Stock and Flow (Application/Use, Importance and Effect to Economy)

STOCKS AND FLOWS IN MICROECONOMICS

In economics and business, the concept of stocks and flows is crucial to understanding the
development of economic variables. It is most commonly used in macroeconomics, labor
economics, and accounting. More generally, the concept of stocks and flows is central in system
dynamics theory, which describes the development of complex systems.

Most economic variables are either stocks or flows. Stock variables describe the state of the
economy at a given point in time, whereas flow variables describe the changes in the economy
over a period of time. If one looks at an extremely small period of time, flows will be close to
zero, whereas stocks could have any value. Stocks are accumulated or depleted over time by
flows, whereas flows represent the rate of movement of items in and out of stocks. Frequently,
stocks are characterized by nouns and flows, which represent processes, by verbs.

Flows can be divided into inflows—flows that add to stocks—and outflows—flows that deplete
the stocks. The difference between inflows and outflows is called net inflows. The figure
illustrates the relationship between stocks and flows. If the inflow is greater than the outflow or
net inflow is positive, the stock will be rising; if the inflow is less than the outflow, net inflow is
negative, and the stock will be falling.

The simplest illustration of stocks and flows is a bathtub. The level of water in the bathtub is a
stock, the water coming from the faucet is an inflow, and the draining of the water through the
drain is an outflow. If we plug the drain and turn on the faucet, the net inflow will be positive,
and the stock of water in the bathtub will be rising. If, instead, we close the faucet and open the
drain, the net inflow of water will be negative, and the stock of water in the bathtub will fall.

STOCKS AND FLOWS IN MACROECONOMICS

Economic development cannot be well described or understood without knowledge of which
variables represent stock and which variables represent flows. Most macroeconomic variables
reported by statistical agencies are flow variables. Gross Domestic Product (GDP) represents the
value of final goods produced by the economy during a given year. GDP is a flow that is
measured in dollars, euros, or other currency units per year. GDP is an inflow to the stock of
inventory in the economy. The stock of inventory is not large as most of GDP is either consumed
by individuals or by the government, invested in production by firms, or exported. Consumption,
government spending, and exports are outflows. The remaining GDP is accumulated as
additional inventory.

An important stock that plays a big role in macroeconomics is a stock of government debt. It is
accumulated by the flows of government budget deficits (the difference between budget
spending and budget revenues); it is depleted by the repayment of the debt, through budget
surplus (negative budget deficit). If the government runs a budget deficit for many years in a
row, it will accumulate a large stock of government debt. Because the interest needs to be paid
on the stock of debt and the interest payments are part of budget spending, it becomes harder to
stop accumulating the debt when the stock is already large. This provides an example of how the
stocks themselves can affect the flows: the larger the stock of debt, the larger the interest
spending that is a flow contributing to the stock of debt.

Another important example of stocks and flows in macroeconomics is unemployment. At any

given point in time a number of people in the economy are unemployed. The total number of
unemployed is a stock. In each period a number of people lose their jobs and join the ranks of
unemployed, representing an inflow to unemployment, and a number of unemployed people find
jobs and leave unemployment, representing an outflow from the unemployment. If the rate at
which workers lose their jobs (job separation rate) is higher than the rate at which unemployed
find jobs (job finding rate), unemployment will increase because the net inflow to unemployment
will be positive. Thus policies designed to lower the unemployment rate must take into account
the effects of certain measures on both job finding rate and job separation rate. For example, if a
policy makes it harder for firms to fire workers, it would lower the job separation rate. However,
such a policy would also make firms more reluctant to hire new workers, lowering the job
finding rate. The overall effect of such a policy on unemployment is uncertain.

STOCKS AND FLOWS IN MICROECONOMICS

Each individual’s wealth is a stock. It is accumulated by the inflow of income and depleted by
the outflow of spending. The best way to picture this is by thinking about a bank account. The
balances in the bank account represent the stock of cash available to the individual; the direct
deposit of the salary is an inflow to the account, and check and cash withdrawals are the outflow.
If the net inflow is positive, the balances in the bank account will rise. Of course, individuals can
hold other assets in addition to bank accounts. Frequently, the largest portion of an individual’s
wealth is the value of his or her house. Economists believe that the stock of wealth affects the
flow of consumer spending—the higher the wealth, the larger portion of income the consumers
are willing to spend, which lowers the net inflow of income. This is a mechanism through which
economists at the beginning of the 2000s linked the U.S. housing boom to the nation’s low
savings rate.

Firms also have a stock of wealth, usually referred to as the firm’s net worth, or capital stock,
which is the difference between a firm’s assets and liabilities. If a firm is publicly traded,
individuals and financial institutions can buy shares of that firm’s stock, which would give the
buyer an ownership share of the stock of the firm’s wealth. Firms accumulate their capital
through the inflow of investment. The stock of capital depletes through the outflow of
depreciation and capital that is used up in production.

Explanation of Concept
To simply understand the concept of stock and flow we will take some real-life examples:

Suppose there is a water tank, so the level of water in the water tank represents stock, whereas
the water flowing in from the tap to the tank is inflow and the water draining out through the
pipe, is an outflow.

stock-vs-flow-example1
 Let’s say you deposit $1000 dollars every month to your bank account and withdraw $200
dollars from your bank account. So the money added to and withdrawn from the account is nothing but
the inflow and outflow of funds. But the amount available in your bank account will be the stock of
funds.

A stock (or "level variable") in this broader sense is some entity that is accumulated over time by
inflows and/or depleted by outflows. Stocks can only be changed via flows. Mathematically a stock can
be seen as an accumulation or integration of flows over time – with outflows subtracting from the stock.
Stocks typically have a certain value at each moment of time – e.g. the number of population at a certain
moment, or the quantity of water in a reservoir.
 Conclusion

So, it is quite clear from the above explanation that stock is a snapshot of the accumulated
reserve of the commodity, at a particular point. On the other hand, flow is basically the operations
which cause the stock to rise or fall.

Let’s take a common example of a company’s financial statement. If we want to know the stock
we always go for the Balance Sheet, but if we want to know the flow, then we check the income
statement.

Key Differences Between Stock and Flow

The points given below state the difference between stock and flow:

In simple words, the stock is nothing but the quantity of any commodity or asset available,
accumulated or held, at a particular point in time. On the contrary, flow is the difference or changes in
the commodity or asset, during a particular period, i.e. between two given consecutive dates.

Stock is a static concept, which means that whenever we measure stock, it gives a picture of the
goods available or left at that particular moment. But, flow is a dynamic concept because it takes into
account such variables which show a constant activity, progress or change.

Stock determines the level of stock on a specific point in time, which is accumulated or depleted
due over time due to flows. As against, flows indicates the rate of inward and outward movement of the
goods, from the stock.

While stock reflects the state, i.e. position of the economy at a specific time, flow indicates the
changes in the economy, over an interval of time.

Stock is concerned with the quantity of economic variable, gauged at a particular point in time.
For instance: Bank Deposit as on 31st December 2020 is ₹ 10,00,000. Contrastingly, Flow is associated
with the quantity of economic variable measured during a particular period of time, For instance:
Interest paid by the bank on Savings Account on a quarterly basis for the year 2020.

While the stock is measured in units, flow is measured in units per time, i.e. it is measured per
hour, per day, per week, per month and so on.

Stock is not time dimensional. Meaning that we measure the stock, without referring to the
duration of time, but when we talk about flow, it is time dimensional, as we always measure the flow of
variable in relation to the duration of time.

Stock and flow are mutually interdependent, in the sense that stock is accumulated over a
period of time, by inflows and it is reduced by outflows. So, the stock is influenced by flows. As against,
the flow tends to influence stock in the sense that it will increase the stock of any item, it flows into or
decreases the same, it flows out of.