INPUT OUTPUT ANALYSIS

Industries in an economy are usually inter related in the sense that the output of one industry is
used as the input of the other industry.
Input output analysis is a technique that allows this inter dependence to be studied
mathematically
The primary purpose of this study is to make useful predictions

An input output table consist of the following items:

• Transaction table
It’s a matrix of absolute or actual inputs and outputs of an economy for a given period.
transaction table usually reflect historical figures of an economy that can be defined by
sectors which are interdependent
a transaction table assumes a given state of technological knowhow

• Inter industry/inter- sectoral intermediate demand

This consist of input sold and purchased within the production sector but excluding final
demands
inter industry transactions represent the intermediate consumption of goods and services to
enable further production within the sector.

• Final demand
This accounts for final consumption of goods and services and is made up of the following
components
i. Consumption
ii. Exports
iii. Government services
iv. Inventory accumulation

• Total output
This is a summation of intermediate demand and final demand
i.e. Total demand = intermediate demand+ final demand

• Primary inputs
These are inputs required in the production process but which are outside the manufacturing
e.g.
a) Land(rent)
b) Labour(wages)
c) Entrepreneurship
d) Depreciation
The total of the primary inputs is referred to as value added

• Total input
It is the summation of the inter industry input and primary inputs
i.e. Total input = inter industry input + primary input

Accounting for profit as an input

Total output = Total input
Revenue= Cost + Profit
Formulation: Total output = Intermediate demand + final demand

Recall: X = A.X + D
Where: A is technical matrix represents the unit, input required per output
 X is the total output vector
D is the final demand vector

X – AX = D
NB: Introduce an appropriate identity matrix
Therefore; IX – AX = D
X (I – A) = D
X = D / (I – A)

Therefore; X = (I – A)-1 D
Where: (I – A) represent Leontief matrix
(I – A)-1 represents Leontief inverse matrix
NB: Both matrixes are named after Prof Wassily Leontief whose pioneering work in this area
won him the Nobel prize in economics in 1973

Assumptions of input output analysis

1. Production is subject to constant returns to scale i.e. Constant input- output ratios
2. Each industry in the economy produces a single homogenous product and if the industry is
multi product, then the various products are produced in a constant proportion
3. Each industry in the economy is assumed to use a fixed input-output ratio
4. Input output ratios also known as technical coefficients representing the amount of inputs
required to produce a unit of output of a given product are assumed to remain constant in a
given period.
5. The matrix of technical coefficient is known as technological matrix, technical matrix, input
-output matrix or matrix of technical factors, is assumed to be constant in a given period.
6. The state of technology of the economy is assumed to be constant

Steps for LEONTIEF inverse matrix

i. Obtain the Leontief matrix
ii. Calculate the determinant
iii. Obtain and calculate then co factors
iv. Obtain the co factor matrix
v. Obtain the adjoint matrix as the transpose of the co factor matrix
vi. Calculate the Leontief matrix as follows

Open model vs closed model

The open output model incorporates final demand
Ie. Total output = intermediate demand + final demand
X = A.X + D

Closed input output model does not consider final demand

Ie. Total output = intermediate demand
X = MX
Where M = technical matrix for closed model

NB:
This model can be solved using rows and columns operation technique (Gauss Jordan)
 LINKAGES
A forward linkage is the process of some out [put after it has left the original producer e.g. A
forward linkage of dairy farming is a dairy factory
A backward linkage is an industry supplying inputs either directly to the business in question
or indirectly by supplying inputs to other suppliers

Use of input output in cost allocation

Input output analysis can be used to allocate cost/ overheads of one debt to other departments.
Where service department benefits production department, input output analysis can be used to
allocate such service overheads to production departments especially where a service
department serves other service departments (service department overheads services)

Question One
Consider a three-sector economy whose transactions table is provided below:
INPUT – OUTPUT TABLE (Shs Millions)
OUTPUT/Purchases or user of outputs
Agricultur Manufacturing Services Final Total
e demand output
Agriculture 90 80 35 95 300
INPUTS/
Manufacturing 30 160 70 140 400
Sellers or
Producers Services 60 120 140 30 350
of Inputs
Primary inputs
(Value added) 120 40 105
Total Value
of Inputs 300 400 350 1,050

Suppose the final demand for the next planning period changes to Shs 100M, Shs 150M and Shs
25M for the three sectors respectively.

Required
a) Determine the output levels required for each sector so as to satisfy intermediate and final
demand.
b) Account for sources of input for services sector.
c) How is output of agricultural sector distributed?

Question Two
a) Distinguish between input-output analysis and Markov analysis (6 marks)

b) Briefly explain the importance of input-output analysis (6 marks)

 c) A small economy has three main industries which are steel, motor vehicles and construction.
The industries are interdependent. Each unit of steel output requires 0.2 units from steel, 0.3
units from motor vehicles and 0.4 units from construction. A unit of motor vehicles output
requires 0.2 units from steel, 0.4 units from motor vehicles and 0.2 units from construction. A
unit of construction output requires 0.3 units from steel, 0.4 units from motor vehicles and
0.1 units from construction. The final demand is 20 million units from steel. 50 million units
from motor vehicles and 30 million units from construction
Required:
i) The technical coefficient matrix (4 marks)

ii) Total output of each industry, given that the Leontief’s inverse matrix is

0.46 0.24 0.26

1 0.43 0.60 0.41
0.192 0.30 0.24 0.42 (4 marks)

iii) If the final demand from steel drops by 2 million units, and that from motor vehicles
increases by 10 million units, but there is no change in the final demand from construction,
what would be the change in the total output of construction (6 marks)

Question Three
A miniature economy has three industries motor vehicles, electricity and steel. These industries
are interdependent such that, the output of one industry is the input of another. The following
table shows the input ratios of each industry
Output Input
Motor vehicles Electricity Steel
Motor vehicle 0.17 0.25 0.25
Electricity 0.25 0.25 0.33
Steel 0.50 0.33 0.33

The Leontief inverse matrix is computed as below:

3.08 1.98 2.15
(I – A)-1 = 2.64 3.41 2.70
3.96 3.19 4.46
Required:
i) Define the term “input ratio” (2 marks)
ii) Interpret the input column and output row for motor vehicles using the input ratios table
(4 marks)
iii) Determine the primary inputs required by each industry, if the final demand is Sh. 216
million, Sh. 240 million and Sh. 360 million for motor vehicles, electricity and steel
industries respectively (6 marks)
iv) The assumptions made in making the analysis above (2 marks)
 MARKOV ANALYSIS

Markov process originated from studies done by A Marvok in an attempt to explain

mathematically the physical phenomenon known as Brownian motion
A Markov process or motion is defined as a probabilistic sequence of event in which the
chance of occurrence of an event depends upon the immediate proceeding event.
A Markov process is a stochastic system where the state of a given phenomenon in future can
be predicted from the current state.

Markov process allows future state to be predicted and for that reason, Marvok processes find
the following applications:
• Marketing and market share prediction
• Personnel management i.e. to analyse shift of personnel among department, divisions
branches etc
• Finance i.e. in the prediction of share prices
• Debt management i.e. to estimate the provision of bad and doubtful debt

Transition matrix
Its also known as transition probability matrix which is a matrix of chance or probability of
an event depending upon the last event generated.
The transition matrix indicates the transition probability of, moving from any one state to
another.

Properties/features of probability matrix

• It’s a square matrix i.e. number of rows exactly equals number of columns
• The sum of row equals to one
• The main/leading principle diagonal represent the retention probability
• Implicit in any transition is a given fixed time period

Assumptions of markov analysis

a) The number of possible states is infinite
b) The probability on change in state (transition probability) remains constant throughout
particular analysis
c) The size and makeup of the system remain static e.g. in market share analysis, we assume
that;
d) The competing firms did not change i.e. no new entry or exit
e) The customers we are dealing with do not change
f) The transaction matrix does not change
g) The various state is both manually exclusive and collectively exhaustive
Manually exclusive
This means that if the system is in one state, it can not be in another state simultaneously i.e.
the occurrence of any one state precludes the occurrence of any other state
Collectively exhaustive
This means that all the possible states have been considered and are included in the analysis

h) Forecasting is possible given the initial state of the system and a matrix of transition
probability i.e. initial probability vector matrix transition matrix
i) Forecasting begins from the initial state of the system which is known

Transient/transition analysis
This analysis is used to forecast the state of the system in future given the immediate preceding
state and a matrix of transition probabilities.
Eg. State 1 = State 0 * Transition probability matrix
Ie. S1 = S0 * T
S2 = S1 * T
Therefore: Sn = Sn-1 * T

Steady state (equilibrium)/ eventual support

A steady state is that state in the long run where an equilibrium is attained.
A Markov process eventually settles down in the sense that it reduces a point where the net
gains exactly equal the net loss
This steady state represents a dynamic equilibrium and for any changes will occur but the
overall % market share remains the same.

Eg. For a 2x2 matrix; (X, Y) * T = (X, Y)

Where: X + Y = 1 so; Y = 1 – X
Therefore: (X, 1-X) * T = (X, 1-X)

For a 3x3 matrix; X+Y+Z = 1 SO; Z = 1-X-Y

Therefore: (X, Y, 1-X-Y) * T = (X, Y, 1-X-Y)

Absorption state
It’s a state that can not be left once entered. It has a transition probability of unity to itself i.e.
(1) and (0) to all other states e.g. payment of bill, termination of an employee’s
contract/services etc.

If a Markov chain has both absorbing and non absorbing state, the various states may be
rearranged so that the transition matrix can be rewritten as follows in a composition of 4 sub
matrices

I : O
R : Q

Where:
I = an identity matrix indicating one always remains in an absorbing state once it is reached;
0 = a zero matrix representing 0 probability of transmission from the absorbing states to the
non-absorbing states,
R = the transition probabilities from the non-absorbing states to the absorbing states, and
Q = the transition probabilities between the non-absorbing states.

Closed state
It is a state where one left can not be re entered
These are states generally used to model facilities, segments, divisions etc that are being
phased out.

Recurrent/cycle state (Cyclic)

It is a state that can be left many times
It is usually used to model frequently recurring situations in business

Question One
a) Define the following terms as used in Markov analysis
i) Equilibrium or steady state (2 marks)
ii) Absorbing state (2 marks)
iii) Closed state (2 marks)
iv) Recurrent/transient state (2 marks)
v) Markov process (2 marks)
vi) Transition matrix (2 marks)
vii) Initial probability vector (2 marks)

b) Two TV stations Channel 1 (C1) and Channel 2 (C2) compete for viewers. Of those who view
C1 on a given day, 40% view C2 the next day. In the case of those who view C2 on a given
day, 30% switch over to C1 the next day. Suppose yesterday, of the total viewers 60% viewed
C1 and the rest C2, determine the percentage of viewers for each station:
i) Today
ii) Tomorrow
iii) In the long run (equilibrium / steady state).

Question Two
Embakasi village consists of a total of 1,600 Households. A market research firm gathered data in
an attempt to investigate the loyalty of these households for a particular brand of toilet soap, X, Y
and Z sold in the village shops. A consumer survey at the end of December 2024 revealed the
following brands switching patterns.
To
X Y Z
X 400 50 50
From Y 100 350 50
Z 60 180 360
Required:
a) Determine the transition matrix for the above Markov process.
b) Determine the number of the households using each of the three types of soap at the end of
February 2025.
c) Determine the steady state distribution of the usage of the three types of toilet soap.

Question Three
A company employs four classes of machine operators (A, B, C and D), all new employees are
hired as class D and through a system of promotion, may work up to a higher class. Currently,
there are 200 class D, 150 class C, 90 class B and 60 class A employees. The company has signed
an agreement with the union specifying that 20 percent of all employees in each class be
promoted one class in each year. Statistics show that each year, 25 percent of class D employees
are separated from the company by reasons such as retirement, resignation and death. Similarly,
15 percent of class C, 10 percent of class B and 5 percent of class A employees are also separated.
For each employee lost, the company hires a new class D employee
Required
i) The transition matrix (4 marks)
ii) The number of employees in each class two years after the agreement with the union
(8 marks)

Question Four
In considering her future market strategy, Mama Saidi notes that her own customers are quite
loyal; 80% being repeat customers. Bwana Shida, the competitor holds 70% of his customers.
The advertising manager of Mama Saidi believes that they have two advertising strategies:
customer loyalty to their brand could be raised to 85% or they could increase switching to their
brand to 35%.

In either case, the advertising campaign would cost Shs 2,500,000 and would bring in Shs
1,250,000 as profits, for each percentage point increase in market share.
Required
a) What is Mama Saidi’s market share before the commencement of the advertising
campaign?
b) Which advertising strategy would give the greatest boost in market share?
c) Is the best advertising campaign profitable?
d) Discuss the limitations of the above analysis.

Question Five
The manufacture of Tamu Soft drinks has been facing stiff competition on its main brand Tamu-
Cola soda. The management is considering an extensive advertising and rebranding campaign for
Tamu-Cola soda. If the current branding remains, the transition matrix of consumers between
Tamu-Cola soda and other brands will be as follows:

To
Tamu-Cola Others
Tamu-Cola 0.85 0.15
From
Others 0.25 0.75
After the advertising and rebranding campaign the transition matrix is expected to change as
follows:
To
Tamu-Cola Others
Tamu-Cola 0.90 0.10
From
 Others 0.30 0.70

The advertising and rebranding campaign is expected to cost Sh. 20 million each year
There are 40 million consumers of soft drinks in the market and for each consumer the average
profitability is Sh. 5 annually
Required:
i) The equilibrium state proportion of consumers using Tamu-Cola before the advertising
campaign (5 marks)
ii) The equilibrium state proportion of consumers using Tamu-Cola after the advertising
campaign (5 marks)
iii) The expected annual profit increase or decrease after the advertising campaign. Would you
recommend the advertising campaign? (3 marks)

Question Six
Joe Biashara, the owner of Sound Systems, believes that the store’s inventory can be modeled as a
Markov process. If items are either classified as in stock, out of stock, discontinued from stock or
put on clearance sale, then the following transition matrix has been estimated: -
NEXT MONTH
In Out of Discontinued Put on Clearance
Sale
Stock Stock from Stock
In Stock .67 .20 .05 .08
THIS Out of Stock .48 .42 .10 0
MONTH Discontinued 0 0 1 0
Clearance Sale 0 0 0 1

a) Rewrite the transition matrix for the problem in the form:

I : O
R : Q

Where:
I = an identity matrix indicating one always remains in an absorbing state once it is reached;
0 = a zero matrix representing 0 probability of transmission from the absorbing states to the
non-absorbing states,
R = the transition probabilities from the non-absorbing states to the absorbing states, and
 Q = the transition probabilities between the non-absorbing states.

b) Compute the fundamental matrix for this problem.

c) What is the probability of an item currently out of stock eventually being discontinued from
stock?

Difference between Input-Output and Markov Analysis

Input output analysis Markov analysis

It’s a deterministic focusing It is a stochastic (probabilistic)

technique that uses external forecasting technique that makes a
(exogenous) factors to make prediction based on closed system
predictions
Forecasting is possible with the Forecasting is possible with a transition
technical matrix A and a vector of probability matrix (T) and some initial
final demand D state (S)

X = (I – A)-1 D Sn = Sn-1 * T

Input output ratios (coefficients) Transition probability which form the

which form the technical matrix transition probability matrix represent
represents the amount required for a chance/ probability of moving from one
unit of output state to another

The technical matrix is assumed to The transition probability matrix is

be constant throughout the analysis assumed constant throughout the
analysis

There is no concept of equilibrium, In the long run, the system attains

instead a constant known state of steady state(equilibrium)
technology is assumed

The sum of the column coefficients The sum of the row probabilities in the
in the technical matrix = 1(unit) transition matrix =1
when primary inputs are included

CPA KIMANI JM.