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PROFESSOR:SHUBHANGI JORE

Input -output analysis is a technique of studying the production structure of an economy , considering the mutual interdependence of the various production sector . The input -output analysis thus seeks to analysis interindustry relationship in order to understand the interdependence and complexities of the system and to find the condition for maintaining balance between demand and supply of each industry .

Input -output analysis is based on a number of assumptions .These are (1)No two products are produced jointly .Each industry produce one homogeneous good .However this assumptions can be relaxed if it is possible to take the good as a composite unit .the good is made of several item produced in a fixed proportion a package of 100bicycle,20motocycle ,30scooter and 10 car taken together as a unit of transport equipment . (2)Factor and commodity price are given . (3)Amount of factor services as well as the nature and extent of consumer demand is given . (4)Industries do not enjoy external economics or diseconomies (5)Firms enjoy constant returns to scale . (6)There is pure competition in the producing sector .

Input-Output Analysis arose to deal with the problem of interindustry demand, but the same method can be used to show how changes in one region affect the economies of regions linked to it. Suppose we have information on how changes in production in

Santa Clara and Santa Cruz Counties affect the demand for each other's output. (Santa Clara County is essentially the famed Silicon Valley and Santa Cruz County is a county to the south of it over the Santa Cruz Mountains and on Monterey Bay of the Pacific Ocean.) If production in Santa Clara County increases there will be more income not only for residents of Santa Clara County but also for the residents of Santa Cruz County because some of the jobs in Santa Clara County will go to Santa Cruz County residents. The residents of both counties will decide how much of their income they will spend, where, and for what. Some of that spending will be in the two counties and be for goods and services that are produced locally. Likewise when production in Santa Cruz County increases some of the jobs will go to Santa Clara County residents and some of these will spend their income in Santa Cruz County as well as in Santa Clara County.

Matrix (mathematics)

Specific entries of a matrix are often referenced by using pairs of subscripts. In mathematics, a matrix (plural matrices, or less commonly matrixes) is a rectangular array of numbers, Suppose we have that information in matrix form: County of Production County of Residence Santa Clara Santa Cruz Santa Clara 0.5 0.2 Santa Cruz 0.1 0.4

This is like a matrix of marginal propensities to consume in macroeconomic theory. In macroeconomic theory if income is spent for products outside of the economy it is

considered a leakage. In this regional setting some of these leakages leak back into the economy. The matrix above corresponds to the matrix A in input-output analysis. In macroeconomic theory the income multiplier k is equal to:

1/(1-c)

where c is the marginal propensity to consume. This could be written as:

k = (1-c)-1.

With the regional interaction there is a matrix of multipliers and the matrix is equal to:

(I-A)-1.

For the above matrix the matrix I-A is: County of Production County of Residence Santa Clara Santa Cruz Santa Clara 0.5 -0.2 Santa Cruz -0.1 0.6

The determinant of I-A is (0.5)(0.6)-(-0.1)(-0.2)=0.30-0.02=0.28. This means the matrix I-A does have an inverse. Remember that for a 2x2 matrix the inverse is found by interchanging the diagonal elements and changing the sign of the off-diagonal elements, then dividing every element by the determinant. This gives:

County of Production County of Residence Santa Clara Santa Cruz Santa Clara 2.14286 0.71429 Santa Cruz 0.35714 1.78571

This means that when the demand for Santa Clara County's output increases by $1 the output in Santa Clara County increases by $2.14 and in Santa Cruz County by $0.71. On the other hand, if the demand for Santa Cruz County's output increases by $1 then output in Santa Cruz County increases by $1.79 and in Santa Clara County by $0.36.

The above shows how once the matrix A is known how the inter-relationships between the parts is determined in the form of the inverse of the (I-A) matrix. So once A is determined the rest is merely numerical computation. But the matrix A first has to be established. The derivation of the matrix A involves several economic processes. First, there is the distribution of income (and jobs) to the sub regions. This is given in the form of a matrix which will be called the matrix J (for jobs). Suppose J has the following value: County of Production County of Residence Santa Clara Santa Cruz Santa Clara 0.75 0.25 Santa Cruz 0.20 0.80

This says that 75% of the jobs and income go to Santa Clara County residents and 25% go to residents of Santa Cruz County. On the other hand, 20% of the jobs and income in Santa Cruz County go to Santa Clara County residents and the other 80% to Santa Cruz County residents. But not all of a dollar of production goes for labor income. Let us say that in both counties one third of the revenue goes for labor income. This means that the effect of additional dollars of production would have the following effects on incomes. This is the matrix Y (for income).

County of Production County of Residence Santa Clara Santa Cruz Santa Clara 0.250 0.083 Santa Cruz 0.067 0.267

There is also the matrix that tells where people spend their money and how much of it goes for local production. This is the matrix S (for spending). County of Residence County of Spending Santa Clara Santa Cruz Santa Clara 0.80 0.10 Santa Cruz 0.30 0.60

This says that that when Santa Clara residents get another dollar of income 80% is spent in Santa Clara County and another 10% is spent in Santa Cruz County. On the other hand, when Santa Cruz residents get another dollar of income 30% is spent in Santa Clara County and 60% at home in Santa Cruz County. In both cases all of the spending goes for goods or services which are produced in the county of the spending. Note that the orientation of this table is opposite of the previous tables. To construct the matrix A we have to follow a dollar of production to its disbursement as income to the two counties and the allocation of the recipients spending between the two counties. This illustration is going to leave out several other important economic processes such how much of labor income goes for taxes, savings and imports. These omissions are to keep the detail to a minimum. According to matrix J, when a dollar of production is produced in Santa Clara County, $0.25 goes to Santa Clara County residents who spend 80% of it in Santa Clara County and $0.083 goes to Santa Cruz County residents who spend 30% of it in Santa Clara County. Altogether then the $1 of production in Santa Clara County leads to (0.25) (.8)+(0.083)(.3)=0.225 of addition consumer demand in Santa Clara County. This is the element in the first row, first column of the matrix A. The dollar of additional

production also leads to increased demand in Santa Cruz County I . e,. (0.25) (0.1)+(0.083)(.6)=0.075. This is the element in the second row, first column of A. When an additional dollar of production takes place in Santa Cruz County the additional spending in Santa Clara County is (0.063)(0.8)+(0.267)(.3)=0.131, the element of the A matrix in the first row, second column. The final element is the spending in Santa Cruz County resulting from an additional dollar of production in Santa Cruz County. This is (0.63)(0.1)+(0.267)(0.6)=0.167. Thus the A matrix is County of Production County of Residence Santa Clara Santa Cruz The (I-A) is then County of Production County of Residence Santa Clara Santa Cruz Santa Clara 0.775 -0.075 Santa Cruz -0.131 0.834 Santa Clara 0.225 0.075 Santa Cruz 0.131 0.167

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