SUPPLY CONSTRAINTS

IN IO AND SUT MODELS

ANALYSIS

IFPRI On-Line
2018
 The Consequences of Supply
Constraints
 Have examined standard IO and SUT multiplier models
 They assume:
 Final demand is exogenously determined
 Prices are fixed
 Output is demand driven
 Fixed proportions production technology
 Supply can expand to satisfy any demand increase
 What if a sector is capacity constrained & cannot expand output?
 Other sectors using its output as inputs may not be able to expand
 But what happens to the multiplier  0?
Examples of Supply Constraints
 Wine exports & the local supply of grapes by agriculture
 After 1994 global demand for South Africa wine increased
 No increase in output of agriculture
 Export of premium wine  local shortage of cheap wine  imports
 New power station & the supply of coal
 No increase in output of coal
 Export of coal diverted to new power station
 Supply constrained multipliers not zero
 … because inputs can be sourced from other uses

 But likely to be lower

Setting up a Supply-constrained IO
Multiplier Model (SUT to follow later)
 Standard IO Model: demand driven model
 All Final demand is exogenously determined
 Remember how we assumed fixed final demand
 All Outputs are endogenously determined
 Remember how we solved for output

 Supply Constrained IO model:

 Make output of the constrained sector exogenous
 Make final demand for the constrained sector endogenous

 How can this be done???

Linear Algebra of the Basic Multiplier Model
Exogenous

x  I  A
1
f
For three industries this can be written as:

bar
X1 F1
bar
X2 = (I-A)-1 • F2
bar
X3 F3
Find equivalent to the Leontief
Instead, challenge is to find a new matrix such that output in industry 1 is fixed
that satisfies the new relation
bar
X1 F1
bar
F2 = ?? • X2
bar
X3 F3
Algebra for sector 2 to be constrained
Set up basic (unconstrained) solution
x  A xf xA x  f x I  A  f
(1  a11 ) X 1  a12 X 2  a13 X 3  F1
 a21 X 1  (1  a22 ) X 2  a23 X 3  F2
 a31
31 X 1  a32 X 2  (1  a13 ) X 3  F3

Swap…for the 2nd sector to be output constrained

Rewrite: exogenous to rhs & endogenous to lhs
(1  a11 ) X 1  0  a13 X 3  F1  a12 X 2
a21 X 1  F2  a23 X 3  (1  a22 ) X 2
a31 X 1  0  (1  a13 ) X 3  F3  a32 X 2
 Solution for constrained model
Now, rewrite in Matrix Algebra
 (1  a11 ) 0 a13   X 1   1 a12 0   F1 
     
  a21 1  a23 F
 2    0  (1  a22 ) 0  X2 
 a 0 (1  a33 )   X 3   0 1   F3 
 31 a32
M mendo  N mexo
Solution
mendo  M 1 N mexo
1
 X 1   (1  a11 ) 0 a13  1 a12 0   F1 
      
F
 2    a21 1  a23   0  (1  a22 ) 0  X2 
 X   a 0 (1  a33 )  0 1   F3 
 3  31  a32
 Comparison with unconstrained
1
Comparing constrained solution mendo  M N mexo
1
 X 1   (1  a11 ) 0 a13  1 a12 0   F1 
      
F
 2    a21 1  a23   0  (1  a22 ) 0  X2 
 X   a 0 (1  a33 )  0 1   F3 
 3  31  a32

…..with base / unconstraint solution (multiplied by I)

1
 X 1   (1  a11 ) a12 a13   1 0 0   F1 
      
X
 2    a21 (1  a22 )  a23   0 1 0   F2 
 X   a    0 0 1 F 
 3  31 a32 (1 a33 
)   3 
We swap:
1. columns in Leontief (A) and I and changes their signs
2. entries in x and f
 Now for small changes
Apply to small D in mixed exogenous variables

1
m endo  M N m exo
1
 X 1   (1  a11 ) 0 a13  1 a12 0   F1 
      
F
 2    a21 1  a23   0 (1  a22 ) 0   0 
 X   a   0  0 
 3  31 0 (1 a33 
)  a 32 1  

1
 X 1   (1  a11 ) 0 a13  1 a12 0  0 
      
F
 2    a21 1  a23   0  (1  a 22 ) 0 X
 2 
 X   a   0  0 
 3  31 0 (1 a33 
)  a 32 1  
SUPPLY CONSTRAINTS: SUT
MODEL
 The Basic Set-up
 In SUT can now choose to constrain
 activities
and/or
 commodities
 Activity constraints = capacity bottlenecks
 Commodity constraints = production and import constraints
 Initially assume only activities can be supply constrained
 …since commodities can be imported
 Next Step: Supply Constrained in SUT

mendo   M N  m exo compare with x   I  B  f

1 1

In which
• 𝐌−1 ∙ 𝐍 replaces 𝐈 − 𝐁 −1
• 𝐦𝐞𝐱𝐨 vector of exogenous variables
• With at least one element of activity output
• Allows for exogenous change in supply (activity output)
• 𝐦𝐞𝐧𝐝𝐨 vector of endogenous variables
• With at least one element of activity final demand
• Contradiction: as activities do not have final demand
• Convert to ΔFD of commodities with supply coefficients
Exercises using same SUT as multiplier model
SUT Supply Constrained Multiplier Exercise 6 Comm.xls sheets:
1. Methodology
2. Supply Constr Multiplier Model
 I, B, M and N are given
 Check toggle, conditional format & if-statement to set-up M and N
 Calculate constrained inverse with constrained act: AUTL
 Run scenario: 10% increase in exports of CHMF commodities
 Also calc unconstrained (basic Leontief) inverse (I-B) for comparison

SUT Supply Constrained Multiplier Exercise 21 Comm.xlsx:

 Similar structure as 6 comm sheet
 Calculate constrained inverse with constrained act: AELW
 Run scenario: 10% increase in exports of CIAS commodities
 Bonus in 6 comm solution (only):
Hypothetical Extraction of Activity
Related question is sometimes raise:
 What is the impact of an activity closing down
 Iron & Steel Industry in SA
1
 Full shut down  1  a11  0 a13 
 
 Check M&B L HX  0 1 0 
 Second activity  a 0 1  a33  
 31

 Can compare multipliers (column totals) as % of base multipliers

 Which activities are impacted most
 Shut down to a degree, say 80%
1
 1  a11  1  0.8 * a12 a13 
 
LHX   1  0.8  * a21 1  1  0.8 * a22  1  0.8  * a23 
 
 a31 1  0.8  32
* a  33  
1  a
END