Saturday, 6 July 2013

What Are the Stock and Flow Variables?

Flow variables refer to those economic variables that are measured over a period of time or per unit of time. The timeline in this regard can be per quarter or per year. Examples of flow variables include income, budget deficits, investment expenditure, sales revenue and gross profit. Stock variables, on the other hand, mean those economic variables that are measured at a point in time. Hence debt, wealth, employment, money supply and capital stock (such as factories, inventory and infrastructure) are good examples of the stock variable.

EXAMPLES 
                      A stock variable measures a variable at a specific point in time, for example the amount of foreign direct investment at the moment in a specific country. This variable is only denominated in terms of a currency. A flow variable on the other hand looks at the measure of a variable over a period of time, for example the GDP of a country as this variable looks not only at a fiscal amount but also also a time amount (in this case the amount of money spent in the economy over the course of a year).

Stock and Flow Variables Relationship: An Analogy

  • The stock and flow variables are inextricably related. This is because, in many applications, a flow variable is interpreted as the rate of change of a stock variable. A sink with water flowing in the faucet is a good analogy for understanding the relationship between the stock and flow variables. Stock variable is represented by the quantity of water in the sink at any moment -- an amount that can be measured in gallons without any time dimension. In contrast, flow variable is interpreted here as the rate at which the water gush enters the sink, which is measured as gallons per minute. Note that while flow variable is a time-dimensional variable, stock variable is not. Hence, because households receive their income per month or per year (that is, it is time-dimensional), income is regarded as a flow variable. Wealth is a stock variable since it is measured in monetary terms at a particular point in time.

Interpretation vs. Controversy

  • The classification of economic variables into stock and flow variables is done for the sake of convenience. In reality, it is difficult to establish a clear borderline between these two variables. This implies that, depending on the nature of an analysis, it is possible to interpret a stock variable as a flow variable and vice versa. For instance, national income can be interpreted as a stock variable for the year of reference even though it is a flow variable. In a similar vein, employment can be treated as a flow variable when it is viewed in terms of work effort per man hour. Also, money transforms from a stock variable to a flow variable when it is exchanged for goods and or services.


Application: Financial Statements

  • An understanding of the differences between stock and flow variables is useful when preparing, analyzing and interpreting financial statements. Organizations use their balance sheets to report their financial positions at a particular point in time. This means they can know their financial status for a certain date, say, June 2011, by examining their balance sheets. Organizations’ management can accurately categorize the items in their financial statements if they understands the differences between these two variables. For instance, the two major items in the balance sheets, namely liabilities and assets, are called stock variables. In contrast, the two main items in the organization’s income statement, namely revenues and expenses, are flow variables because they show the changes in the organizations’ financial position over a period of time, say, for the year ended June 2011.

Case Study: Mutual Dependence of Stock and Flow Variables

  • Stock and flow variables are mutually dependent. For instance, the quantities of savings people have are highly dependent on the frequency or the rate of flow of deposits into their savings accounts. Similarly, their stock of savings determines their flow of withdrawals, say, per month.

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