Unveiling Cost Burden Interdependencies with the Use of the Hypothetical Extraction Method

Abstract

Networked economies constitute an interlocked mechanism of direct effects and indirect feedbacks. Each piece of the mechanism plays a specific role influencing the overall performance of the system. In the setup of an interindustry economy, the interlocked pieces are typical economic sectors. Any sector influences other sectors and is in turn being influenced by them. We propose a new methodology to unveil the underlying cost linkage effects being exerted by sectors and affecting the complete price system. The methodology reformulates the Hypothetical Extraction Method, usually applied to the quantity side of the economy, and extends it to the cost side of the economy. The derived cost linkage indicators reveal valuable information that may be used in the design of tax reforms or efficiency policies. We present a practical example of the capacities of this new proposal using US data.