What Is Input-Output Analysis?

Input-output analysis (I-O) is a form of macroeconomic analysis based on the interdependencies between different 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. I-O economic analysis was originally developed by Wassily Leontief (1906–1999), who later won the Nobel Memorial Prize in Economic Sciences for his work in this area.

Key Takeaways

  • Input-output analysis is a macroeconomic analysis based on the interdependencies between different economic sectors or industries.
  • Input-output analysis is used to estimate the impacts of positive or negative economic shocks and analyzes the ripple effects throughout the economy.
  • The use of input-output analysis is not common in the Western world or neoclassical economics but often used in Marxist economics when central planning of an economy is required.
  • Input-output tables are the foundation of input-output analysis, depicting rows and columns of data that quantify the supply chain for all of the sectors of an economy.
  • Three types of impacts are modeled in input-output analysis. They are direct impact, indirect impact, and induced impact.
  • These impacts on the economy are determined when certain input levels are changed.

Understanding 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 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 (e.g., the amount of 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.

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 for personal consumption. This analysis can also be run in reverse, seeing what effects on inputs were likely the cause of observed changes in outputs.

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.