What is Input-Output Analysis
Input-output analysis ("I-O") is a form of macroeconomic analysis based on the interdependencies between economic sectors or industries. This method is 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.
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 all sectors of an 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. While input-output analysis is not commonly utilized by neoclassical economics or by policy advisers in the West, it has been employed in Marxist economic analysis of coordinated economies that rely on a central planner.
BREAKING DOWN Input-Output Analysis
Three Types of Economic Impact
I-O models estimate three types of impact: direct, indirect and induced. These terms are another way of referring to initial, secondary and tertiary impacts that ripple throughout the economy when a change is made to a given input level. By using I-O models, economists can estimate the change in output across industries due to a change in inputs in one or more specific industries. The direct impact of an economic shock is an 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, impact would be due to the suppliers of the inputs hiring workers to meet demand. The induced, or tertiary, impact would result from the workers of suppliers purchasing more goods and services. This analysis can also be run in reverse, seeing what effects on inputs were likely the cause of observed changes in outputs.
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. The induced impact is the amount of money that the new workers spend on goods and services.