MA 102 PROJECT

Mathematics, IIT Gandhinagar

THE LEONTIEF ECONOMIC MODEL

Dip Nilim Das

Gaurav Sonkusle
Rajas Prasad Shah
Mithbavkar Ojas
Rohit S Patil
1

Under the guidance and help of Prof. Chetan Pahlajani and aSanjay Amrutiya
1
April 14, 2018
Contents

0.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
0.2 Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
0.3 The Leontief Open Economy Production Model . . . . . . . . . . . . . . . . . . . . . . . . . . 2
0.4 Mathematical Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
0.5 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
0.6 Some additional Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
0.7 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
0.8 An economic interpretation for the columns of (I − C)−1 . . . . . . . . . . . . . . . . . . . . 8
0.9 Refrences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

1
0.1 Introduction
Linear algebra is an important basic course in university mathematics, finite dimensional vector space
and linear transformation theory mainly on matrix theory, and the combination of matrix. To master the
difficult and abstract course first of all, we must get its odour in our daily life to stimulate interest in learning.
In this report we will be studying the application of mathematics in one of the subject of economics
known as the Leontief Input/Output model

0.2 Definition
The Leontief model is a model for the economics of a whole country or region. In the model there
are n industries producing n different products such that the input equals the output or, in other words,
consumption equals production.
The model can be divided into two categories:-

• Open model: The model pertaining to open economy i.e. some production consumed internally by
industries, rest consumed by external bodies
• Closed model: The model pertaining to a closed economy i.e. entire production consumed by the
industries

0.3 The Leontief Open Economy Production Model

Suppose that an economy has sectors (such as agriculture sector, energy sector, ...) Production and
consumption for each sector is measured through money(the value of goods produced or consumed).
We begin with a consumption matrix C. The j th column of lists the amount of product that sector Sj
consumes from each of the sectors S1 , S2 , S3 , ......Sn to produce one unit of its output. Each entry cij in C
is in terms of money and so cij > 0
The matrix C has been written below:
 
c11 ... c1j ... c1n
C =  ci1 ... cij ... cin 
cn1 ... cnj ... cnn
So column 1 lists the consumption by sector 1 fro all the sector from all the sectors to produce one unit of
its own product. the sum of the entries in Column 1 is the total cost of all products consumed by sector 1
to produce one unit of its product.
In the same way, the entries in Column represent the consumption (demands, or costs) of sector Sj from
all the sectors in order to produce one unit of output. If the sum of the columns of the sector is < 1, we say
that the sector is profitable

2
0.4 Mathematical Formulation
 
xj c1j

 . 


 . 

Now if we multiply a column be xj > 0 then the vector C = 
 xj cij  lists the consumption by sector


 . 

 . 
xj cnj
Sj to produce xj units of its own product  
x1

 x2 

 x3 
Let x1 , x2 , x3 , ....xn be the amounts to be produced by sectors S1 , S2 , .....Sn respectively then x =  

 . 

 . 
xn
is called the production vector the economy.
What would the vector Cx mean? It is the linear combination of the columns of C with the xi as weighs
 
c11 x1 + ..... + c1n x1

 . 


 . 

Cx =  ci1 xi + ...... + cin xi 



 . 

 . 
cn1 xn + ..... + cnn xn

 
Demand from sector 1 to produce x

 . 


 . 

Cx = 
 Demand from sector i to produce x 


 . 

 . 
Demand from sector 1 to produce x

In other words, lists the total demands that must be delivered from each sector to achieve production
vector x. The equation Cx = x asks for an equilibrium production,i.e., a production vector x for which the
economy is in balance, where the list x of products from each sector equals the list Cx of total demands
from the sectors. In a closed economy everything is just shuffled among the industries itself

Now we add another feature to the economic model: the open sector. It is non productive,i.e., it produces
nothing that the sectors use. The open sector simply “demands” products from sectors S1, S2,......Sn

 
d1
 . 
 
 . 
 
Suppose that the vector d =   di  tells how many units the open sector demands from each sector s1,

 . 
 
 . 
dn
s2 ...sn. The vector d is called the final demand vector
3
 We want to know if it is possible to set a level of production so that both B the productive and open
sectors are satisfied, with nothing left over. That is, we want to find an B so that

x = Cx + d
,
where,

x = Total production
Cx = Demand from productive sectors open sector to produce (called intermediate demand)
d= demand from open sector

Using the identity matrix I, we can rewrite the equation as :

Ix = Cx + d

Ix − Cx = d
(I − C)x = d

0.5 Example
Let us consider a economy with 4 productive sectors S1 , S2, S3, ...., S4

If the the consumption of each sector is listed as columns, then the consumption matrix is
 
.10 .05 .30 .20
.15 .25 .05 .10
C= .30 .10 .10

.25
.15 .20 .10 .20

Each entry in the matrix is less than 1 and so each sector is profitable Then
 
.90 −.05 −.30 −.20
−.15 .75 −.05 −.10
I −C = −.30 −.10 .90 −.25


−.15 −.20 −.10 .80

4
  
25000
10000
30000, then we want to solve -
If demand from the open sector is d =  

50000

(I − C)x = d

   
.90 −.05 −.30 −.20 25000
−.15 .75 −.05 −.10 x = 10000
 

−.30 −.10 .90 −.25  30000
−.15 −.20 −.10 .80 50000

Row reducing the augmented matrix gives

   
.90 −.05 −.30 −.20 25000 1 0 0 0 85580
−.15 .75 −.05 −.10 10000 0 1 0 0 50620 
  =⇒ ............. =⇒  
−.30 −.10 .90 −.25 30000 0 0 1 0 96160 
−.15 −.20 −.10 .80 50000  0 0 0 1 103220

85580
 50620 
Thus the equation will be satisfied with x = 
 96160 


103220
The row reduced form of I − C shows that I − C is invertible

This statement can be proved from the following discussion:

Suppose G is any n×n matrix with every entry >0and all column sums 61C m approaches 0 as m app.∞

Lets prove the theorem with a 2x2 matrix

Let α= the larger of the two column sums in C. Then by the definition of α: a + c 6 α and b + d 6 α
(and one of the two actually equals α).The assumptions about C in the theorem tell us that 0 6 α 6 1.
 
x y
for x, y, z, w 6 0 and is multiplied from left, we get
z w
   
x y ax + bz ay + bw
C =
z w cx + dz cy + dw

and the column satisfy:

Sum of column 1: (a + c)x + (b + d)z 6 αx + αz

sum of column 2: (a + c)y + (b + d)w 6 αy + αw

5
    
x y a b
Hence , each column in product 6 α. Now, let = =C and use this observation:
z w c d
     
a b x y a b a b
= = C 2,
c d z w c d c d

and sum for column 1 for C2 6α (old column 1 sum in C) = α(a + c) 6 α.α 6 α2

and sum for column 2 for C2 6α (old column 2 sum in C) = α(b + d) 6 α.α 6 α2

•
(I − C)m+1 = (I − C)(I + C + C 2 + C 3 + ..... + C m )

= I 2 − CI + IC − C 2 + IC 2 − C 3 + ..... + IC m − IC m+1

= I − C + C − C 2 + C 2 ...... − C m + C m − C m+1
= I − C m+1

• Since Cm → 0as m →∞, Cm+1 ≈ 0and therefore

(I-C)(I+C+C2 + C 3 + ..... + C m ) ≈ I
(I+C+C2 + C 3 + ..... + C m ) ≈ (I − C)− 1

If (I-C) is invertible and (I − C)− 1 has all non-negative elements, then of course, there is an
unique solution x = (I − C)−1 d has all non negative entries.

0.6 Some additional Observations

After the content analysis of the above mentioned articles, some additional observations are listed
below:

• (I − C)− 1 ≈ I + C 2 + C 3 + ..... + C m , so

(I − C)−1 d ≈ (I + C 2 + C 3 .... + C m )d

(I − C)−1 d = d + Id + dC 2 + dC 3 ....dC m ...

Since C m → 0 as m → ∞, we can approximate x ≈d + Id + dC2 + dC 3 ....dC m when m is large
• The column vectors in (I − C)−1 actually have an economic interpretation: See the remarks following
the example

6
0.7 Example
The consumption matrix G is based on input-output data for the U.S. economy in 1958, with data for 81
sectors grouped here (for manageability) into ( larger sectors: (1) nonmetal household and personal products
(2) final metal products (such as autos) (3) basic metal products and mining (4) basic nonmetal products
and agriculture (5) energy (6) services and (7)entertainment and miscellaneous products. Here, units are in
millions of dollars.

Solution:
 
0.1588 0.0064 0.0025 0.0304 0.0014 0.0083 0.1594
0.0057 0.2645 0.0436 0.0099 0.0083 0.0201 0.3413
 
0.0264 0.1506 0.3557 0.0139 0.0142 0.0070 0.0236
 
0.3299 0.0565 0.0495 0.3636
C=  0.0204 0.0483 0.0649

0.0089 0.0081 0.0333 0.0295 0.3412 0.0237 0.0020
 
0.1190 0.0901 0.0996 0.1260 0.1722 0.2368 0.3369
0.0063 0.0126 0.0196 0.0098 0.0064 0.0132 0.0012

It turns out that (I − C) is invertible

 
74000
 56000 
 
 10500 
 
 25000 
Let the final vector d=  
 17500 
 
196000
5000
Now the solution of the equation x = Cx + d is obtained from a computer software like MATLAB

Now MATLAB gives :

 
1.2212 0.0271 0.0226 0.0677 0.0135 0.0227 0.2167
0.0432 1.4046 0.1244 0.0466 0.0404 0.0516 0.5103
 
0.0806 0.3387 1.5927 0.0555 0.0508 0.0326 0.1810
 
(I-C)−1 = 
0.6732 0.1905 0.1763 1.6448 0.0948 0.1266 0.3265

0.0636 0.0531 0.1010 0.0897 1.5393 0.0575 0.0590
 
0.3409 0.2711 0.2953 0.3253 0.3842 1.3674 0.6371
0.0213 0.0303 0.0392 0.0231 0.0175 0.0211 1.0246
So,
   
74000 99580
 56000  97700
   
 10500  51230
   
(I − C)−1 d = (I − C)−1  25000 =13157
   
 17500  49490
   
196000 32955
5000 13840

7
0.8 An economic interpretation for the columns of (I − C)−1
Suppose C is an n × n consumption matrix with entries ≥ 0 and column sums each less than 1.

Let

(
x = production vector that satisfies a final demand d
(*)
4x = production vector that satisfies a different final demand 4 d

Then by (*)

x = Cx + d

4x = C 4 x + 4d
Adding the equations and rearranging, we get

x + 4x = C(x + 4x) + (d + 4d)

So production level (x + 4x) fulfills the final demand (d + 4d)

 
1
 0 
 
Suppose we let 4d =   .  ,i.e., ”increase the final demand from sector S1 by 1 unit, with no change

 . 
0
in the final demand from other sectors”

Since
4x = C 4 x + 4d, we have (I − C) 4 x = 4d, or
 
1
 0 
 
4x = (I − C)−1 4 d = (I − C)−1 
 . 

 . 
0
     
col 1 col 2 col n
= 1. of  + 0. of  + ... + 0. of 
−1 −1 −1
(I − C) (I − C) (I − C)
 
col 1
= of 
(I − C)−1
 
1

 0 

So the 4x corresponding to 4d =  .  is the first column of (I − C)−1 .
 
 . 
0
8
 In other words: a change of one unit in the final demand from sector S1 requires a change 4x in the
production vector required to satisfy the new demand and 4x = the first column of (I − C)−1 !

Similarly, you can see that a change of one unit in the demand of sector S2 causes a change in production
vector 4x = the second column of (I − C)−1 ;etc.

So the column vectors in (I − C)−1 are not just ”accidental” vectors that pop up in computing the
inverse; they have economic meaning.

0.9 Refrences
• Leontief, W., input output Economics, Second Edition, Oxford University Press, New York, 1986.

• David C. Lay, Fourth Edition, Linear Algebra and its Applications, University of Maryland.

• The Leontief model and economic theory by Giandemetrio Marangoni University of Verona.