EFA (30): Stocks and flows

Look at the following three statements and see if you can find anything strange about them:

• "It's amazing. Company X is worth more than the gross domestic product (GDP) of country Y."
• "My neighbour's house is worth 20 times what I earn each year."
• "Last month, 300,000 people lost their jobs and the number employed fell from 131.5 to 131.2 million."

Each of these statement is interesting and possibly true. But each involves a confusion between two concepts: stocks and flows. These are the subject of the 30th item in our Economics for Amateurs (EFA) series.

The difference between stocks and flows is as follows: a stock is something that can be measured at a particular point in time. For example, the value of your neighbour's house or of company X. Or the amount of unsold goods a firm has at a particular moment.

A flow, on the other hand, is the change in a stock during a particular time period. For example, the amount a country produces during a year (its GDP), or the amount you earn per month or per year.

So now we can see why the three statements are strange. The first two, though not uninteresting, are comparing apples with oranges. The value of a company (stock) is not the same concept as a country's GDP (flow).

You should either compare the value of the company to the value of the country, or compare the value added (profit) produced by the company each year to the country's GDP.

The same goes for the second example. You should either compare your neighbour's income to yours, or the value of her house to yours.

Example three is more complicated. Again, a flow (the number of people losing their jobs) is being related to a stock (the number unemployed). This is OK as it goes. But the statement would be true only if nobody was hired (another flow) during this period, which is highly unlikely.

Take, for example, the US labour market. In recent months, average payroll losses — the fall in the number of people employed — have been 300,000 per month. But this figure hides the huge changes going on in the labour market. On average, there were 3.7 million hirings per month and 4 million "job separations" of all types (lay offs, people who retired etc.).

In other words, if the change in the value of a stock (employment) is the result of two flows (hirings and separations), you need to look at both flows to get the full picture. See here for a good analysis of the US.