In Economics, what is an Input-Output Model?
An input-output model is a way of depicting economic relationships between suppliers and producers in an economy. These models can be used for a number of purposes, including prediction of the profitability of an industry and analysis of the effects of changes in the economy. Both national and regional governments have used input-output models to determine where to allocate government funds and to increase efficiency by determining which industries have the greatest economic effect.
The input-output model was evolved into usable form by Wassily Leontief, a Russian-born economist. He developed a way of converting massive amounts of raw economic data collected by companies and governments into matrixes for easier study. These matrixes could then be manipulated to examine the potential results of price changes, material shortages, and other alterations in the economy. Leontief received the Nobel Prize in economics for this achievement.
Input-output models are usually applied to large scale economic systems but can also be used to analyze individual companies. A closed input-output model consists of a system which receives no external inputs, and all the outputs of the system are consumed within the system itself. Such systems exist but are rare. More common is the open input-output model, which consists of a system that consumes a portion of its own output and sends the rest to some external entity. For example, an oil company may sell most of its gross output to other companies and retain the rest for its own use.
A number of academic concepts are related to input-output models. Economic base analysis studies local economies in relation to their exports by analyzing employment figures. It is based on the premise that a local economy consists of an export-based component and a component which supports the production of those exports. Increasing the number of exports would cause the supporting local economy to grow. The resulting information is used to determine which export industries would provide the greatest local economic growth.
Another related concept is shift-share analysis. Shift-share analysis seeks to understand fluctuations in the employment rates of local economies in relation to the overall national economy and the national state of specific industries. Factoring out the effect of the national economic influences gives a clearer picture of the local economy. This allows the local government to determine how to invest resources in a way that will build up the local economy, instead of trying to influence factors the research indicates they cannot control.
@hamje32 - I think that economics is part art, part science. Quantifying inputs and outputs is the science part; the art part is recognizing that there are things outside your control.
I vaguely recall from my college economics class hearing about something called an economics multiplier, to measure how changes in outside events affect the model.
In other words, there are things they don’t know which could turn any model on its head.
That’s why you get different answers from economists about economic projections. They’re all trying to predict what those outside variables will be and how they will impact their models.
@Charred - Economics is a fascinating subject. I, too, read Friedman’s book and found it to be brilliant. What I don’t understand is why so many different economists make so many different predictions about where the economy is heading.
If they all work with the same io models, they should come to the same conclusions I would think. But the fact is if you put a hundred economists in the same room-and all of them are free market economists-you would still get different predictions about the future of the economy.
If economic activity is as simple as inputs and outputs, they should come up with the same answer, just like two plus two equals four every time.
I remember long ago reading the book Free to Choose, by the late economist Milton Friedman. He was a brilliant man, and was able to explain the concepts behind a free market economy very well.
I remember him describing the process of manufacturing a pencil, using it as an input output model example. He talked about the different inputs, the suppliers who make the different parts of the pencil, and the final output, the pencil itself.
His description was brilliant and I think meant to reveal on one level the complexity of the process behind making a pencil, and on the other level to use it as an illustration of a model economy, of course on a smaller scale.
He said that the model economy operates with an invisible hand, just like the pencil manufacturer operates in response to demand, without government intervention.
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