Lecture # 6 - Input-Output Analysis

Important for production planning.

It is a way to represent the production in an economy

It assumes:

– There are n interlinked industries

– Each industry produces one single good.

– Each industry uses a …xed-proportion technological process

Idea: Suppose we produce glass

– Our output can be sold directly to consumers (e.g. to home-owners), or can be used
as an input for other industries (e.g cars)

– We can used inputs from other industries to produce our good (e.g. machinery, which
is made of steel)

So there is interindustry dependence

– Our output should be consistent to the input requirements of the economy.

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 Simplest case: Suppose we divide the economy into 3 sectors:

1. Agriculture

2. Manufacturing

3. Services

.The three industries each use inputs from two sources:

1. Domestically produced commodities form the three industries

2. Other inputs, such as imports, labour, and capital.

The outputs of the industries have two broad uses or destinations:

1. Inputs to production of the three industries (intermediate inputs)

2. Final demand (Consumption, Investment, Government expenditure, Exports)

All this can be summarised in a so-called input-output table (in billions of euros):

Outputs
Agriculture M anuf actures Services F inal demand T otal

Agriculture 30 40 0 30 100

M anuf actures 10 200 50 140 400

Inputs
Services 20 80 200 200 500

Other sources 40 80 250 230 600

T otal 100 400 500 600 1600

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Take for example manufacturing:

– Its output is worth e400 bln, which is allocated as follows:

e10 bln is used by the agricultural sector

e200 bln as intermediate goods for the manufacturing sector
e50 bln. is used by the services sector.
e140 bln. is the …nal demand (consumption, investment, government expenditure
& exports

– In order to produce, the manufacturing sector uses inputs worth of e400, of which

e40 bln comes from the agricultural sector,

e200 bln from the manufacturing sector (intermediate inputs),
e80 bln from the services sector,
e80 bln from other sources, including imports, labour and capital

– Note that sector outputs equal sector inputs and that the economy-wide value of inputs
equals the value of outputs at e1600 bln.

De…ne the following 2 vectors

2 3
30
6 7
6 7
6
– b = 6 140 7
7 is the vector of …nal demands for output of the industry sectors
4 5
200
2 3
100
6 7
6 7
–x = 6 7
6 400 7 is the vector of total ouput of the industry sectors
4 5
500

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 As said above, one (critical) assumption is that each sector produces according to …xed-
proportion technological coe¢ cients (also called input-output coe¢ cients)

Example: agriculture uses e20 bln from the services sector. Given that the value of its
total inputs is e100 bln, then services represent 20=100 = 0:20 of its total inputs.

– The Leontie¤ assumption is that, whatever the value of the inputs used by agriculture,
0.20 (or 20%) comes from services.

As such, we can calculate the input-output coe¢ cients by dividing each element in the
input-output table by its column total:
Outputs
Agriculture M anuf actures Services F inal demand T otal

3 1 1 1
Agriculture 10 10 0 20 16

1 1 1 7 1
M anuf actures 10 2 10 30 4
Inputs
1 1 2 1 5
Services 5 5 5 3 16

2 1 1 23 3
Other sources 5 5 2 60 8

T otal 1 1 1 1 1

In matrix notation:
2 3 1 3
10 10 0
6 7
6 7
–A = 6
6
1
10
1
2
1
10
7 is the matrix of inter-industry coe¢ cients
7
4 5
1 1 2
5 5 5

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One important consequence of the input-output analysis is that we can express the vector
of total demand (x) as a function of the …nal demand (b) and the matrix of inter-industry
coe¢ cients (A):
x = Ax + b

(Verify it)

Then:

x Ax = b
(I A) x = b

If (I A) has an inverse:

1 1
(I A) (I A) x = (I A) b
1
x = (I A) b

1
The matrix (I A) is known as the input-output inverse, or the Leontie¤ inverse

– Let’s …nd it!!!

2 3
1:49 0:32 0:05
6 7
6 7
– (I A) 1
=6
6 0:42 2:23 0:37 7
7
4 5
0:64 0:85 1:81
1
– Show that x = (I A) b

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Application:

Suppose there is a change in …nal demand, from b1 to b2 : What is the change in total
demand?

– For example, suppose there is an increase in the demand for agriculture products in
the US (increase in exports)
1
– Then x2 = (I A) b2

In general, if:

1
– x1 = (I A) b1
1
– x2 = (I A) b2
1 1
– Then x = x2 x1 = (I A) b2 (I A) b1
1
– So x = (I A) b; where b = b2 b1

6
Derivatives of Functions of One Variable
Rate of Change and the Derivative

Suppose you have a function y = f (x)

What happens to y if there is a change in x?

– Examples:

What happens to the equilibrium solution of Y if there is a change in the marignal

propensity to consume?
What if all of a sudden, all consumers are willing to pay an extra e100 for an
iPod (rightward shift in demand)

Initial state: x0 =) y0 = f (x0 )

Suppose x changes to a new value x0 + x

– x : denotes the change in x

Then the value of the function y = f (x) changes from f (x0 ) to f (x0 + x)

Di¤erence quotient: represents the change of y per unit of change in x

y f (x0 + x) f (x0 )
=
x x

– The di¤erence quotient is a function of x0 and x

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Derivative: the rate of change of y when x is very small:
y f (x0 + x) f (x0 )
lim = lim
x!0 x x!0 x

– It reads: "the limit of the rate of change of y as x approaches 0"

– The derivative is a function (if you want, a "derived " function)

The original function is called the "primitive" function

– The derivative is a function ONLY of x0

– The rate measured by the derivative is the instantaneous rate of change

– Notation:
dy y
f 0 (x) lim
dx x!0 x
/c x

Example: Suppose y = f (x) = 7x 3

– f (x0 ) = 7x0 3

– f (x0 + x) = 7 (x0 + x) 3
y 7(x0 + x) 3 (7x0 3) x
– x = x =7 x =7
dy y
– So dx f 0 (x) lim x =2
x!0

Example: Suppose y = f (x) = x2 + 5

– f (x0 ) = (x0 )2 + 5

– f (x0 + x) = (x0 + x)2 + 5

(x0 + x)2 +5 (x20 +5) x+( x)2
– y
x = x = 2x0 x = 2x0 + x
dy y
– So dx f 0 (x) lim x = 2x0
x!0
– Since we pick x0 arbitrarily, we can drop the subscript.