Chapter 4

Systems of
Linear Equations;
Matrices

Section 7
Leontief
Input-Output
Analysis

Copyrightfor
Barnett, Finite Mathematics © 2015, 2011, and
Business, 2008 Pearson
Economics, Education, Inc.
Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 1
 Input-Output Analysis
Wassily Leontief (1905-1999) was awarded the Nobel Prize
in economics because of the impact his work in input-output
analysis had on economic planning for industrialized
countries.

Input-output analysis attempts to establish equilibrium

conditions where industries have enough output to satisfy
each other’s demands in addition to final outside demands.

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 2
 Two-Industry Model
To illustrate the concept of input-output analysis, we examine
an economy comprised of only two industries, and electric
company E and a water company W.
The output for each company is measured in dollars.
The electric company uses both electricity and water (inputs)
in the production of electricity (output).
The water company uses both electricity and water (inputs) in
the production of water (output).
Suppose that the production of each dollar’s worth of
electricity requires $0.30 worth of electricity and $0.10 worth
of water.
Further suppose that the production of each dollar’s worth of
water requires $0.20 worth of electricity and $0.40 worth of
water.
Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 3
 Two-Industry Model continued
Suppose the final demand (the demand from all other users of
electricity and water is
d1 = $12 million for electricity
d2 = $8 million for water.
How much electricity and water should be produced to meet
this final demand?

If the electric company produces $12 million worth of

electricity and the water company produces $8 million worth
of water, the production processes would require
Electricity 0.3(12) + 0.2(8) = $5.2 million of electricity
Water 0.1(12) + 0.4(8) = $4.4 million of water

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 4
 Two-Industry Model continued
With production requirements of $5.2 million of electricity
and $4.4 million of water, there remains only $6.8 million of
electricity and $3.6 million of water to meet the final demand.

To meet both the internal demands of production and the

external demand of the market, both companies must produce
more than just the final demand.
They must produce exactly enough to meet their own internal
demands plus the final demand.
To compute the required total output for each company we set
up a system of equations where
x1 = total output from electric company
x2 = total output from water company
Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 5
 Two-Industry Model continued
The internal demand for these levels of production are
0.3x1 + 0.2x2 Internal demand for electricity
0.1x1 + 0.4x2 Internal demand for water

Combining the internal demand with the final demand

produces the system of equations

Total Internal Final

output demand demand
x1  0.3x1  0.2 x2  d1
x2  0.1x1  0.4 x2  d2

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 6
 Two-Industry Model continued
In matrix form, this system is
 x1  0.3 0.2   x1   d1 
 x    0.1 0.4   x    d 
 2   2  2
or X = MX + D
 x1 
where X    Output matrix
 x2 
 d1 
D    Final demand matrix
d2 
E W
E 0.3 0.2 
M   Technology matrix
W  0.1 0.4 
Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 7
 Two-Industry Model continued
The technology matrix is the heart of input-output analysis.
The elements in the technology matrix are determined as
follows (read left to right and then up):
E Output W

 input from E   input from E  
   
to produce $1 to produce $1
E     
 of electricity   of water



Input   =M
 input from W   input from W  
W    
to produce $1 to produce $1
   
 of electricity   of water




Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 8
 Two-Industry Model continued
We solve the matrix equation for X

X = MX + D

X – MX = D

IX – MX = D

(I – M)X = D

X = (I – M)–1 D Assuming (I – M) has an inverse

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 9
 Two-Industry Model continued
We find (computation details left to the student)
 0.7 0.2  1  1.5 0.5
I M    and (I  M )   
 0.1 0.6   0.25 1.75 

 x1   1.5 0.5  d1   1.5 0.5 12   22 

 x   0.25 1.75  d   0.25 1.75  8   17 
 2   2     

The electric company must produce an output of $22 million

and the water company must produce an output of $17
million so that each company can meet both internal and final
demands.

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 10
 Summary Solution to a Two-
Industry Input-Output Problem
Given two industries, C1 and C2, with
Technology Output Final demand
matrix matrix matrix
C1  a11 a12   x1   d1 
M  X   D 
C2  a21 a22   x2  d2 
(aij is the input required from Ci to produce a dollar’s worth
of output for Cj.)
The solution to the input-output matrix equation
Total output Internal demand Final demand
X  MX  D

is X = (I – M)–1 D assuming that (I – M) has an inverse.

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 11
 Example 1 Input-Output Analysis
A Three Sector Model
Suppose an economy is based on three sectors, agriculture
(A), energy (E), and manufacturing (M).
Production of a dollar’s worth of agriculture requires an input
of $0.20 from the agriculture sector and $0.40 from the
energy sector.
Production of a dollar’s worth of energy requires an input of
$0.20 from the energy sector and $0.40 from the
manufacturing sector.
Production of a dollar’s worth of manufacturing requires an
input of $0.10 from the agriculture sector, $0.10 from the
energy sector, and $0.30 from the manufacturing sector.

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 12
 Example 1 Input-Output Analysis
A Three Sector Model continued
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 begin by forming a blank 3×3 technology matrix and
label the rows and columns in alphabetical order.
Technology matrix
Output
A E M
A  
Input E  

M  

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 13
 Example 1 Input-Output Analysis
A Three Sector Model continued
Next we analyze the production information in the problem to
complete the technology matrix.
“Production of a dollar’s worth of agriculture requires an
input of $0.20 from the agriculture sector and $0.40 from the
energy sector.”
A E M
A 0.2 
E 0.4 

M  0 

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 14
 Example 1 Input-Output Analysis
A Three Sector Model continued
Next we analyze the production information in the problem to
complete the technology matrix.
“Production of a dollar’s worth of energy requires an input of
$0.20 from the energy sector and $0.40 from the
manufacturing sector.”
A E M
A 0.2 0 
E 0.4 0.2 
 
M  0 0.4 

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 15
 Example 1 Input-Output Analysis
A Three Sector Model continued
Next we analyze the production information in the problem to
complete the technology matrix.
“Production of a dollar’s worth of manufacturing requires an
input of $0.10 from the agriculture sector, $0.10 from the
energy sector, and $0.30 from the manufacturing sector.”
A E M
A 0.2 0 0.1 
E 0.4 0.2 0.1 
 
M  0 0.4 0.3 

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 16
 Example 1 Input-Output Analysis
A Three Sector Model continued
Therefore,
Technology matrix Final demand Output
A E M matrix matrix
A 0.2 0 0.1   20   x1 
M E 0.4 0.2 0.1  D  10  X   x2 
 
M  0 0.4 0.3  30   x3 

where M, X, and D satisfy the input-output equation

X = MX + D

Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 17
 Example 1 Input-Output Analysis
A Three Sector Model continued
As previously found, the solution to the equation X = MX + D
is X = (I – M)–1 D.
We first find I – M and then compute (I – M)–1.
The calculator screen shots show the computations (where
matrix M is labeled as [A] ) for I – M and (I – M)–1.

I M ( I  M ) 1
Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 18
 Example 1 Input-Output Analysis
A Three Sector Model continued
The output matrix X = (I – M)–1 D.
The calculator screen shots show the computation for finding
the matrix X (where matrix M is labeled as [A] ).

An output of $33 billion for agriculture, $37 billion for energy,

and $64 billion for manufacturing will meet the given final
demands.
Barnett, Finite Mathematics for Business, Economics, Life Sciences, and Social Sciences, 14e, GE
Copyright © 2019, 2015, 2011 Pearson Education Ltd. Slide 19