FAQ

Frequently Asked Questions

FAQ

1.  What are some of the definitions used in impact models?

Direct Impact

All 'first round' economic activities which contribute to GDP, employment, household income.  These can vary from investment in a new or expanded facility to wages paid to employees directly involved in production of the operation for which an impact statement is required.

Gross Domestic Product (GDP)

The measure of economic activity in an economy, in this case the Nova Scotia economy.  GDP measured on an expenditure basis is expressed as:

GDP = C + G + I + X - M

where:

C       = Personal consumption (expenditure) of goods and services.

G       = Government expenditures on goods and services.

I        = Investment in capital, machinery equipment and inventories.

X       = Exports of goods and services.

M      = Imports of goods and services.

GDP is also measured on an income basis and consists of :

-         labour income

-         corporate profits before taxes

-         interest and investment income

-         net farm income

-         unincorporated business income

-         inventory valuation adjustment

-         indirect taxes less subsidies

-         capital consumption allowance

Gross domestic product of an industry is the value added by labour and capital in transforming inputs purchased from other producers into outputs.

Indirect Impact

All 'subsequent rounds' of economic activities which contribute to GDP, employment, household income.  These activities are not directly associated with the production activity but are a result of direct production activities.  These indirect contributions also include 'induced contributions' which measure the economic activity associated with the respending of wages paid in the direct, indirect, and to a lesser extent earlier rounds of induced activity.

Input-Output (I-O)

The input-output model measures the wide economic impact of a direct economic event by the known inter-industry dependency in the given economy.  Different sectors of an economy depend on other sectors of the economy to supply its inputs or purchase its output to varying degrees.  The imbalance in this supply/demand relationship is made up by imports (supply) and exports (demand).

The input-output model measures total economic activity defined as direct + indirect + induced activities.   For an explanation on direct, indirect and induced activity see preceding GDP definition.

Input-Output Multipliers

Relate the indirect and induced impact by industry to the direct increase or reduction of the output of a given industry.  The sum of all industries indirect and induced impacts plus the direct industry impact equals the total impact. 

Multipliers are produced for output, income, GDP, and employment


2.  What are the limitations of an impact model?
 

Model Limitations 

An input-output model, like any model, is an approximation to reality.  It is built on assumptions that are never fully realized in the real world.  While most analysts are well aware of the limitations of any I-O model it may be helpful to the general reader to review these limitations.

Input-Output Lacks an explicit time dimension

An input-output system provides a snapshot of an economy for a period of time (usually a one-year period).  If the economy is in disequilibrium, all future uses of the tables and the related impact models will reflect the structural implications of the atypical year.

Multiplier effects do occur over time.  However, the impact models associated with input-output systems imply that the multiplier effects are virtually instantaneous.  There is some evidence to show that the multiplier effects take from two or three years to move through an economy.

Sensitivity to relative price changes

Relative prices between commodities will change from the base year of model construction to the period in which the model is used.  Therefore, the analysis of projects via input-output analysis in the future will reflect one set of relative prices, while the direct requirements coefficients in the tables reflect the relative prices of the base year.  If the relative price changes are not accounted for, future data supplied to the impact model will produce “incorrect” impact results.

For example, say, in 1984 an industry required $100 of lumber for every $1,000 of output (i.e. 10 percent of inputs).  If an analysis of the same industry were conducted in 2011, prices for the same volume of lumber may have increased to $150 while inflation on all other inputs was only 10 percent.  Therefore, the total output value (for the same amount of production) is now $1,140, of which lumber is 13.2 percent of inputs.  The relative price change in lumber has caused an increase in the size of its technical coefficient.  Using unadjusted data in the 2011 model would produce incorrect impact results to the extent that relative prices change.

Constant technology

As mentioned earlier, the input-output system is a static model.  However, times change and so do the technologies used.  To mitigate this limitation, most input-output systems are updated on a periodic basis.  The PEI Input-Output system has been updated over the years.  Such an update picks up any technology changes in the economy.  Between updates no changes in technology are assumed.

Constant returns to scale

Input-output systems assume constant returns to scale; that is, all inputs change in the same proportion as any change in an industry’s output.  This assumption implies that even for one dollar increase in sales, the model will show impacts on wages, salaries and employment associated with the multiplier effects.  However, common sense tells us that this is not true.  Such a small increase would not necessarily cause, especially in the short run, generation of a commensurate increase in wages or employment. However, in the long run, it can be assumed that even a small increase in final demand will produce the multiplier effects estimated by an input-output system.

In the short run, industries can draw on inventories, use their labor more efficiently, etc. to increase output with limited impact effects.  However, if the new level of final demand is maintained, then firms in the long run will move back to their historical steady-state level of the utilization of factors of production.  In the long run, increases in, say, household income due to increases in final demand will reflect the technical coefficients’ relationship between income and output modeled in the input-output system.

No supply constraints

Input-output systems assume that whatever is demanded by industries as inputs can be supplied.  They assume no productive capability constraints.  This problem is not   significant when there is excess capacity in an economy.  However, when economies are operating at or near capacity, this limitation is important.  The multipliers for an economy near capacity will be underestimated.  This is because increased final demand will require new capital investment whose own direct and multiplier effects are not captured within the standard input-output system.

Fixed consumption patterns

The consumption patterns that result in household re-spending multipliers are assumed to be fixed and linear.  As Canadians become “better off” they redirect real growth in income to savings and luxury consumption.  Because the input-output system is static, it does not model the effect of non-linear patterns in household consumption (as real incomes increase) within its multiplier estimates.  This problem is partially overcome by regularly updating input-output systems.

Conclusion

Although the list of limitations may appear long, a similar or longer list is associated with almost any form of economic analysis.  The limitations occur in different areas in other analytical tools.  No one economic model is expected to provide the comprehensive “answer”.  Economic analysis techniques should be used in a complementary fashion to appreciate the full scope of a problem.  In a very real sense, then, quantitative economic models should be used to examine the structural implications of changes in an economy and should not be treated as providing “the” answer.