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Lecture 2b - Introduction to econometric & input-output models. RALE – Lecture 2b Last session Multipliers & output models This session: Econometric & I-O models Aims To examine regional econometric models Introduce the concept of the I-O approach.

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## Lecture 2b - Introduction to econometric & input-output models

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**Lecture 2b - Introduction to econometric & input-output**models Regional and Local Economics (RALE) Lecture slides – Lecture 2b**RALE – Lecture 2b**Last session Multipliers & output models This session: Econometric & I-O models Aims • To examine regional econometric models • Introduce the concept of the I-O approach. • Review selection of studies, look at the limitations & review extensions Objectives • Be familiar with regional econometric models. • Awareness of the I-O methodology. • Ability to access a range of studies & be conversant with the limitations • To have an awareness of improvements that have been made. Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Econometric models**Multiplier models estimate changes in TOTAL regional income and employment they do not detail the effects of alternative policies - so there is a need to use something else Requirements of econometric models • Detailed enough to provide info on a wide range of data. • Need to be able to model for different spatial areas. • Models need to be “internally consistent” What are they? “An interdependent set of equations. Each equation determines the numerical value of one regional variable. Right hand side consists of both endogenous and exogenous variables e.g. tax, birth and death rates etc.” Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Competitiveness of region’s exports**Region’s productivity Net Migration Population of working age World demand for goods and services Participation rate Supply of labour Regional unemployment Regional wage level Output of export sector Regional employment Wages & salaries Transfer payments Non-export sector Regional income Taxes Regional econometric model (Conceptual) Adapted from Armstrong and Taylor (2000) pp 32 Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Evaluation of Rival Regional Econometric Models**• Hunt (et al) found little or no consistency across the results • Differences only explained by detailed analysis of the model’s underlying structures, the data sets used, derivation of regional data and treatment of regional and sector productivity. • They suggest modellers may be attempting to model the impossible - lack of differentiated data on MPC. Follow up study of stand alone models Liverpool-Cardiff and Cambridge Econometrics Local Economy Forecasting Model • L-C model subjected to academic scrutiny the LEFM has not. • The LEFM is much more disaggregated than the L-C model • The L-C model is supply-side driven the LEFM is demand driven. • The L-C is based on a system of inter-linked equations whereas the LEFM has an input-output approach as its’ underlying philosophy. Regional and Local Economics (RALE) Lecture slides – Lecture 2b**output**The Input- Output concept Imports labour • Basis of approach is that production of an OUTPUT requires INPUTS . • The input- output linkages are recorded in a “transactions” or “flows” matrix which records all payments TO and FROM a sector within a year. • Works on basis of double-entry book keeping, so that Gross Outputs must equate to Gross Inputs. Semi finished products Raw materials Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Rows show sale of outputs**Columns show purchase of inputs Output 100 Input 100 Transaction Tables • Main UK Input-Output table uses a 123 sector model but a simpler version can be used. Simpler versions used to demonstrate the concept e.g. 3 sectors. • Cells in columns = purchases that a sector makes (inputs) • Cells in Rows = Sales of Products from sector (outputs) Regional and Local Economics (RALE) Lecture slides – Lecture 2b**The Transaction Table**GDP = C+G+I+(X-M) = 125+(30-30)+15+(80-60) = 160 Adapted from Armstrong and Taylor (2000) pp 39 Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Two Ways to construct the Transactions Matrix**• The DOMESTIC flow & The TOTAL flows approaches -10 -40 -5 KEY ASSUMPTIONS: • Production Technology is in fixed proportions therefore if demand doubles inputs will have to double. • There are no constraints on productive capacity thus the supply of factor inputs is perfectly elastic Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Technical Coefficients**• The Technical Coefficients allow us to estimate the effect of a change in final demand. • TC = the flow of output from industry i to industry j divided by the gross output of industry j. • The matrix of technical coefficients allows us to see the effect of an increase in final demand throughout the whole system. • If Agricultural demand increases by £10 then it will require additional input of: Agriculture 0.2*£10 = £2 Manufacturing 0.2*£10 = £2 Services 0.0*£10 = £0 Households 0.4*£10 = £4 Government 0.1*£10 = £1 Imports 0.1*£10 = £1 Regional and Local Economics (RALE) Lecture slides – Lecture 2b**The Process**Agriculture 13.26 Manufacturing 3.02 Services 0.67 Total 16.95 Multiplier 1.69 Adapted from Armstrong and Taylor (1993) pp 38 Regional and Local Economics (RALE) Lecture slides – Lecture 2b**The inverse Matrix**- = Identity matrix A matrix 1- A matrix Invert the Matrix Matrix of multipliers 1- A-1 matrix Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Summarising changes in demand**• To summarise the effect of a change in demand, multipliers are used - there are 2 types TYPE 1 & TYPE 2 • TYPE 1 multipliers treat the household sector as exogenous • The key to calculating multipliers is the matrix of multipliers (I-A)-1 and the row of household coefficients Regional and Local Economics (RALE) Lecture slides – Lecture 2b**TYPE 2 multipliers treat the household sector as endogenous**• Commentators suggest that the Type 2 multipliers overestimate the scale of additional spending because it assumes all additional income is spent Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Applications of input-output analysis**• Often used to study island economies ( they are relatively self-contained) see Lewis & McNicholl for study of the Shetlands. • Harris, Urban Studies Vol. 34 No.4 pp 605-626 looks at the University of Portsmouth, contains a discussion about the merits of using the partial survey method and type 1 & 2 multipliers. • Hill looks at the effect of overseas students on the Welsh economy. • Bishop et al. look at the impact of the naval base at Plymouth and its impact on the economy of Devon and Cornwall. • Clark & Grainger, et al Portsmouth Naval Base4 Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Strengths**• Shows the supply chain linkages • Captures the full system effects • The methodology is transparent • Produces more detailed sectoral results • Applicable to scenario (what if) analysis Weaknesses • Availability and reliability of data • Production techniques are assumed fixed • Import propensities may chane • Changes in industry linkages • Assumption of constant returns • Assumption of no supply constraints Regional and Local Economics (RALE) Lecture slides – Lecture 2b**New directions**• To get over the problem of fixed technology and excess supply the I - O model is expanded to include a supply-side and is linked to an econometric model • This allows for price & quality adjustments to be incorporated • Time dimension allows adjustment of output/labour ratio and changes in consumption patterns Advantages • The sectoral diversity of I-O is maintained and the dynamic, price responsiveness and forecasting abilities of the EC model are captured. • See Integrated Econometric and I-O models – Issues and Opportunities by Rey (2000) (Papers in Regional Science Vol. 79 pp271 – 292) Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Integration of Input – Output and regional econometric**models Regional and Local Economics (RALE) Lecture slides – Lecture 2b**Summary econometric and Input - Output modelling**• More complex relationships can be modelled by using econometric models – problem which model to use. • More robust than economic base or Keynesian multipliers • Transparent Interaction between a region's industries • More precise tool for forecasting exogenous shocks. • Used in a wide range of studies and seen as reliable • Problems restrictive assumptions and data availability • Integration with econometric models improves performance in the short-run and creates a “dynamic” model • Next week: Regional growth disparities - the Neoclassical and Keynesian perspectives Regional and Local Economics (RALE) Lecture slides – Lecture 2b

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