = Adj/A

The value of determinant = .36

Hence, the total output of agriculture sector (x1)

= .5x100+.3x150/.36 = 264

The total output of industrial sector (x2)

= .3 x 100 +.9 x 150/.36 = 458

THE DYNAMIC INPUT-OUTPUT MODEL

So far we have studied an open static model. “The model becomes Dynamic when it is closed by
the linking of the investment part of the final bill of goods to output.” The dynamic input-output
model extends the concept of inter-sectoral balancing at a given point of time to that of inter-
sectoral balancing over time. This necessarily involves the concept of durable capital. The
Leontief dynamic input-output model is a generalization of the static model and is based on the
same assumptions. In a dynamic model, the output of a given period is supposed to go into
stocks, i.e., capital goods, and the stocks, in turn, are distributed among industries. The balance
equation is:
Here Xi(t) represents the total flow of output of ith industry in period t, which is used for three
purposes:
(i) for production in the economy’s n. industries xil(t), xi2(t), etc., in that period;
(ii) as net addition to the stock of capital goods in n industries i.e., S’t which can also be written
as ΔSi(t)=Si(f+l)–Si(t), where Si(t) indicates the accumulated stock of capital in the current
period (t), and Si(t+l) is next year’s stock; and
(iii) as consumption demand for the next period Di(t+l).

If we ignore depreciation and wear-tear, then Si(t+l)–Si(t) is the net addition to capital stock out
of current production. Equation (4) can, therefore, be written as:
Xi(t) = xil+xi2+xi3+... xin+Si (t+1)–Si(t) + Di(t)+Yi(t)
Yi(t) stands for the amount absorbed by the outside sector in period t.
Just as the technical co-efficient was derived in the case of the static model the capital co-
efficient can be found out in a similar manner. Capital co-efficient of the ith product used by the
jth industry is denoted by where, Sij represents the amount of capital stock of the jth product
used by the jth industry. Xj is total output of industry j and bij is a constant called capital co-
efficient or stock co-efficient. Equation (5) is known as the structural equation in a dynamic
model.
If the bij co-efficient is zero, it means that no stock is required by an industry and the dynamic
model becomes a static model. Moreover, bij can neither be negative nor infinite. If the capital
co-efficient is negative, the input is in fact an output of an industry.
USE OF INPUT-OUTPUT TECHNIQUE IN PLANNING
The knowledge of both the fundamental relationships of “flow coefficients” of the static model
and of “capital coefficients” of the dynamic model is required for the development plans. The
input-output table tells us about the inter-relationships between various sectors and the structural
relationships within each sector. On the basis of this information, the planning authority can
determine the effect of a change in one sector on all other sectors of the economy and thus plan
accordingly.

With the help of the static analysis “flow coefficients” of each industry can be calculated and
known during a given period of time. But in an economy fast moving towards economic
development, the flow structure of the economy does not remain stable. Again, a static model
takes the capital structure of the economy as given. In fact, the capital requirements of the
economy change with economic development. It is only “when we properly harmonize the
capital structure with the flow structure that we get a comprehensive input-output system which
is very useful for dynamic analysis in connection with planning.
Given the basic conditions and also time period (say five years) one can calculate the flow
coefficients and the capital coefficients of an economy. In addition to all this if the time shape
of the final demand is also known, one could find out definitely (by solving a system of linear
non-homogenous differential equations) what should be the consistent and optimum levels of
output of various industries after five years.” The input-output technique with it’s basic
assumption of constant “technical coefficient” is of much help to a planning authority in an
underdeveloped country. A linear homogeneous input-output model fits in an underdeveloped
economy where reliable statistical data about technical coefficients are not easily available. By
assuming constant “flow” and “capital coefficients” the need for collecting and computing vast
statistical data is greatly reduced. Since inputs are considered proportional to outputs, this
technique is certainly of immense help in determining the amount of inter-industry flows of
goods and services in an underdeveloped country.
“From the planning point of view, the dynamic input-output model has much appeal; it helps in
identifying a moving equilibrium of outputs. Investment is specified of a disaggregated level in
terms of specific investment goods and is treated endogenously. The planner is helped to see
more clearly the implications of raising the level of investment in a particular sector’, given the
requirements of inter-sectoral balancing.” The input-output analysis is also used for national
economic planning. The static and dynamic models can be applied in preparing the Plan-frame’
in underdeveloped economies. The input-output model provides the necessary information about
the structural coefficients of the various sectors of the economy during a period of time or at a
point of time which can be utilized for the optimum allocation of the economy’s resources
towards a desired end. The dynamic model is particularly helpful in a developing economy
which can estimate through the input-output table the impact of different growth rates of the
various sectors of the economy and thus choose the most desired one.
A United Nations study lists the following uses of input-output models in development
programming:
“(i) They provide for individual branches of the economy’s estimates of production and import
levels that are consistent with each other and with the estimates of final demand.

“(ii) The solution to the model aids in the allocation of the investment required to achieve the
production levels in the programme and it provides a more accurate test of the adequacy of
available investment resources.

“(iii) The requirements for skilled labour can be evaluated in the same way.

“(iv) The analysis of import requirements and substitution possibilities is facilitated by the
knowledge of the use of domestic and imported materials in different branches of the economy.

“(v) In addition to direct requirements of capital, labour and imports, the indirect requirements in
other sectors of the economy can also be estimated.

“(vi) Regional input-output” models can also be constructed for planning purposes to explore the
implications of development programmes for the particular region concerned, as well as for the
economy as a whole.”

It concludes that these models “are primarily applicable in economies that have achieved a
certain degree of industrial development and hence have a substantial volume of inter-industry
transactions.”

Limitations of Input – Output Analysis:

 - Assumption of constant coefficients of production unrealistic – It tells us nothing as to how
technical coefficients would change with changed conditions in techniques of production.
- The rigidity of the input-output model cannot reflect the outputs of one industry to inputs of
others.
- There is no mechanism for price adjustment in the input-output analysis which makes it
unrealistic. “ The analysis of cost-price relations proceeds on the assumption that each industrial
sector adjusts the price of its output by just enough to cover the change in the case of its primary
and intermediate output.
- The model thrives on equations that cannot be easily arrived at.

NOTE: PLEASE CONSULT M.L JINGHAN (39th Edition) “ The Economics Of development and
Planning” For Complete Information. Thanks.