What is Input-Output Analysis?

What is Input-Output Analysis?

Input-Output (I-O) Analysis is a form of macroeconomic analysis based on the interactions between different economic sectors or industries. This method is often used to estimate the impact of positive or negative economic shocks and to analyze the domino effects in an economy. I-O economic analysis was originally developed by Wassily Leontief (1906-1999), who later received the Nobel Prize in Economics for his work in the field.

Input-Output Analysis is a macroeconomic analysis based on the interactions between different economic sectors or industries.

Input-output analysis is used to estimate the impact of positive or negative economic shocks and to analyze the impact on the economy as a whole.

The use of input-output analysis is not common in the western world or neoclassical economics, but is commonly used in Marxist economics when central planning of an economy is required.

Use of input-output analysis

Input-output analysis is not often used in neoclassical economics. Nonetheless, it is a fundamental concept in Marxist economics as one of the methods of central economic planning. The input-output model analyzes the physical quantities produced and consumed in each industry, thus determining resource allocation to achieve equilibrium.

The input-output method is in contrast to material balance planning. The latter method counts the raw materials and inputs available in an economy. She then compares the inputs with the output targets of the respective industry using a balance sheet.

Although planning economies are few in existence today, input-output analysis is not losing ground in practice. One is Environmentally Extended Input-Output Analysis (EEIOA), which accounts for environmentally-related inputs by adding additional columns with inputs such as gasoline and coal.

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Example of Input-Output Analysis

Here’s an example of how I-O analysis works. A local government wants to build a new bridge and needs to justify the cost of the investment. To do so, it hires an economist to conduct an I-O study.

The economist talks to engineers and construction companies to estimate how much the bridge will cost, the supplies needed, and how many workers will be hired by the construction company.

The economist converts this information into dollar figures and runs numbers through an I-O model, which produces the three levels of impacts. The direct impact is simply the original numbers put into the model, for example, the value of the raw inputs (cement, steel, etc.).

The indirect impact is the jobs created by the supplying companies, so cement and steel companies. These companies need to hire workers to complete the project. They either have the funds to do so or have to borrow the money to do so, which would have another impact on banks.

The induced impact is the amount of money that the new workers spend on goods and services for themselves and their families. This includes basics such as food and clothing, but now that they have more disposable income, it also relates to goods and services for enjoyment.

The I-O analysis studies the ripple effects on various sectors of the economy caused by the local government wanting to build a new bridge. The bridge may require certain costs from the government, utilizing taxes, but the I-O analysis will show the benefits the project generates by hiring companies that hire workers that spend in the economy, helping it to grow.