Chapter 4

Systems of Linear
Equations;
Matrices

Section 7
Leontief Input-Output
Analysis
 Learning Objectives for Section 4.7
Leontief Input-Output Analysis

 The student will be able to formulate and solve the

two-industry model of input-output analysis.
 The student will be able to formulate and solve the
three-industry model of input-output analysis.

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 Leontief Input-Output Analysis

 In this section, we will study an important economic

application of matrix inverses and matrix
multiplication.
 This branch of applied mathematics is called input-
output analysis and was first proposed by Wassily
Leontief, who won the Nobel Prize in economics in
1973 for his work in this area.

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 BASIC INPUT-OUTPUT

 the input output models define the process by which an input is

transformed into an output as an activity.
 Assumptions;
 1. each industry produces one homogenous commodity(permits the
case of two or more jointly produced commodities, provided they are
produced in a fixed proportion to one another)
 2. each industry uses a fixed input ratio for the production of its
output.
 3.Production in each industry is subjected to constant returns to scale
so that a kfold change in every input is exactly a k-fold change in
output.

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 BASIC INPUT-OUTPUT

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 Basic Input-Output Problem

The main problem of input-output analysis is the

following:

Consider an economy with several industries. Each

industry has a demand for products from other
instrustries (internal demand). There are also
external demands from the outside. Find a production
level for the industries that will meet both internal and
external demands.

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 Two-Industry Model
Example

We start with an economy that has only two industries

(agriculture and energy) to illustrate the method. Later, this
method will generalized to three or more industries.
These two industries depend upon each other. For example,
each dollar’s worth of agriculture produced requires $0.40 of
agriculture and $0.20 of energy. Each dollar’s worth of energy
produced requires $0.20 of agriculture and $0.10 of energy.
So, both industries have an internal demand for each others
resources. Let us suppose there is an external demand of
$12,000,000 of agriculture and $9,000,000 dollars of energy.

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 Example:
Matrix Equations

Let x represent the total output The external demands of 12 and

9 million must also be met, so
from agriculture and y
the revised equations are :
represent the total output of
energy (in millions of $) x = 0.4x + 0.2y + 12
y = 0.2x + 0.1y + 9
The expressions
These equations can be
0.4x + 0.2y represented by the following
0.2x + 0.1y matrix equation:
can be used to represent the
internal demands for  x   0.4 0.2   x   12 
agriculture and energy.  y   0.2 0.1  y    9 
      
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 Example:
Technology Matrix (M )
 0.4 0.2  A Read left to right, E
 0.2 0.1 
  then up
  input from   input from  
A     
 agriculture   agriculture  
  to produce   to produce $1  
     
  $1 of agriculture   of energy   =M
  input of energy   input of energy  
E     
  to produce $1   to produce $1 of 
    energy 
  of agriculture    

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 Example:
Solving the Matrix Equations

 x   0.4 0.2   x   12 
 y   0.2 0.1  y    9 
      
We can solve this matrix equation as follows:
X = MX+D
X – MX = D
IX – MX = D
(I – M)X = D
X ( I  M )  1 D
if the inverse of (I – M) exists.
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 Example:
Solution

1
We will now find X ( I  M ) D
First, find (I – M):
 1 0   0.4 0.2   0.6  0.2 
 0 1    0.2 0.1   0.2 0.9 
     
The inverse of (I – M) is:

 1.8 .4 
 .4 1.2 
 

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 Solution
(continued)

After finding the inverse of (I – M), multiply that result by

the external demand matrix D. The answer is:
Produce a total of $25.2 million of agriculture and $15.6
million of energy to meet both the internal demands of each
resource and the external demand.

 1.8 .4   12   25.2 
 .4 1.2   9   15.6 
    

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 Another Example

Suppose consumer demand changes from $12 million dollars

of agriculture to $8 million dollars and energy consumption
changes from $9 million to $5 million. Find the output for
each sector that is needed to satisfy this final demand.

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 Example
(continued)

Suppose consumer demand changes from $12 million dollars

of agriculture to $8 million dollars and energy consumption
changes from $9 million to $5 million. Find the output for
each sector that is needed to satisfy this final demand.
Solution: Recall that our general solution of the problem is
1
X ( I  M ) D
The only change in the problem is the external demand
matrix. (I – M) did not change. Therefore, our solution is to
multiply the inverse of (I – M) by the new external demand
matrix D.

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 Example
Solution

1
X ( I  M ) D

 1.8 .4   8   16.4 

 .4 1.2   5  9.2 
     

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 Summary of Two Industry Solution

Given two industries, C1 and C2 , with

C1 C2
C1  a11 a12   x1   d1 
M   X   D  
C2  a21 a22   x2   d2 

where 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 X  MX  D
is
 
1
X I M D

assuming that I – M has an inverse.

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 More Than Two Sectors
of the Economy

This method can also be used if there are more than two
sectors of the economy. If there are three sectors, say
agriculture, building and energy, the technology matrix M
will be a 3  3 matrix. The solution to the problem will still
be
1
X ( I  M ) D
although in this case it is necessary to determine the inverse
of a 3  3 matrix.

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 Example:
Three-Industry Model
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.
Find the output from each sector that is needed to satisfy a final
demand of $20 billion for agriculture, $10 billion for energy,
and $30 billion for manufacturing.
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 Example
(continued)

The technology matrix is as follows:

Output
A E M
A  0.2 0 0.1
Input  0.4 0.2 0.1
E   =M
 0 0.4 0.3
M
 0.8 0  0.1  1.3 0.1 0.2 
I  M   0.4 0.8  0.1 ( I  M )  1  0.7 1.4 0.3
 0  0.4 0.7   0.4 0.8 1.6 

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 Example
(continued)

Thus, the output matrix X is given by:

X (I - M)-1 D
 x1   1.3 0.1 0.2   20   33
 x   0.7 1.4 0.3  10   37 
 2     
 x3   0.4 0.8 1.6   30   64 

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

energy, and $64 billion for manufacturing will meet the
given final demands.

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 exercise

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 exercise

 Calculate the values of X

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