ON THE PLAUSIBILITY OF THE SUPPLY—DRIVEN INPUT‐OUTPUT MODEL: A THEORETICAL BASIS FOR INPUT‐COEFFICIENT CHANGE*

Abstract

ABSTRACT. Oosterhaven (1988) labels the supply‐driven input‐output model “theoretically implausible” and criticizes the straightforward use of the model for impact studies. This comment extends and corrects some of the issues addressed by Oosterhaven. We derive the characteristics which industry production relations must possess to be consistent with the implied changes in industry inputs and outputs when supply‐side input‐output models are employed for impact analysis. First, it is shown that an implicit assumption is the characteristic of perfect substitutability among all inputs in each industry production function. This is the polar opposite of the Leontief assumption of zero elasticity of factor substitution among all inputs, and is very unrealistic for large changes from the initially observed solution since it implies that all inputs are non‐essential in the production process and that any input can be substituted for all others simultaneously. Second, it is shown that the model may still be reasonable for approximating the effect of small changes since the implied production relation may be interpreted as a cost minimizing choice for a standard constant‐returns‐to‐scale production function linearized around the initial solution under the assumption that relative prices are unchanged. Under this alternative interpretation, the supply‐side model may be expected to provide a reasonable approximation, useful for analyzing changes in the neighborhood of the initial solution, but would appear to be inappropriate for analyzing large changes.

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