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Stock and Flow (From Wikipedia, the free encyclopedia)
Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those
that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents
a quantity existing at that point in time (say, December 31, 2004), which may have accumulated in the past. A flow
variable is measured over an interval of time. Therefore a flow would be measured per unit of time (say a year). Flow is
roughly analogous to rate or speed in this sense.
For example, U.S. nominal gross domestic product refers to a total number of dollars spent during a specific time
period, such as a year. Therefore it is a flow variable, and has units of dollars/year. In contrast, the U.S. nominal capital
stock is the total value, in dollars, of equipment, buildings, inventories, and other real assets in the U.S. economy, and has
units of dollars. The diagram provides an intuitive illustration of how the stock of capital currently available is increased
by the flow of new investment and depleted by the flow of depreciation.
Stocks and flows have different units and are thus not commensurable – they cannot be meaningfully compared,
equated, added, or subtracted. However, one may meaningfully take ratios of stocks and flows, or multiply or divide
them. This is a point of some confusion for some economics students, as some confuse taking ratios (valid) with
comparing (invalid).
The ratio of a stock over a flow has units of (units)/(units/time) = time. For example, the debt to GDP ratio has
units of years (as GDP is measured in, for example, dollars per year whereas debt is measured in dollars), which yields the
interpretation of the debt to GDP ratio as "number of years to pay off all debt, assuming all GDP devoted to debt
repayment".
The ratio of a flow to a stock has units 1/time. For example, the velocity of money is defined as nominal GDP /
nominal money supply; it has units of (dollars / year) / dollars = 1/year.
In discrete time, the change in a stock variable from one point in time to another point in time one time unit later is equal
to the corresponding flow variable per unit of time. For example, if a country's stock of physical capital on January 1,
2010 is 20 machines and on January 1, 2011 is 23 machines, then the flow of net investment during 2010 was 3 machines
per year. If it then has 27 machines on January 1, 2012, the flow of net investment during 2010 and 2011 averaged
machines per year.
A flow diagram of money through a closed 3-sector and 3-market economy (Source:
Macroeconomics 4th Ed., N. G. Mankiw, 2000)
(LSCS) Chapter 12: Aggregate Supply (AS) and Aggregate Demand (AD)
Chapter 18: Extending the Analysis of AS
(HCCS) Chapter 8: Aggregate Supply (AS) and Aggregate Demand (AD)
(HAND-OUTS)
There are generally three forms of the aggregate supply (AS) function.
a) The Immediate short-run aggregate supply (ISRAS) or Keynesian-range or Recessionary-range AS Curve
Within a very short timeframe, firms can only change the amount of labor used but not capital (such as building new
factories or installing more machines.) This form demonstrates what happens to the economy when unemployment is a
pressing issue and when business inventory increases due to lack of aggregate demand. Hence, an increase in production
will not cause inflation (i.e. ∆P = 0.)
b) The long-run aggregate supply (LRAS) or (YLR = long-run output) or (Qf = full-employment output)
or the Classical AS Curve
Over the long run (LR), only real variables (i.e. population, technology, human capital, resources and international
trade) can affect YLR. In the LR, everything in the economy is assumed to be used optimally; thus, the economy operates
along its production possibilities frontier (PPF.) The LRAS is shown as perfectly vertical as output is fixed.
c) The Short-run or Intermediate aggregate supply (SRAS or AS) Curve
As an interim between ISRAS and LRAS, the AS form slopes upward and reflects when capital as well as labor can
change. In the SR, wages do not adjust fully with a rise in P –due to insufficient time and information for full adjustments
by workers; therefore, outputs increase as prices increases. The SRAS curve is affected by capital, labor, technology, and
wage rate.
The aggregate demand (AD) curve is the total planned demand for final goods and services in the economy (Y.) It is
the amount of goods and services in the economy that will be purchased at all possible price levels at a given time and a
specific general price level where AD = C + I + G + (EX - IM) = C + I + G + Net Exports (NX)
in which
a) Consumers' expenditure on goods and services (C): includes demand for durables & non-durable goods.
b) Gross Domestic Fixed Capital Formation (I): includes investment spending by companies on capital goods (i.e.
machinery, buildings, etc.) Investment also includes spending on working capital such as stocks of finished goods (i.e.
inventory) and work in progress.
c) General Government Final Consumption (G): is defined as government spending on publicly provided goods
and services such as defense, education, research and developments (R&D), roads and highways, airports, hospitals, food
stamps, housing subsidies, aids to needy families or in-kind and in-cash transfers programs, etc.
d) Exports of goods and services (EX): are an inflow of demand into the circular flow of income in the economy
and add to the demand for US produced output. When export sales from the US are healthy, production in exporting
industries will increase, adding both to national output and also the incomes of those people who work in these industries.
e) Imports of goods and services (IM): are a withdrawal (leakage) from the circular flow of income and spending
in the economy. Goods and services come into the economy - but there is a flow of money out of the country.
The AD curve slopes downward because of the following effects
a) Real money balances: As the price level falls, the real value of money balances held increases. This increases
the real purchasing power of consumers which causes consumption to go up.
b) Interest rates: There will be pressure on the monetary authorities to cut nominal interest rates (i) as the price
level falls. Lower nominal interest rates should encourage an increase in consumer demand and planned investment.
c) International competitiveness: If the US price level is lower than other countries (for a given exchange rate),
US goods and services will become more competitive as foreign goods are relatively more expensive for domestic
consumers. Therefore, EX goes up and IM decreases and the US has a trade surplus (i.e. NX > 0.)
Sources: 1) “http://wikipedia.org/; entries: “aggregate supply” “aggregate demand”, 2010.
2) http://tutor2u.net/economics/content/topics/ad_as/ad-as_notes.htm, 2010.
Note: LRAS (Long-run AS); YLR (Long-run real output); QF (full-employment output in the Product Market)
(LSCS) Chs (11: The Aggregate Expenditures Model) – (10: Basic Macroeconomic Relationships)
(HCCS) Chs (9: Classical Macro and Self-Regulating Economy) – (10: Keynesian Macro and Econ Instability)
(19: Debates in Macroeconomics over the Role of Government)
Some key differences between the Classical and Keynesian Schools of macroeconomic Theories
Source: http://www.nvcc.edu/home/mheslop/classicals_keynesians.pdf
Classical Macroeconomics
1) Staunch believers in the efficacy of free markets to self-equilibrate in the allocation of resources and the achievement
of long run equilibrium between AD and AS
2) Given (1) above Classical economists firmly believed that the state and governments had no need to play a major role
in economic management since free markets left on their own tend to do a more efficient job in regulating the economic
cycles or business cycles i.e. Classicals believed in a small or minimalist role for the state or governments in economic
management
3) Given (1) and (2) above the Classicals espoused the view that policymakers or governments had no need to use or rely
on fiscal and monetary policies to influence the inherent fluctuations (i.e. ups and downs) in the business cycles
4) Given (1) above Classical economists believed that free and competitive markets through the interaction of the market
forces of supply and demand are flexible and as such adjust flexibly to prices and output without reliance on government
policies
5) Classical economists were staunch believers in the long run capacity of free market economies to achieve long run fullemployment output level (i.e. YLR or Qf or potential GDP)
6) Classical economists believed that the long run adjustment of AD and AS to full employment GDP, labor productivity
and growth were more important than their short-run adjustment
7) Classical economists focused more on the significance of the supply side of an economy i.e. they believed that AS was
more important than AD or the demand side of an economy i.e. they paid more attention to the supply side or the
production of wealth in an economy rather than the distribution of wealth
8) Classical economists focused on the supply side of an economy or AS because they believed in Jean Baptiste Say’s law
viz “Supply creates its own Demand” in an economy
Keynesian Macroeconomics
“For at least another hundred years we must pretend to ourselves and to every one that fair is foul and foul is fair;
for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still.”
John Maynard Keynes quotes (English economist, journalist, and financier, 1883-1946)
1) John Maynard Keynes (in the “General Theory” (1936)) and Keynesians believe that “free market” economies do not
self-equilibrate or clear themselves in the short run and as such they achieve less than full-employment or potential GDP
equilibrium –even when the economy is in its SR equilibrium!
2) Keynes and Keynesian economists given (1) above doubted the efficacy of “free markets” in achieving short-run
equilibrium GDP
3) Keynes and Keynesians staunchly advocated a more significant role for the state and governments to use fiscal and
monetary policies particularly the former to regulate i.e. to stimulate and de-stimulate the fluctuations in the business
cycles
4) Keynes and Keynesians believed that capitalist economies are inherently unstable and that free markets make them
even more so hence they advocate a more meaningful role for states and governments to play an activist role via fiscal
policies to stabilize business cycles
5) Keynes and Keynesians believed that prices in capitalist market economies “are sticky downwards” i.e. all prices
including interest rates and wage rates do not self-adjust by themselves based on the logic of changes in the market forces
of supply and demand in the short-run because of what Keynes called “institutional factors” in these markets i.e. the
presence of monopolies such as trade unions in labor markets and oligopolists in financial and product markets. The latter
“institutional factors” identified by Keynes distort market prices and delay their flexible determination in the way the
Classicals suggest at least in the short-run
An Example (for your HW #2)
Consider a closed economy where Y = C + I + G with the following information
C = 200 + 0.75 (Y – T); I = 50 + 0.01Y; G = 170; T = 180
(A) What is the equilibrium level of Y? What is the total of national saving? Show your work!
(B) If the new planned investment function is: I = 50 + 0.10Y, what is the new equilibrium value for Y*? Comparing to
Y* in (A), please explain why the two values of Y*‘s are different.
(C) If disposable income increases by $1,000, what is the change in national income? How so?
Solutions:
Another Example (for your HW #2)
Class:
Subject:
Macroeconomics (ECON 2301)
Take-home Assignment #2
****SAMPLES ****
Due Date: On the Date of Exam #2
Instructions: Please follow the instructions and show the steps to your answer. Written explanation is expected to be
free of grammatical and syntax errors (as much as possible) and NO plagiarism. Arithmetical steps should follow college
standards. Graphs, tables, flows and other visual representations should be of good quality and with clear details. It is also
important that you show the formula first before deriving any arithmetical results –if applicable.
Try your BEST in doing school work –AS ALWAYS! Late homework will not be accepted.
IMPORTANT: Write your answers on separate sheets of paper and turn them in with your name and section number on
the first page. DO NOT turn in the handout.
Problem #1 (10 Points) ****SAMPLES ****
In this problem, please draw your own short-run AD-AS diagrams with clear details –for each question. Make sure to
label the followings: the axes, the curves, the initial equilibrium values, the direction of the curve, shifts and the terminal
equilibrium values. You should use the “causeeffect” method in explaining changes in the economy illustrated in your
diagrams –in writings and with steps by steps.
Notes: The following “Product Market” model is for a closed 3-sector economy with no international trade.
WHERE
P1 = 184; P2 = 200; P3 = 210; P4 = 206; P5 = 208; P6 = 215; P7 = 220; P8 = 230
Y1 = 7.6; Y2 = 8; Y3 = 8.6; Y4 = 9.2; Y5 = 10; Y6 = 10.24; Y7 = 11; Y8 = 12.2 (in trillions of $)
(5 Points) (A) In the 1st quarter of Year 1, the economy was in equilibrium at Point E3. Three months later, it arrived to
Point E2. Please suggest an economic factor that caused the changes.
(5 Points) (B) In the 3rd quarter of Year 2, the economy was at Point E3. A few months later, it arrived to Point E4. Please
suggest an economic factor that caused the changes.
Problem #2 (10 Points) ****SAMPLES ****
In this problem, please draw your own long-run AD-AS along with the (missing) short-run AS curve (with clear details)
for each question. Make sure to label the followings: the axes, the curves, the initial equilibrium values, the direction of
the curve, shifts and the terminal equilibrium values. You should use the “causeeffect” method in explaining changes in
the economy illustrated in your diagrams –in writings and with steps by steps.
Notes: The following Price-Output (P-Y) model is for a closed 3-sector economy with no international trade.
WHERE
P1 = 84; P2 = 100; P3 = 110; P4 = 106; P5 = 108; P6 = 115;
LRAS1 = $13 trillions; LRAS2 = $13.6 trillions; LRAS3 = $15 trillions;
YLR = LRAS = Classical AS = QF = long-run output level = full-employment production
(5 Points) (A) In 1992, the economy was in equilibrium at Point E8 on the AD1 curve and YLR1. Five years later, it arrived
to Point E4 on the AD3 curve and YLR2. Suppose that workers worked longer hours. Please explain the long-term
impact on this economy.
(5 Points) (B) In 2007, the economy was in equilibrium at Point E7 on the AD4 curve and YLR2. Two years later, it arrived
to Point E9 on the AD2 curve and YLR1. Suppose that the cost of acquiring a quality education increased. Please
explain the long-term impact on this economy.
Problem #3 (10 points) ****SAMPLES ****
Consider a closed economy where Y = C + I + G with the following information
C = 100 + 0.75 (Y – T); I = 200;
G = 130 + 0.10Y;
T = 150
(4 Points) (A) What is the equilibrium level of Y this year? What is the total of national saving? Show your work!
(4 Points) (B) Next year, the new government spending function became G = 130 + 0.15Y. What is the new equilibrium
value for Y*? Comparing to Y* in #3A, please explain why the two values of GDP are different.
(2 Points) (C) What is the annual percentage change in GDP for this hypothetical closed 3-sector economy?
Problem #4 (10 Points) ****SAMPLES ****
The following table contains cells for a closed 3-sector economy with the following macroeconomic functions (C, I, G
and T.)
C = 200 + 0.60 (Y – T);
I = 350 + 0.05Y;
G = 300 + 0.10Y;
T = 350 + 0.10Y
Your job is to fill in the remaining cells with appropriate values. Remember to show the formulas and your work in order
to earn full credits!
Problem #5 (10 Points) ****SAMPLES ****
Consider the following table for a 2-sector economy with various after-tax income levels
(8 Points) (A) Please construct the C(YD) (i.e. the consumption ) and S(YD) (i.e. the saving) functions. Show your works –
as always!
(2 Points) (B) What is the equilibrium level of output (Y*)? Please explain your answer.
**** DO NOT COPY THE FOLLOWING SAMPLE SOLUTIONS AS YOUR ANSWERS FOR YOUR TAKE-HOME ASSIGNMENT
(or Homework) #2. ** STUDY AND USE THEM AS A GUIDE TO YOUR OWN WORK. ***
**** THEY ARE SAMPLE ANSWERS ****