MCom I Semester Managerial Economics Input-Output Analysis Study Material Notes
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MCom I Semester Managerial Economics Input-Output Analysis Study Material Notes: Input-Output Analysis and Introductions main Features of Input-output Analysis Assumption of Input-Output Analysis Input-Output Framework Uses of Input-Output Analysis Limitation of Input-Output Analysis :
MCom I Semester Business Environment Consumer Protection Study Material Notes
INPUT-OUTPUT ANALYSIS
INPUT-OUTPUT ANALYSIS: AN INTRODUCTION
The concept of input-output analysis was first developed by Quesnay in the 18th century and gave the name of Tableau Economique but the real credit of the development of input-output analysis goes to American economist Prof. W. W. Leontief. It is based on national economic balance. It explains inter-relationship and inter-dependence of various sectors of an economy. It explains that the output of an industry is an input for the others. Whatever is used by an industry in the production of a commodity, is called input and whatever is produced by that industry, is called output. Since this analysis explains the inter-dependence of inputs and outputs of various industries, it is known as inter-industry analysis also. In the words of Prof. Hicks, “Input is something which is bought by the enterprise and output is something which is sold by it”. For example, for coal industry, coal is output and steel is input while for iron and steel industry, steel is output and coal is input.
MAIN FEATURES OF INPUT-OUTPUT ANALYSIS
(1) A Technological Problem. Input-output analysis is a technological problem. It is concerned only with production and not with demand. It describes the use of various inputs by different industries and their possible output with the help of available resources.
(2) Based on Empirical Facts. Input-output analysis is based upon empirical facts only. The estimates of inputs and outputs of various industries are made on the basis of empirical data. Being so, it differs from general equilibrium theory as propounded by Walras which is purely analytical and theoritical
(3) Based on General Equilibrium. Input-output analy- sis is based upon general equilibrium. It gives practical shape to general equilibrium analysis. It considers the mutual dependence between various industries. It states that inputs of one industry are the outputs of other industries and vice-versa. For example, agricultural products are the input of a number of industries as raw materials and the outputs of a number of industries are the inputs of agriculture.
ASSUMPTIONS OF INPUT-OUTPUT ANALYSIS
(1) Constant Demand and Prices, Input-output analysis assumes that the demand for final product and the prices of all inputs and outputs are given and remain constant. It does not consider the variations in these prices because the main purpose of this study is to analyse the relationship between changes in physical outputs only.
(2) Fixed Coefficients of Production. Input-output analysis assumes that the input ratios to produce a given output of various products are fixed. It does not consider any change in the technique of production or factors or production or marginal rate of technical subtitution.
(3) Constant Returns to Scale. Input-output analysis assumes that constant returns to scale apply in the economy. It implies that the proportionate change in output and the proportionate changes in all inputs are equal. For example, if the quantity of all inputs is increased by 10%, output will also increase by 10%.
(4) Large Enough Demand. Input-output analysis assumes that the demand for final product is large enough to enable all the industries to work at full capacity. It implies that all the inputs are assumed to be fully utilised.
(5) No Joint Product. It assumes that there are no joint products in the economy. Therefore, it is assumed that one industry manufactures one product only.
(6) Fixed Level of Technology. It assumes a fixed level of technology. Thus, input-output analysis does not consider technological changes.
(7) Two-Sector Economy. Input-output analysis assumes a two-sector economy. The whole economy is assumed to be divided into two sectors– Inter-industry sector’ and ‘final demand sector’.
(8) Linear Relationship. It is assumed that the output of an industry will depend directly upon the outputs of all industries utilising this product, the whole output meant for households and final consumers. For example, an increase of 10% in the output of all industries using steel will result in an increase of 10% in steel oputput.
INPUT-OUTPUT FRAMEWORK
(1) Input-output Table. An input-output table depicts the flow of output of a given industry into various industries and final demand of various inputs for the output. If there are three sectors in an economy, the input-output table can be prepared as follows
Input-output Table
| Agriculture Sector | Industrial Sector | Households or Final Demand | Total Product | |
| Agricultural Sector | 100 | 80 | 220 | 400 |
| Industrial Sector | 140 | 60 | 300 | 500 |
(2) Transaction Matrix. Transaction matrix represents the use of total product of an industry by different sectors of economy. Output of an industry may be utilised either for investment or for final consumption. It is illustrated in following table
(3) Statis Input-output Model. To explain the concept of input-output analysis Prof. Leontiff developed a static input-output model. It uses two equations- (1) Balance equation, (ii) Structural equation.
(i) Balance Equation. Balance equation states that the output of an industry is consumed either by itself or by other industries or by external sectors. It can be presented as follows
X=X 1 + S2 + X3 +……………Xin +D
Whereas, X = Output of producing industry.
X1, X/2…….. = Use by the industries of external sector.
D = Use by household sector.
(ii) Structural Equation. This equation presents the structural flow of an economy. It states that the output of an industry is used by all the industries of an economy. On the basis of structural equations, a technological martix can be prepared for the economy as a whole. Structural equation of an industry states the input-output coefficient
USES OF INPUT-OUTPUT ANALYSIS
“The input-output analysis is of tremendous value and importance to the development of the science of economics and it is only natural that there should be controversy concerning the certain aspects of its methodology and the domain of its acceptability.” -Prof. Huckwitch
(1) Consistent Forecasting. Input-output analysis helps in forecasting. To estimate the output of all industries, consistent forecast of the outputs of each of these industries are to be made. Thus, it helps in forecasting.
(2) Helpful in the Solution of Regional and Inter-regional Problems. Regional input-output tables are used to study the problems concerned with regional output and employment. Inter-regional input-output tables are used to we effect of changes in demand for the outputs of one region on inter-regional trade flows.
Helpful in Checking Internal Consistency of A Plan. Input-output analysis helps in developing a plan for a country in the manner that it may promote balanced growth of all parts of country. This analysis helps in Co-ordinating the plans of different sectors of an economy.
(4) Helpful in Transport Planning and Locational Decisions. Input-output analysis can be used to develop a particular mode of transportation so that the smooth flow of goods and services may be ensured. This analysis can be also used to make locational choices for big industries.
(5) Helpful in National Income Accounting. Input-output analysis is of great value in national income accounting because it studies economic aggregates and monetary flows.
(6) Helpful in Decision-making. Input-output is of great help in decision-making process. It helps in planning allocation of resources, decisioin-making etc.
LIMITATIONS OF INPUT-OUTPUT ANALYSIS
Having become absorbed in the question of consistency, we completely neglect economic effiency…….there is nothing in this model of economic organisation that would tend to bring about an economically efficient allocation of resources -Heniz Kohler
(1) Based on Unreal Assumptions. Most important of input-output analysis is that it is based on a number of assumptions, many of which are unreal. Some of the important assumptions of this analysis which do not hold true in real life are-i) Application of constant returns to scale, (ii) Consistency of technical coefficient, (iii) Stability of technical coefficient, (iv) Constant rate of factor substitution, (v) Fixed input-output relationship, (vi) Fixed investments and savings.
(2) Dynamic Nature of Economy. There is a large number of sectors and industries in an economy. Each sector and industry works within its own resources and limitations. This analysis is unable in analysing and solving the problems of all the industries.
(3) Ignorance of Demand. An important limitation of input-output analysis is that it is based on production only. If ignores the role of demand. Therefore, it is an incomplete study.
(4) Use of Mathematical Techniques and Models. Input-output analysis uses a number of mathematical techniques, matrix and models. It makes the concept highly complicated. It cannot be used by everyone.
(5) Related with A Point of Time. Input-output analysis is related with a particular time only. It does not apply on a change in economic conditions of level of technology.
