Stocks, Flows, and Depreciation

• A quantitative measure of the aggregate level of final goods produced in the economy is required.
• A common measuring rod is needed to assess total final goods and services.
• Different physical units like metres, tonnes and numbers cannot be added directly.
• Money is used as the common measuring rod in the economy.
• Each commodity produced for sale has a monetary value.
• The sum of the monetary values of all such commodities gives a measure of final output.

• Intermediate goods are crucial inputs in production and use significant manpower and capital stock.
• The value of final goods already includes the value of intermediate goods used in their production.
• Counting intermediate goods separately, along with final goods, leads to double-counting.
• Double-counting highly exaggerates the final value of economic activity.

Flow Concepts

• Statements about income or output are incomplete without mentioning the time period.
• Income, output and profits make sense only when a time period is specified.
• These quantities are called flows because they occur in a period of time.
• A definite time period must be specified to measure flows.
• Many flows are expressed annually, such as annual profits or production.
• Flows are defined over a period of time.

Stock Concepts

• Capital goods or consumer durables do not wear out or get consumed in a fixed short time period.
• They continue to serve through different cycles of production.
• Buildings and machines exist irrespective of any specific short time period.
• Additions occur when new machines are added, and deductions occur when machines fall into disuse and are not replaced.
• These quantities are called stocks.
• Stocks are defined at a particular point of time.

Example of Tank and Tap:

• Water flowing from a tap into a tank per minute is a flow.
• Water present in the tank at a particular point of time is a stock.

• Change in stock over a specific period, such as machines added this year, can be measured.
• Such changes in stocks are flows measured over time.
• A machine can remain part of the capital stock for many years until it wears out.
• The same machine is part of the flow of new machines only in the year it is installed.

Gross Investment and Capital Goods

• The part of final output that comprises capital goods is gross investment.
• Capital goods include machines, tools, implements, buildings, office spaces, storehouses and infrastructure like roads, bridges, airports and jetties.

Replacement of Capital and Depreciation

• Not all capital goods produced in a year are additions to existing capital stock.
• A significant part of current capital goods output maintains or replaces existing capital stock.
• Existing capital stock suffers wear and tear and needs maintenance and replacement.
• Part of the current capital goods goes only to replace old capital and does not add to the total stock.

Net Investment (New Capital Formation)

• The replacement value must be subtracted from gross investment to get net investment.
• This deletion from gross investment to allow for normal wear and tear is called depreciation.
• New addition to capital stock is measured by net investment or new capital formation.