What is 'Input-Output Analysis'
Input-output analysis ("I-O") is a form of economic analysis based on the interdependencies between economic sectors. This method is most commonly used for estimating the impacts of positive or negative economic shocks and analyzing the ripple effects throughout an economy. This type of economic analysis was originally developed by Wassily Leontief (1905–1999), who later won the Nobel Memorial Prize in Economic Sciences for his work in this area.
BREAKING DOWN 'Input-Output Analysis'The foundation of I-O analysis involves input-output tables. Such tables include a series of rows and columns of data that quantify the supply chain for sectors of the economy. Industries are listed in the headers of each row and each column. The data in each column corresponds to the level of inputs used in that industry's production function. For example, the column for auto manufacturing shows the resources required for building automobiles (i.e., so much steel, aluminum, plastic, electronics, and so on). I-O models typically include separate tables showing the amount of labor required per dollar unit of investment or production.
Three Types of Economic Impact
I-O models estimate three types of impacts: direct, indirect and induced. These terms are another way of saying initial, secondary and tertiary impacts that ripple throughout the economy. By using I-O models, economists can estimate the change in inputs across industries due to a change in output in one or more specific industries. The direct impacts of an economic shock are the initial change in expenditures. For example, building a bridge would require spending on cement, steel, construction equipment, labor and other inputs. The indirect, or secondary, impacts are due to the suppliers of the inputs hiring workers to meet demand. The induced, or tertiary, impacts result from the workers of suppliers purchasing more goods and services.
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 impacts are simply the original numbers put into the model, so for example, the value of the raw inputs (cement, steel, etc.). The indirect impacts are the jobs created by the supplying companies, so cement and steel companies. The induced impacts are the due to the amount of money that the new workers spend on goods and services.