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Application of linear algebra

Leontief Economic Model

Dip—Rohit—Rajas—Ojas—Gaurav

IIT Gandhinagar

April 13, 2018

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Basics of Leontief Input Output Model

Continued

What is the Leontief input output (LIO) model?

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Basics of Leontief Input Output Model

Continued

What is the Leontief input output (LIO) model?

Came out of Wassily Leontief’s Nobel prize winning work and
a “high concentration of theory without fact on the one hand,
and a mounting accumulation of fact without theory on the
other.”

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Basics of Leontief Input Output Model

simple explanation

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.
i.e used to answer:
What level of total output does an economy need to produce
to meet a given demand using a given consumption matrix ?

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Basics of Leontief Input Output Model

Two Economic Models :

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Basics of Leontief Input Output Model

Two Economic Models :

Closed Economic Model:
entire production consumed by industries.
Problem: Gives the condition for equilibrium

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Basics of Leontief Input Output Model

Two Economic Models :

Closed Economic Model:
entire production consumed by industries.
Problem: Gives the condition for equilibrium
Open Economic Model:
some production consumed internally by industries, rest
consumed by external bodies.
Problem: Find production level if external demand is given.

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Closed and Open Economic 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)

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Closed and Open Economic Model

Consumption matrix
 
c11 ... c1j ... c1n
C = ci1 ... cij
 ... cin 
cn1 ... cnj ... cnn

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

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Closed and Open Economic Model

Now if we multiply a column by xj > 0 then the vector

 
xj c1j
 . 
 
 . 
 
C = xj cij 

 . 
 
 . 
xj cnj
lists the consumption by sector Sj to produce xj units of its own
product

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Closed and Open Economic Model

Let x1 , x2 , x3 , ....xn be the amounts to be produced by sectors

S1 , S2 , .....Sn respectively then
 
x1

 x2 

 x3 
x = 

 . 

 . 
xn

is called the production vector of the economy.

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Closed and Open economic model

What would the vector Cx mean? It is the linear combination of

the columns of C with the xi as weights

   
c11 x1 + ..... + c1n xn Dem.fromsec.1toproducex

 . 


 . 


 . 


 . 

Cx = 
 ci1 x1 + ...... + cin xn 
 Cx = 
 Dem.fromsec.itoproducex 


 . 


 . 

 .   . 
cn1 x1 + ..... + cnn xn Dem.fromsec.ntoproducex

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Closed and Open Economic Model

What equation Cx = x is denoting?

The equation asks for an equilibrium production

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Closed and Open Economic Model

What equation Cx = x is denoting?

The equation 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.

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Closed and Open Economic Model

What equation Cx = x is denoting?

The equation 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.
This condition is for Closed Economy
In a closed economy everything is just shuffled among the
industries itself

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Closed and Open Economic Model

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

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Closed and Open Economic Model

Demand vector  
d1
 . 
 
 . 
 
The vector d = 
 d i
 tells how many units the open sector

 . 
 
 . 
dn
demands from each sector s1, s2 ...sn. The vector d is called the
final demand vector

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Closed and Open Economic Model

What is the purpose of open model?

We want to know if it is possible to set a level of production x
so that both the productive and open sectors(e.g government,
consumers,export etc) are satisfied, with nothing left over.

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Closed and Open Economic Model

That is, we want to find an x so that

x = Cx + d

where,

x = Total production

Cx = Demand from productive sectors to produce x (called

intermediate demand)

d = Demand from non-productive(open sectors) (calledfinal

demand)

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Closed and Open Economic Model

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

Ix = Cx + d

Ix − Cx = d
(I − C )x = d

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Closed and Open Economic Model

Theorem
If C and d have non-negative entries and the column sum in C are
all < 1 (i.e if every sector is profitable),then(I − C ) must be
invertible. Therefore, there must be unique production vector
satisfying the equation(I − C )x = d, namely x = (I − C )−1 d

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Closed and Open Economic Model

Let us look over an example.

Consider an economy with consumption matrix:

 
0.50 0.40 0.20
C =  0.20 0.30 0.10 
0.10 0.10 0.30

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Closed and Open Economic Model

Let us look over an example.

Consider an economy with consumption matrix:

 
0.50 0.40 0.20
C =  0.20 0.30 0.10 
0.10 0.10 0.30

And suppose the final demand is 50,30,20 units for manufacturing,

agriculture, services.

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Closed and Open Economic Model

Let us look over an example.

Consider an economy with consumption matrix:

 
0.50 0.40 0.20
C =  0.20 0.30 0.10 
0.10 0.10 0.30

And suppose the final demandis 50,30,20

 units for manufacturing,
50
agriculture, services ,i.e., d =  30 
20
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Closed and Open Economic Model

Now, the matrix I − C

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Closed and Open Economic Model

Now, the matrix I − C =

   
1 0 0 0.50 0.40 0.20
 0 1 0  -  0.20 0.30 0.10 
0 0 1 0.10 0.10 0.30

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Closed and Open Economic Model

Now, the matrix I − C =

   
1 0 0 0.50 0.40 0.20
 0 1 0 - 0.20
  0.30 0.10 
0 0 1 0.10 0.10 0.30
 
0.50 −0.40 −0.20
=  −0.20 0.70 −0.10 
−0.10 −0.10 0.70

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Closed and Open Economic Model

To solve for x using the equation (I − C )x = d , row reduce the

augmented matrix

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Closed and Open Economic Model

To solve for x using the equation (I − C )x = d , row reduce the

augmented matrix,
 
0.50 −0.40 −0.20 50
 −0.20 0.70 −0.10 30 
−0.10 −0.10 0.70 20

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Closed and Open Economic Model

To solve for x using the equation (I − C )x = d , row reduce the

augmented matrix,
   
0.50 −0.40 −0.20 50 5 −4 −2 500
 −0.20 0.70 −0.10 30  ∼ −2 7 −1 300 
−0.10 −0.10 0.70 20 −1 −1 7 200

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Closed and Open Economic Model

To solve for x using the equation (I − C )x = d , row reduce the

augmented matrix,
   
0.50 −0.40 −0.20 50 5 −4 −2 500
 −0.20 0.70 −0.10 30  ∼ −2 7 −1 300 
−0.10 −0.10 0.70 20 −1 −1 7 200
 
1 0 0 226
∼ ... ∼ 0 1 0 119 
0 0 1 78

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Closed and Open Economic Model

To solve for x using the equation (I − C )x = d , row reduce the

augmented matrix,
   
0.50 −0.40 −0.20 50 5 −4 −2 500
 −0.20 0.70 −0.10 30  ∼ −2 7 −1 300 
−0.10 −0.10 0.70 20 −1 −1 7 200
 
1 0 0 226
∼ ... ∼ 0 1 0 119 
0 0 1 78
Rounding the last column to the nearest whole unit, we can see
that manufacturing must produce approximately 226 units,
agriculture 119 units, and services only 78 units.
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Remark
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

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Remark
An economic interpretation for the columns of (I − C )−1

Then by (*)

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

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

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Remark
An economic interpretation for the columns of (I − C )−1

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

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

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Remark
An economic interpretation for the columns of (I − C )−1

Since

4x = C 4 x + 4d, we have (I − C ) 4 x = 4d, or

 
1
 0 
C )−1 C )−1 
 
4x = (I − 4 d = (I −  . 

 . 
0

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Remark
An economic interpretation for the columns of (I − C )−1
     
col 1 col 2 col n
= 1. of  + 0. of  + ... + 0. of 
(I − C ) −1 (I − C ) −1 (I − C ) −1

 
col 1
= of 
(I − C ) −1
 
1

 0 

So the 4x corresponding to 4d = 
 .  is the first column of

 . 
0
(I − C )−1 .
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Remark
An economic interpretation for the columns of (I − C )−1

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.

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Remark
An economic interpretation for the columns of (I − C )−1

So the column vectors in (I − C )−1 are not just ”accidental”

vectors that pop up in computing the inverse; they have economic
meaning.

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Sources and References

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

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