Economic activity is the process by which the stock of
resources or stock of capital produces a flow of output of goods
and services that people utilize in partial satisfaction of their unlimited
wants. This process involves not only the production of goods and
services but their distribution among the various members of the
community. Since output is the flow of goods and services produced
by the economy's capital stock, we must be clear about what
we mean by the terms stock and flow if we are to
understand the nature of capital and its relationship to output and
income.
The levels of certain variables at a point in time can be
viewed as stocks---for example, the stock of automobiles in
Ontario on some particular date was, say, 1.2 million. A process
occurring over an interval of time can be viewed as a flow. For
example, the flow of liquor drank by the townsfolk per month in the
past year was 320 quarts.
One interpretation of a flow is as a change in a stock---the stock
of liquor on the shelf was 700 quarts on the first of June and the
stock was 380 quarts on the first of July so, since none was added,
the flow consumed during the month was therefore 320 quarts. But a
flow need not necessarily imply a change in a stock. Suppose, for
example, that the distillery produced 640 quarts of liquor during the
month of June and the public drank all of them. The stock of liquor
on the shelf did not change during the month. Of course, had nothing
been consumed, the stock on the shelf would have risen by 640
quarts---had none been produced the stock would have declined by
640 quarts. The important insight here about capital and output is
that the distillery (representing a stock of human and physical
capital) produced a flow of output at the rate of 640 quarts per
month, independently of whether this liquor was consumed or
added to inventory. More broadly, the stock of capital provides
services to the community taking the form of a flow of consumables.
The stream of output yielded by a stock of capital is
often referred to as the services of capital, or the services
yielded by capital. For example, the stock of a capital good,
say cars, represents the source of a flow of income---car
services---which might be thought of as the ability to get quickly
and comfortably from point A to point B. If one owns a car, one can
indefinitely obtain a steady flow of services from it as long as
one feeds it a flow of gasoline and pays the necessary sequence
of repair bills.
To take another example, consider an electronics technician who
has the necessary stock of skills (human capital) to be
able to repair radios and TV sets. That technician can produce through
time a flow of repair jobs per month (per year), providing a stream
of services to others who, in return, will pay him a flow of income per
month (per year). Alternatively, of course, like everyone else the
technician can utilize his whole range of personal characteristics to
produce a flow of leisure for himself. Note that flows are always
defined per unit time---they occur at some rate through time.
Every consumable or absorbable good in the economy represents a
flow of output from some stock of human and/or physical capital
and/or natural resources that produces it. Apples represent the
flow of output from a stock of apple trees. Lumber represents the
flow of wood obtained by cutting down trees and sawing them into
appropriate lengths. This may be associated with either an increase
or decline in the stock of standing timber, depending on how fast
the trees are growing.
Note also that the flow of lumber obtained from cutting down
trees may be used to increase the stock of lumber on hand in the
form of inventories. These inventories are capital just like
trees are but the flow of services they yield are not tangible
like the flow of lumber yielded by the stock of trees.
The stock of lumber in inventory yields a flow of intangible
services that are very valuable to people in the economy---the
services of not running out of stock if there is an unusually
large flow of lumber demanded for house construction during a
period of time. The lumberyard owner is willing to pay for these
services by giving up the interest she could otherwise earn on
the funds invested in the inventories because she can pass this
cost on to the consumer in the form of a higher markup of selling
price over cost. Consumers of lumber are willing to pay this
higher price because they find it a costly waste of time to shop
at establishments that have lower prices but too frequently run
out of stock.
You should now be ready to take a test on your understanding of
what an economy is and of the distinctions between income and
capital and stocks and flows. Detailed answers are available
on-screen for all questions. But you should always think about
the question and construct your own answer before going to
the one here provided.
All discussions of basic economic concepts must begin with
what we mean by the term "the economy". This term,
which is loosely used in popular discussion, needs a proper
definition before analysis can proceed. We can visualize the economy
as a collection of resources together with the set of institutions
that govern their use. The resources include human skills, land,
buildings, machinery, houses, and so forth. Added together, they
compose the economy's capital stock and, given appropriate
institutions, produce the flow of commodities and services that
the public enjoys. The institutions within which these resources
are organized and managed are the business firms, corporations,
government agencies, non-profit organizations, cooperatives, etc.
that appear everywhere we look. These organizations function within
a legal framework, created and managed by government through
the political process, that establishes their rights and obligations
along with those of private individuals and provides, when the situation
demands, regulation of particular activities. The size of the flow of
commodities and services that can be produced with the capital stock
will thus depend on the social and political institutions through which
the people who live in this economy organize themselves. An important
aspect of this institutional framework is the process by which tasks
are assigned to government, the extensiveness of the tasks so assigned,
and the procedures by which government collects taxes and allocates its
expenditures and manipulates the private sector.