The economist Michal Kalecki once joked that economics is the science of confusing stocks and flows. These two concepts are important, but easy to mix up.
A flow is a process that occurs through time. To measure it, we need start and end points.
Spending and income are key economic flows. We measure them as amounts that occur over a period of time, such as a year.
Other examples of economic flows include saving and depreciation. Saving, as we saw in the previous post, is the amount of disposable income not consumed. Depreciation is the reduction in value of an asset over time due to wear and tear as the asset is used. For instance, a machine that costs a business $10,000 to purchase might last five years, suggesting depreciation of $2,000 per year.
A stock is something that is measured at a particular point in time. For example, the number of hats you currently own is a stock.
A notable economic stock is the amount of wealth currently possessed by the community. Another key stock is the amount of fixed capital equipment that has been accumulated and is currently available for use in production. Still another important stock is the number of people currently in the labor force.
A fundamental point is that flows add to (or subtract from) stocks. It is said that “flows accumulate into stocks”.
For example, saving is a flow that adds to the stock of financial wealth.
By way of illustration, suppose a household’s financial wealth (net of financial liabilities) at the start of the year is $50,000 and its income from all sources amounts to $100,000 for the year. If the household saves $10,000 of this income, its net financial wealth will have grown to $60,000 by the end of the year:
Initial Stock of Net Financial Wealth ($50,000) + Flow of Saving ($10,000) = Final Stock of Net Financial Wealth ($60,000)
Similarly, depreciation is a flow that subtracts from the stock of fixed capital equipment.
Let’s say the business mentioned above purchases twenty machines for $10,000 each and that the life span of the machines is five years. The initial stock of equipment will be valued at $200,000 (= 20 x $10,000). Each machine depreciates by $2,000 per year. Since there are 20 machines, this gives total depreciation for the year of $40,000:
Initial Stock of Equipment ($200,000) – Flow of Depreciation ($40,000) = Final Stock of Equipment ($160,000)