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Math 547
Research Project
Minju Kim
Leontief Input-Output Model
(Application of Linear Algebra to Economics)

Introduction
Professor Wassily Leontief started input-output model with a
question, what level of output should each of the n industries
in an economy produce, in order that it will just be sufficient to
satisfy the total demand for that product? Leontief Input-
output analysis which was developed by Professor Wassily
Leontief in the 1930s is a method used to analyze the
relationships between sectors in an economy. These sectors are
interdependent on the other sectors in the economy. In order to
produce something, each sector needs to consume of its own
output and some of output from the other sectors. He developed the models to model economies
using empirical data. He divided U.S. economy into 500 economic sectors and described the
interdependence between sectors with input-output matrices. With input-output model, it became
possible to determine the total output of industries that must be produced to obtain a given
amount for final demand. By using the Leontief Input-output Model, it is possible to find
production levels which will meet the demands of all sectors inside and outside of that economy.
On October 18 in 1973, Wassily Leontief won Nobel Prize in economy for this work in this area.
This analysis has been used extensively in economic production planning and in developing
countries. Also, by looking at the Leontief Input Output Model, it is possible to tell whether an
economy is productive or non-productive.

Assumptions for the Input-Output Model
Since Leontief input-output model normally can have a large number of industries and it will be
quite complicated. For a simplification, the following assumptions are adopted
1) Each industry produce only one homogeneous commodity
2) Each industry uses a fixed input ratio for the production of its output
3) Production in every industry is subject to constant return to scale (constant returns to
scale means k-fold change in every input will result in an exactly k-fold change in output)


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Using of Linear Algebra for the Model
The Leontief model represents the economy as a system of linear equations. To find P
(production vector) in terms of d (demand vector), we will solve sets of linear equations. Such
equations are naturally represented using the formalism of matrices and vectors. We will solve
linear equations with matrix algebra. In matrix algebra, we will use matrix inverses and matrix
multiplication. Also, to find a solution, we will use Gaussian-elimination technique. To decide if
the economy is productive, we will use the Hawkins-Simons conditions.

The Open Leontief Model
There is a Closed Leontief Model where no goods leave or enter the economy. However, in real
economic world, it does not happen very often. Normally, a certain economy has outside demand
from like government agencies. Therefore, we will use the Open Leontief Model. In Open
Leontief Model, there are industries in an economy. Each industry has a demand for products
from other industries (internal demand). Also, there are external demands from outside. We will
find a production level for the industries that will satisfy both internal and external demands.
Consider there are n interdependent industries (or sectors): S
1
, S
2
,..,S
n




From this, we can get linear equations,





We can have matrix A and vectors P, and d,
A = [
() () ()
() () ()

() () ()
], P= [

], and d=[

]
We can write above linear equations as P = AP + d
Matrix A is called input-output matrix or consumption matrix. A consumption matrix shows the
quantity of inputs needed to produce one unit of a good. The rows of the matrix represent the
p
1
= m
11
p
1
+ m
12
p
2
+ + m
1n
p
n
+d
1
p
2
= m
21
p
1
+

m
22
p
2
+ + m
2n
p
n
+ d
2

: : : : :
p
n
= m
n1
p
1
+ m
n2
p
2
+ + m
nn
p
n
+d
n

Let m
ij
: the number of units produced by industry Si to produce one unit of industry S
i
P
k
: the production level of industry S
k
m
ij
p
j
: the number of units produced by industry Si and consumed by industry S
j
d
i
: demand from the i
th
outside industry
Then, total number of units produced by industry S
i,
p
i=
p
1
m
i1
+ p
2
m
i2
+ + p
n
m
in
+ d
i

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producing sector of the economy. The columns of the matrix represent the consuming sector of
the economy. The entry m
ij
in consumption matrix represent what percent of the total production
value of sector j is spent on products from sector i. d is the demand vector. Demand vector d
represents demand from the non-producing sector of the economy. Vector P represents the total
amount of the product produced.



To solve this linear system,


If consumption matrix A and demand vector d have nonnegative entries, and if consumption
matrix A is economically feasible, then the inverse of the matrix (I-C) exists and the production
vector P has nonnegative entries and has the unique solution for the model. We call matrix A is
productive in this case.

The Open Leontief Model with Real Data
To help understanding how the Open Leontief Model works, I have a real data to explain.
Agriculture Manufacturing Services Open Sector
Agriculture 34.69 4.92 5.62 39.24
Manufacturing 5.28 61.28 22.99 60.02
Services 10.45 25.95 42.03 130.65
Total Gross Output 84.56 163.43 219.03
<Exchange of Goods and Services in the U.S. for 1947 (in billions of 1947 dollars)>
By dividing each column of a 3 X 3 table by the Total Gross Output for sectors, we can get the
consumption matrix from the table.
In this data, open economy consists of three industries: Agriculture, Manufacturing, Services.
These three industries depend upon each other. To produce $1 of Agriculture, Agriculture must
purchase $0.4102 of its own production, $0.0624 of Manufacturing, and $0.1236 worth of
Services. To produce $1 worth of Manufacturing, it needs $0.0301 of Agriculture, $0.3783 of
Manufacturing, and $0.1588 of Services. To produce $1 worth of Services, Services industry
must buy $0.0257 of agriculture, $0.1050 of Manufacturing, and $0.1919 of Services. There is an
external demand of $39.24 worth of Agriculture, $60.02 worth of Manufacturing, and $130.65
worth of Services. We can find the production level of each three industries with the Open
Leontief Model to satisfy both internal and the external demands.
P = AP + d [

] = [

] + [

]

P = AP + d (I A)P = d P = (I-A)
-1
d

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Solution for Real Data using the Open Leontief Model
The input-output matrix (or consumption matrix) of the economy is
A = [



] .
Matrix A is showing relationships of inputs consumed per unit of sector output.
External demand for the economy is d = [

]
P = (I A)
-1
d
I A = [



]
To find out (I A)
-1
, first we need to know if inverse of (I-A) exists.



.



Since det(I-A)=0.5898*0.6217*0.8081+0.9376*0.8412*0.9743+0.8764*0.9699*0.8950-
0.5898*0.8412*0.8950-0.8764*0.6217*0.9743-0.9376*0.9699*0.8081=0.1157520, there exists
an inverse of matrix (I-A).
(I A)
-1
= [



]
P = (I A)
-1
d = [



] [

] = [

]
Therefore, the total output of the Agriculture must be $82.40. The total output for the
Manufacturing must be $138.85. The total output for the Services sector is $201.57.
In 3x3 matrix, B = [



].
There exists an inverse of matrix B detB = b
11
b
22
b
33
+b
21
b
32
b
13
+b
31
b
12
b
23
-b
11
b
32
b
23
-b
31
b
22
b
13
-
b
21
b
12
b
33
0, and it is
B
-1
=

[



]
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Or we can get a production vector using the Gauss elimination method.




[
] =
[



] [



]
[



] [



]
3 x 3 matrix (I-A) is invertible since rref (I-A)= I
3
and Rank(I-A)= 3. So, invertible matrix of
matrix I-A exists. Therefore, we can get (I A)
-1
= [



]
Which gives P = (I A)
-1
d = [



] [

] = [

]

Characteristics on Consumption Matrices A in Open Leontief Model
In the Closed Leontief Model where no goods leave or enter the economy, consumption matrices
would have columns adding to one. However, in the Open Leontief Model, the sum of columns
in consumption matrix must be less than 1. In a real data used above, a consumption matrix A =
[



]. We can check that the sums of each column are less than 1. (The
sum of first column= 0.4102+0.0624+0.1236=0.5962 < 1, the sum of second column=
0.0301+0.3783+0.1588=0.5672 < 1, the sum of third column= 0.0257+0.1050+0.1919=0.3226
<1) Since sums of each column represent the partial input cost incurred in producing a dollars
worth of some commodity. If the sum is greater than or equal to $1, production will not be
economically justifiable.
Coefficients of the consumption matrix must be positive. In order to meet demand, there are
certain restrictions in Open Leontief Model. First, the equation that is being solve is
P = (I A)
-1
d. If an inverse does not exist, then it is impossible to solve for the production vector.
Also, a positive production vector is necessary. Because the demand vector is always positive,
multiplying the demand by the inverse of I-A needs to result in a positive production vector. For
this, (I-A)
-1
needs to be a positive definite matrix. With basic economic knowledge, an increase
Invertibility
An n x n matrix C is invertible if (and only if) rref (C) = In
or, equivalently, if Rank(C) = n


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d > 0 in final demand in equation P = (I A)
-1
d should result in an increase P > 0 in total
output. Therefore, if the matrix (I A)
-1
is not positive, the logic is violated.
Being a positive definite matrix ((I A)
-
1) assures that the economy can meet any given demand.
When this happens, consumption matrix A and the economy are called productive.

Is the Economy Productive?
Now, we know that existence of positive definite matrix ((I A)
-
1) tells us consumptions matrix
A and the economy are productive. To check if the economy is productive, we will try to find out
that inverse of matrix (I A) is a positive definite matrix. For this, we will use the Hawkins-
Simons conditions.



The principal leading minors of a matrix are set of determinants from sub-matrices of a certain
matrix. In the Open Leontief Input-Output Model, they come from (I A). The principal leading
minors start with the determinant of the entry, which is left after every row except the first is
omitted and every column except the first is omitted. The second principal leading minor
excludes every row past the second and every column past the second. Until the determinant of
the entire matrix is taken, this pattern needs to continue.
For example, in a matrix
[

,
The first principal leading minor: the determinant of a11, or a11. The second principal
leading minor: |


|. The third principal leading minor: |



|. It will
continue until the last principal leading minor that is the determinant of the matrix.
If all these principal leading minors are positive, a matrix is invertible and positive definite. Also,
it means that a production vector P satisfies any demand and the economy is productive.

- Examples of Productive Economies
Lets suppose that there is consumptions matrix A in an open economy, A=[



]. We
can check that the sums of the columns are less than 1. It means that the industries require few
inputs to make output and most output will be sent to satisfy an outside demand.
The Hawkins-Simons conditions say,
If all the principal leading minors of a matrix are positive, then an inverse exists and is
nonnegative.

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I A= [



]. The first principal leading minor is 0.9 and it is positive. The second
leading minor is 0.9*0.9-0.8*0.9=0.09 and it is positive. The third leading minor is
0.9*0.9*0.9+0.8*0.6*0.7+0.7*0.9*0.8-0.7*0.9*0.7-0.9*0.6*0.8-0.8*0.9*0.9=0.048 and it is
positive number. We check that all of principal leading minors are positive. So, we can know
that I A is invertible and positive by Hawkins-Simons conditions. Therefore, it means that it
can meet any demand and the economy is productive.

Approaches to Analysis: Multipliers
If there is change in final demand, how does it affect to total output or total factor use? Multiplier
analysis is widely used to analyze the impact of changes in final demand on total output or total
factor use.
Lets assume that there is a change in final demand (d). So, the final demand is changed d to d
+ d. The d can be positive, zero, or negative. We can get (P + P) = A(P + P) + (d + d),
which is sum of P= AP+d and P = AP+d. Solving for P, we get P=(I-A)
-1
d.
Since the matrix (I A)
-1
is positive, if d > 0, then P > 0. Because industries on an economy
depend on each other, the change of final demand of one commodity will cause a change in
output. For example, if there is a positive change of final demand of commodity i, while all other
final demand of commodities remains same, cause increase of production. Therefore, all
industries have to increase their production and increase in factor used can be obtained.













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References
1) The Leontief Input-Output Model. Web. Retrieved from
http://www.personal.psu.edu/kes32/MichiganClasses/math217/Worksheets2/leontief.pdf
2) Kallem, Nicholas. Input-Output Analysis with Leontief Models. Web. Retrieved from
http://home2.fvcc.edu/~dhicketh/LinearAlgebra/studentprojects/spring2006/nicholaskalle
m/Leontief%20project.htm
3) Chiang, Alpha. Leontief Input-Output Models. Web. Retrieved from
http://www.docstoc.com/docs/129503308/From-Chapter-5-Alpha-Chiang-Fundamental-
Methods-of-Mathematical
4) Duchin, Faye. Rensselaer Polytechnic Institute. Department of Economics. Web.
Retrieved from http://www.economics.rpi.edu/workingpapers/rpi0610.pdf