Introduction

In this section we look at an application of matrix algebra.

This application was developed by Wassily Leontief and he

won the Nobel Prize in Economics for this work.

The application involves analyzing national and regional

economies by looking at how various parts of the economy
interrelate.

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Sectors of the Economy

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Sectors of the Economy
First, we can think of the economy of a country or a region
as being composed of various sectors, or groups of one or
more industries.

Typical sectors are the manufacturing sector, the utilities

sector, and the agricultural sector.

To introduce the basic concepts, we shall consider two

specific sectors: the coal-mining sector (Sector 1) and the
electric utilities sector (Sector 2).

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Sectors of the Economy
Each produces a commodity: The coal-mining sector
produces coal, and the electric utilities sector produces
electricity.

We measure these products by their dollar value. By one

unit of a product, we mean $1 worth of that product.

Here is the scenario:

1. To produce one unit ($1 worth) of coal, assume that the
coal-mining sector uses 50¢ worth of coal (to power
mining machinery, say) and 10¢ worth of electricity.

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Sectors of the Economy
2. To produce one unit ($1 worth) of electricity, assume
that the electric utilities sector uses 25¢ worth of coal
and 25¢ worth of electricity.

These are internal usage figures. In addition to this,

assume that there is an external demand (from the rest of
the economy) of 7,000 units ($7,000 worth) of coal and
14,000 units ($14,000 worth) of electricity over a specific
time period (1 year, say).

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Sectors of the Economy
Our basic question is: How much should each of the two
sectors supply to meet both internal and external demand?

The key to answering this question is to set up equations of

the form
Total supply = Total demand.

The unknowns, the values we are seeking, are

x1 = Total supply (in units) from Sector 1 (coal)
x2 = Total supply (in units) from Sector 2 (electricity).

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Sectors of the Economy
Our equations then take the following form:

Total supply from Sector 1 = Total demand for Sector 1 products

x1 = 0.50x1 + 0.25x2 + 7,000

Coal required by Coal required by External demand for

Sector 1 Sector 2 coal

Total supply from Sector 2 = Total demand for Sector 2 products

x2 = 0.10x1 + 0.25x2 + 14,000.

Electricity required by Electricity required by External demand for

Sector 1 Sector 2 electricity
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Sectors of the Economy
This is a system of two linear equations in two unknowns:

x1 = 0.50x1 + 0.25x2 + 7,000

x2 = 0.10x1 + 0.25x2 + 14,000.

We can rewrite this system of equations in matrix form as

follows:

Production Internal demand External demand

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Sectors of the Economy
In symbols,

X = AX + D.
Here,

is called the production vector. Its entries are the

amounts produced by the two sectors.

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Sectors of the Economy
The matrix

is called the external demand vector, and

Organization:

is called the technology matrix.

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Sectors of the Economy
The entries of the technology matrix have the following
meanings:
a11 = Units of Sector 1 needed to produce one unit of
Sector 1
a12 = Units of Sector 1 needed to produce one unit of
Sector 2
a21 = Units of Sector 2 needed to produce one unit of
Sector 1
a22 = Units of Sector 2 needed to produce one unit of
Sector 2.

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Sectors of the Economy
Now that we have the matrix equation
X = AX + D,
we can solve it as follows. First, subtract AX from both
sides:

X – AX = D.

Because X = IX, where I is the 2 × 2 identity matrix, we can

rewrite this as

IX – AX = D.

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Sectors of the Economy
Now factor out X:
(I – A)X = D.

If we multiply both sides by the inverse of (I – A), we get the

solution
X = (I – A)–1D.

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Sectors of the Economy
Input-Output Model
In an input-output model, an economy (or part of one) is
divided into n sectors.

We then record the n × n technology matrix A, whose ijth

entry is the number of units from Sector i used in producing
one unit from Sector j (in symbols, “i → j ”).

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Sectors of the Economy
To meet an external demand of D, the economy must
produce X, where X is the production vector.

These are related by the equations

X = AX + D
or
X = (I – A)–1D. Provided (I – A) is invertible

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Sectors of the Economy
Quick Example
In the previous scenario,

and

The solution is
X = (I – A)–1D

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Sectors of the Economy

Calculate I – A.

Calculate (I – A)–1.

In other words, to meet the demand, the economy must

produce $25,000 worth of coal and $22,000 worth of
electricity.

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Sectors of the Economy
The next example uses actual data from the U.S. economy.
(We have rounded the figures to make the computations
less complicated).

It is rare to find input-output data already packaged for you

as a technology matrix.

Instead, the data commonly found in statistical sources

come in the form of input-output tables, from which we will
have to construct the technology matrix.

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Example 1 – Petroleum and Natural Gas

Consider two sectors of the U.S. economy: crude

petroleum and natural gas (crude) and petroleum refining
and related industries (refining).

According to government figures, in 1998 the crude sector

used $27,000 million worth of its own products and $750
million worth of the products of the refining sector to
produce $87,000 million worth of goods (crude oil and
natural gas).

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Example 1 – Petroleum and Natural Gas cont’d

The refining sector in the same year used $59,000 million

worth of the products of the crude sector and $15,000
million worth of its own products to produce $140,000
million worth of goods (refined oil and the like).

What was the technology matrix for these two sectors?

What was left over from each of these sectors for use by
other parts of the economy or for export?

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Example 1 – Solution
First, for convenience, we record the given data in the form
of a table, called the input-output table. (All figures are in
millions of dollars.)

The entries in the top portion are arranged in the same way
as those of the technology matrix: The ijth entry represents
the number of units of Sector i that went to Sector j.
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Example 1 – Solution cont’d

Thus, for instance, the 59,000 million entry in the 1, 2

position represents the number of units of Sector 1, crude,
that were used by Sector 2, refining.

We now construct the technology matrix. The technology

matrix has entries aij = Units of Sector i used to produce
one unit of Sector j.

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Example 1 – Solution cont’d

Thus,

a11 = Units of crude to produce one unit of crude. We are

told that 27,000 million units of crude were used to
produce 87,000 million units of crude. Thus, to
produce one unit of crude, 27,000/87,000 ≈ 0.31
units of crude were used, so a11 ≈ 0.31. (We
have rounded this value to two significant digits;
further digits are not reliable because of rounding of
the original data.)

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Example 1 – Solution cont’d

a12 = Units of crude to produce one unit of refined:

a12 = 59,000/140,000
≈ 0.42

a21 = Units of refined to produce one unit of crude:

a21 = 750/87,000
≈ 0.0086

a22 = Units of refined to produce one unit of refined:

a22 = 15,000/140,000
≈ 0.11. 24
Example 1 – Solution cont’d

This gives the technology matrix

Technology Matrix

In short, we obtained the technology matrix from the

input-output table by dividing the Sector 1 column by the
Sector 1 total, and the Sector 2 column by the Sector 2
total.

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Example 1 – Solution cont’d

Now we also know the total output from each sector, so we

have already been given the production vector:

Production Vector

What we are asked for is the external demand vector D, the

amount available for the outside economy. To find D, we
use the equation

X = AX + D, Relationship of X, A, and D

where, this time, we are given A and X and must solve

for D.
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Example 1 – Solution cont’d

Solving for D gives

D = X – AX

We rounded to two
significant digits.

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Example 1 – Solution cont’d

The first number, $1,000 million, is the amount produced by

the crude sector that is available to be used by other parts
of the economy or to be exported. (In fact, because
something has to happen to all that crude petroleum and
natural gas, this is the amount actually used or exported,
where use can include stockpiling.)

The second number, $124,000 million, represents the

amount produced by the refining sector that is available to
be used by other parts of the economy or to be exported.

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Example 1 – Solution cont’d

Note that we could have calculated D more simply from the

input-output table. The internal use of units from the crude
sector was the sum of the outputs from that sector:

27,000 + 59,000 = 86,000.

Because 87,000 units were actually produced by the

sector, that left a surplus of 87,000 – 86,000 = 1,000 units
for export. We could compute the surplus from the refining
sector similarly. (The two calculations actually come out
slightly differently because we rounded the intermediate
results.)

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Sectors of the Economy
Input-Output Table
National economic data are often given in the form of an
input-output table.

The ijth entry in the top portion of the table is the number of
units that go from Sector i to Sector j. The “Total outputs”
are the total numbers of units produced by each sector.

We obtain the technology matrix from the input-output table

by dividing the Sector 1 column by the Sector 1 total, the
Sector 2 column by the Sector 2 total, and so on.

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Sectors of the Economy
Quick Example
Input-Output Table:

Technology Matrix:

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Sectors of the Economy
Interpreting (I – A)–1: Indirect Effects
If A is the technology matrix, then the ijth entry of (I – A)–1 is
the change in the number of units Sector i must produce to
meet a one-unit increase in external demand for Sector j
products.

To meet a rising external demand, the necessary change in

production for each sector is given by
Change in production = (I – A)–1D+ ,
where D+ is the change in external demand.

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Sectors of the Economy
Quick Example
Take Sector 1 to be skateboards, and Sector 2 to be wood,
and assume that

Then
a11 = 1.1 = Number of additional units of skateboards
that must be produced to meet a one-unit
increase in the demand for skateboards
(Why is this number larger than 1?)
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Sectors of the Economy
a12 = 0 = Number of additional units of skateboards
that must be produced to meet a one-unit
increase in the demand for wood (Why is
this number 0?)

a21 = 0.6 = Number of additional units of wood that

must be produced to meet a one-unit
increase in the demand for skateboards

a22 = 1.1 = Number of additional units of wood that

must be produced to meet a one-unit
increase in the demand for wood.

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Sectors of the Economy
To meet an increase in external demand of 100
skateboards and 400 units of wood, the necessary change
in production is

so 110 additional skateboards and 500 additional units of

wood will need to be produced.

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