INPUT OUTPUT ANALYSIS

Introduction
Input-output analysis tries to establish equilibrium conditions under which industries in
an economy have just enough output to satisfy each others demands in addition to final
(outside) demands. Given the internal demand within the industries for each others
output, the problem is to determine output levels will meet various levels of final
(outside) demand
Two industry model
We start with an hypothetical economy with only 2 industries, electric company E and
water company W. Output for both companies is measured in dollars. The electric
company uses both electricity and water (inputs) in the production of electricity (output);
and the water company uses both electricity and water (input) in the production of water
(output).
Suppose the production of each dollars worth of electricity required $0.30 worth of
electricity and $0.10 worth of water, and the production o each dollars worth of water
requires $0.20 worth of electricity and $0.40 worth of water.
If the final demand from the outside sector of the economy (the demand from all other
users of electricity and water) is
d1 $12 Million for electricity
d 2 $8 Million for water
How much electricity and water should be produced to meet this final demand.
Suppose that the electric company produces $12 million worth of electricity and the
water company produces $8 million worth of water (the final demand).
Then the production processes of the companies would require.
0.3 12 0.2 8 $5.2 Million of electricity
and
0.1 12 0.4 8 $4.4 Million of water
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leaving only $6.8 million of electricity and $ 3.6 million of water to satisfy the final
demand of the outside sector.
Thus to meet the final demands of both companies and to end up with enough electricity
and water for the final outside demand, both companies must produce more than just the
amount demanded by the outside sector. In fact, they must produce exactly enough to
meet their own internal demand plus that demanded by the outside sector.
Basic input-output problem
Given the internal demand of each industrys output, we wish to determine output levels
for the various industries that will meet a given final (outside) level of demand as well as
the internal demand
If

x1 Total output from Electricity Company

x2 Total output from Water Company

Then the internal demands are: 0.3 x1 0.2 x2 - Internal demand for electricity
0.1x1 0.4 x2 - Internal demand for water
Combining the internal demand with final demand produces the following systems of
equations
Total

Internal

Final

Output

demand

demand

x1 0.3 x1 0.2 x2 d1
x2 0.1x1 0.4 x2 d 2

.. (1)

In matrix form,
x1
0.3 0.2 x1 d1
x 0.1 0.4 x d

2 2
2
X MX D . (2)
d1

d 2

Where D

Final demand matrix

 x
X 1 Output matrix
x2
E W
E
M 0.3 0.2 - Technology matrix
W
0.1 0.4
The technology matrix is the heart of input-output analysis.

The elements in the

technology matrix are determined as follows

output

E
input from E

E to produce $1
electricity
input
input from W
W to produce $1

electricity

W
input from E

to produce $1

water

input from W

to produce $1

water

Remark
Labeling the rows and columns of the technology matrix with the first letter of each
industry is an important part of the process. The same order must be used for columns as
for rows, and that same order must be used for the entries of D (the final demand matrix)
and the entries of X (the output matrix).
Now our problem is to solve (2) for X
X MX D

X MX D
IX MX D
X I M D
X I M D .. (3), Assuming I M has an inverse.
1

 1 0
Where I

0 0
We now find I M ,
0.7 0.2
1 0 0.3 0.2

0.1 0.6
0 1 0.1 0.4

I M
and

I M

1 0.6 0.2 1.5 0.5

0.4 0.1 0.7 0.25 1.75

Then we have
x1
1.5 0.5 d1
x 0.25 1.75 d

2
2
1.5 0.5 12 22
(4)

0.25 1.75 8 17

Therefore, the electric company must have an output of $22 million and the water
company must have an output of $17million so that each company can meet both internal
and final demands.
Check
We use equation (2) to check our work.

Suppose in the original problem that the projected final demand 5 years from now are
d1 24 and d 2 16 . Determine each companies output for this project
x1
1.5 0.5 24 44
x 0.25 1.75 16 34

Summary
Given two industries C1 and C2 with
Technology

output

Final demand

Matrix

matrix

matrix

x
X 1 ,
x2

C1
C a
M 1 11
C2 a21

C2
a12 ,
a22

d1

d 2

. (1)

Where aij is the input required from Ci to produce a dollars worth of output C j , the
solution to the input output matrix equation
Total output

internal demand

MX

final demand
+

D .. (2)

is
X I M D
1

.. (3)

Assuming that I M has an inverse

Three industry model
Equations (2) and (3) in the solution to a two- industry input-output problem are the same
for a three industry economy, a four industry economy or an economy with n industries.
The steps from equation 2 to equation 3 hold for arbitrary matrices as long as the matrices
have the correct sizes and I M

exists.

Example 1
An economy is based on three sectors agriculture (A), Energy (E) and manufacturing (M).
Production of a dollars worth of Agriculture requires an input of $0.20 from agriculture
sector and $0.40 from energy sector. Production of a dollars worth of energy requires an
input of $0.20 from energy sector and $0.40 from manufacturing sector. Production of a
dollars worth of manufacturing requires an input of $0.10 from agriculture sector, $0.10
from energy sector and $0.30 from manufacturing sector.
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Find the output from each sector that is needed to satisfy a final demand of $20 billion for
agriculture $10 billion fro energy and $30 billion for manufacturing.
Solution
Since this is a three industry problem, the technology matrix will be a 3 3 matrix, and
the output and final demand matrices will be

3 1 column matrices. We form the

matrices as follows
Technology matrix

Final demand matrix

A E M
A
0.2 0 0.1

E
M ,
0.4 0.2 0.1
M

0 0.4 0.3
X MX D

and

20
D 10
30

output Matrix
x1
X x2
x3

X I M D

0
0.1
0.8

I M 0.4 0.8 0.1

0
0.4 0.7

I M

1.3 0.1 0.2

0.7 1.4 0.3
0.4 0.8 1.6

Thus, the output matrix X is given by

x1
x
2
x3

33
1.3 0.1 0.2
20

0.7 1.4 0.3
10

37
0.4 0.8 1.6
30

64

An output of $33b for agriculture, $37b for energy and $64b for manufacturing will meet
the given final demands.
Problem 1
An economy is based on 3 sectors coal, oil and transportation. Production of a dollars
worth of coal requires an input of $0.20 from coal sector and $0.40 from the
transportation sector. Production of a dollars worth of oil requires an input of $0.10 from
oil sector and $0.20 from the transportation sector. Production of a dollars worth of

transportation requires an input of $0.40 from the coal sector, $0.20 from oil sector and
$0.20 from the transportation sector.
a) Find the technology matrix M
b) Find I M

c) Find the output from each sector that is needed to satisfy a final demand of $30
billion for coal, $10 billion for oil, and 20 billion for transportation.
Problem 2
The