# 37. Input-Output Models#

## 37.1. Overview#

This lecture requires the following imports and installs before we proceed.

```
!pip install quantecon_book_networks
!pip install quantecon
!pip install pandas-datareader
```

## Show output

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```

```
import numpy as np
import networkx as nx
import matplotlib.pyplot as plt
import quantecon_book_networks
import quantecon_book_networks.input_output as qbn_io
import quantecon_book_networks.plotting as qbn_plt
import quantecon_book_networks.data as qbn_data
import matplotlib as mpl
from matplotlib.patches import Polygon
quantecon_book_networks.config("matplotlib")
mpl.rcParams.update(mpl.rcParamsDefault)
```

The following figure illustrates a network of linkages among 15 sectors obtained from the US Bureau of Economic Analysis’s 2021 Input-Output Accounts Data.

## Show content

```
def build_coefficient_matrices(Z, X):
"""
Build coefficient matrices A and F from Z and X via
A[i, j] = Z[i, j] / X[j]
F[i, j] = Z[i, j] / X[i]
"""
A, F = np.empty_like(Z), np.empty_like(Z)
n = A.shape[0]
for i in range(n):
for j in range(n):
A[i, j] = Z[i, j] / X[j]
F[i, j] = Z[i, j] / X[i]
return A, F
ch2_data = qbn_data.production()
codes = ch2_data["us_sectors_15"]["codes"]
Z = ch2_data["us_sectors_15"]["adjacency_matrix"]
X = ch2_data["us_sectors_15"]["total_industry_sales"]
A, F = build_coefficient_matrices(Z, X)
```

## Show source

```
centrality = qbn_io.eigenvector_centrality(A)
# Remove self-loops
for i in range(A.shape[0]):
A[i][i] = 0
fig, ax = plt.subplots(figsize=(8, 10))
plt.axis("off")
color_list = qbn_io.colorise_weights(centrality,beta=False)
qbn_plt.plot_graph(A, X, ax, codes,
layout_type='spring',
layout_seed=5432167,
tol=0.0,
node_color_list=color_list)
plt.show()
```

Label |
Sector |
Label |
Sector |
Label |
Sector |
---|---|---|---|---|---|

ag |
Agriculture |
wh |
Wholesale |
pr |
Professional Services |

mi |
Mining |
re |
Retail |
ed |
Education & Health |

ut |
Utilities |
tr |
Transportation |
ar |
Arts & Entertainment |

co |
Construction |
in |
Information |
ot |
Other Services (exc govt) |

ma |
Manufacturing |
fi |
Finance |
go |
Government |

An arrow from \(i\) to \(j\) means that some of sector \(i\)’s output serves as an input to production of sector \(j\).

Economies are characterised by many such links.

A basic framework for their analysis is Leontief’s input-output model.

After introducing the input-output model, we describe some of its connections to linear programming lecture.

## 37.2. Input output analysis#

Let

\(x_0\) be the amount of a single exogenous input to production, say labor

\(x_j, j = 1,\ldots n\) be the gross output of final good \(j\)

\(d_j, j = 1,\ldots n\) be the net output of final good \(j\) that is available for final consumption

\(z_{ij} \) be the quantity of good \(i\) allocated to be an input to producing good \(j\) for \(i=1, \ldots n\), \(j = 1, \ldots n\)

\(z_{0j}\) be the quantity of labor allocated to producing good \(j\).

\(a_{ij}\) be the number of units of good \(i\) required to produce one unit of good \(j\), \(i=0, \ldots, n, j= 1, \ldots n\).

\(w >0\) be an exogenous wage of labor, denominated in dollars per unit of labor

\(p\) be an \(n \times 1\) vector of prices of produced goods \(i = 1, \ldots , n\).

The technology for producing good \(j \in \{1, \ldots , n\}\) is described by the **Leontief** function

### 37.2.1. Two goods#

To illustrate, we begin by setting \(n =2\) and formulating the following network.

## Show source

```
G = nx.DiGraph()
nodes= (1, 2, 'c')
edges = ((1, 1), (1, 2), (2, 1), (2, 2), (1, 'c'), (2, 'c'))
edges1 = ((1, 1), (1, 2), (2, 1), (2, 2), (1, 'c'))
edges2 = [(2,'c')]
G.add_nodes_from(nodes)
G.add_edges_from(edges)
pos_list = ([0, 0], [2, 0], [1, -1])
pos = dict(zip(G.nodes(), pos_list))
fig, ax = plt.subplots()
plt.axis("off")
nx.draw_networkx_nodes(G, pos=pos, node_size=800,
node_color='white', edgecolors='black')
nx.draw_networkx_labels(G, pos=pos)
nx.draw_networkx_edges(G,pos=pos, edgelist=edges1,
node_size=300, connectionstyle='arc3,rad=0.2',
arrowsize=10, min_target_margin=15)
nx.draw_networkx_edges(G, pos=pos, edgelist=edges2,
node_size=300, connectionstyle='arc3,rad=-0.2',
arrowsize=10, min_target_margin=15)
plt.text(0.055, 0.125, r'$z_{11}$')
plt.text(1.825, 0.125, r'$z_{22}$')
plt.text(0.955, 0.1, r'$z_{21}$')
plt.text(0.955, -0.125, r'$z_{12}$')
plt.text(0.325, -0.5, r'$d_{1}$')
plt.text(1.6, -0.5, r'$d_{2}$')
plt.show()
```

**Feasible allocations must satisfy**

This can be graphically represented as follows.

## Show source

```
fig, ax = plt.subplots()
ax.grid()
# Draw constraint lines
ax.hlines(0, -1, 400)
ax.vlines(0, -1, 200)
ax.plot(np.linspace(55, 380, 100), (50-0.9*np.linspace(55, 380, 100))/(-1.46), color="r")
ax.plot(np.linspace(-1, 400, 100), (60+0.16*np.linspace(-1, 400, 100))/0.83, color="r")
ax.plot(np.linspace(250, 395, 100), (62-0.04*np.linspace(250, 395, 100))/0.33, color="b")
ax.text(130, 38, "$(1-a_{11})x_1 + a_{12}x_2 \geq d_1$", size=10)
ax.text(10, 105, "$-a_{21}x_1 + (1-a_{22})x_2 \geq d_2$", size=10)
ax.text(150, 150, "$a_{01}x_1 +a_{02}x_2 \leq x_0$", size=10)
# Draw the feasible region
feasible_set = Polygon(np.array([[301, 151],
[368, 143],
[250, 120]]),
color="cyan")
ax.add_patch(feasible_set)
# Draw the optimal solution
ax.plot(250, 120, "*", color="black")
ax.text(260, 115, "solution", size=10)
plt.show()
```

More generally, constraints on production are

where \(A\) is the \(n \times n\) matrix with typical element \(a_{ij}\) and \(a_0^\top = \begin{bmatrix} a_{01} & \cdots & a_{0n} \end{bmatrix}\).

If we solve the first block of equations of (37.1) for gross output \(x\) we get

where the matrix \(L = (I-A)^{-1}\) is sometimes called a **Leontief Inverse**.

To assure that the solution \(X\) of (37.2) is a positive vector, the following **Hawkins-Simon conditions** suffice:

For example a two good economy described by

```
A = np.array([[0.1, 40],
[0.01, 0]])
d = np.array([50, 2]).reshape((2, 1))
```

```
I = np.identity(2)
B = I - A
B
```

```
array([[ 9.e-01, -4.e+01],
[-1.e-02, 1.e+00]])
```

Let’s check the **Hawkins-Simon conditions**

```
np.linalg.det(B) > 0 # checking Hawkins-Simon conditions
```

```
True
```

Now, let’s compute the **Leontief inverse** matrix

```
L = np.linalg.inv(B) # obtaining Leontief inverse matrix
L
```

```
array([[2.0e+00, 8.0e+01],
[2.0e-02, 1.8e+00]])
```

```
x = L @ d # solving for gross output
x
```

```
array([[260. ],
[ 4.6]])
```

## 37.3. Production possibility frontier#

The second equation of (37.1) can be written

or

where

For \(i \in \{1, \ldots , n\}\), the \(i\)th component of \(A_0\) is the amount of labor that is required to produce one unit of final output of good \(i\).

Equation (37.4) sweeps out a **production possibility frontier** of final consumption bundles \(d\) that can be produced with exogenous labor input \(x_0\).

Consider the example in (37.3).

Suppose we are now given

Then we can find \(A_0^\top\) by

```
a0 = np.array([4, 100])
A0 = a0 @ L
A0
```

```
array([ 10., 500.])
```

Thus, the production possibility frontier for this economy is

## 37.4. Prices#

[Dorfman *et al.*, 1958] argue that relative prices of the \(n\) produced goods must satisfy

More generally,

which states that the price of each final good equals the total cost of production, which consists of costs of intermediate inputs \(A^\top p\) plus costs of labor \(a_0 w\).

This equation can be written as

which implies

Notice how (37.5) with (37.1) forms a
**conjugate pair** through the appearance of operators
that are transposes of one another.

This connection surfaces again in a classic linear program and its dual.

## 37.5. Linear programs#

A **primal** problem is

subject to

The associated **dual** problem is

subject to

The primal problem chooses a feasible production plan to minimize costs for delivering a pre-assigned vector of final goods consumption \(d\).

The dual problem chooses prices to maximize the value of a pre-assigned vector of final goods \(d\) subject to prices covering costs of production.

By the strong duality theorem, optimal value of the primal and dual problems coincide:

where \(^*\)’s denote optimal choices for the primal and dual problems.

The dual problem can be graphically represented as follows.

## Show source

```
fig, ax = plt.subplots()
ax.grid()
# Draw constraint lines
ax.hlines(0, -1, 50)
ax.vlines(0, -1, 250)
ax.plot(np.linspace(4.75, 49, 100), (4-0.9*np.linspace(4.75, 49, 100))/(-0.16), color="r")
ax.plot(np.linspace(0, 50, 100), (33+1.46*np.linspace(0, 50, 100))/0.83, color="r")
ax.text(15, 175, "$(1-a_{11})p_1 - a_{21}p_2 \leq a_{01}w$", size=10)
ax.text(30, 85, "$-a_{12}p_1 + (1-a_{22})p_2 \leq a_{02}w$", size=10)
# Draw the feasible region
feasible_set = Polygon(np.array([[17, 69],
[4, 0],
[0,0],
[0, 40]]),
color="cyan")
ax.add_patch(feasible_set)
# Draw the optimal solution
ax.plot(17, 69, "*", color="black")
ax.text(18, 60, "dual solution", size=10)
plt.show()
```

## 37.6. Leontief inverse#

We have discussed that gross output \(x\) is given by (37.2), where \(L\) is called the Leontief Inverse.

Recall the Neumann Series Lemma which states that \(L\) exists if the spectral radius \(r(A)<1\).

In fact

### 37.6.1. Demand shocks#

Consider the impact of a demand shock \(\Delta d\) which shifts demand from \(d_0\) to \(d_1 = d_0 + \Delta d\).

Gross output shifts from \(x_0 = Ld_0\) to \(x_1 = Ld_1\).

If \(r(A) < 1\) then a solution exists and

This illustrates that an element \(l_{ij}\) of \(L\) shows the total impact on sector \(i\) of a unit change in demand of good \(j\).

## 37.7. Applications of graph theory#

We can further study input output networks through applications of graph theory.

An input output network can be represented by a weighted directed graph induced by the adjacency matrix \(A\).

The set of nodes \(V = [n]\) is the list of sectors and the set of edges is given by

In Fig. 37.1 weights are indicated by the widths of the arrows, which are proportional to the corresponding input-output coefficients.

We can now use centrality measures to rank sectors and discuss their importance relative to the other sectors.

### 37.7.1. Eigenvector centrality#

Eigenvector centrality of a node \(i\) is measured by

We plot a bar graph of hub-based eigenvector centrality for the sectors represented in Fig. 37.1.

## Show source

```
fig, ax = plt.subplots()
ax.bar(codes, centrality, color=color_list, alpha=0.6)
ax.set_ylabel("eigenvector centrality", fontsize=12)
plt.show()
```

A higher measure indicates higher importance as a supplier.

As a result demand shocks in most sectors will significantly impact activity in sectors with high eigenvector centrality.

The above figure indicates that manufacturing is the most dominant sector in the US economy.

### 37.7.2. Output multipliers#

Another way to rank sectors in input output networks is via output multipliers.

The **output multiplier** of sector \(j\) denoted by \(\mu_j\) is usually defined as the
total sector-wide impact of a unit change of demand in sector \(j\).

Earlier when disussing demand shocks we concluded that for \(L = (l_{ij})\) the element \(l_{ij}\) represents the impact on sector \(i\) of a unit change in demand in sector \(j\).

Thus,

This can be written as \(\mu^\top = \mathbb{1}^\top L\) or

Please note that here we use \(\mathbb{1}\) to represent a vector of ones.

High ranking sectors within this measure are important buyers of intermediate goods.

A demand shock in such sectors will cause a large impact on the whole production network.

The following figure displays the output multipliers for the sectors represented in Fig. 37.1.

## Show source

```
A, F = build_coefficient_matrices(Z, X)
omult = qbn_io.katz_centrality(A, authority=True)
fig, ax = plt.subplots()
omult_color_list = qbn_io.colorise_weights(omult,beta=False)
ax.bar(codes, omult, color=omult_color_list, alpha=0.6)
ax.set_ylabel("Output multipliers", fontsize=12)
plt.show()
```

We observe that manufacturing and agriculture are highest ranking sectors.

## 37.8. Exercises#

[Dorfman *et al.*, 1958] Chapter 9 discusses an example with the following
parameter settings:

Describe how they infer the input-output coefficients in \(A\) and \(a_0\) from the following hypothetical underlying “data” on agricultural and manufacturing industries:

where \(z_0\) is a vector of labor services used in each industry.

Solution to Exercise 37.1

For each \(i = 0,1,2\) and \(j = 1,2\)

Derive the production possibility frontier for the economy characterized in the previous exercise.

Solution to Exercise 37.2

```
A = np.array([[0.1, 1.46],
[0.16, 0.17]])
a_0 = np.array([0.04, 0.33])
```

```
I = np.identity(2)
B = I - A
L = np.linalg.inv(B)
```

```
A_0 = a_0 @ L
A_0
```

```
array([0.16751071, 0.69224776])
```

Thus the production possibility frontier is given by