Input–Output Analysis,Labour Scarcity and Relative Price Endogeneity: Aggregate Demand Disturbances in a ‘Flex-price’ Leontief System

In this paper, we introduce scarcity into a conventional demand-driven input–output system to produce a ‘flex-price’ Leontief model. We retain the fixed technical coefficients but allow changes in relative prices to reflect variations in the real wage. Because the consumption coefficients increase with the real wage, the aggregate labour demand curve is found to be upward sloping. This produces conventional results, as long as the labour supply curve is perfectly elastic (horizontal). However, once we introduce labour scarcity, in the form of an upward sloping labour supply function, we derive the seemingly paradoxical result that the output and employment effects of a demand expansion are greater here than in conventional input–output. Through simulation, this result is found to be strongly dependent on the assumption of export exogeneity.