Q7. Why are changes in inventories i... [FREE SOLUTION]

Chapter 7: Q7. (page 151)

Why are changes in inventories included as part of investment spending? Suppose inventories decline by $1 billion during 2022. How would this $1 billion decrease affect the size of gross private domestic investment and gross domestic product in 2022? Explain.

Short Answer

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nventory is the total volume of stocks that are currently going through various stages of production and calculated as a current asset. These are unconsumed outputs, so this can be considered a business investment.

The GDP and private domestic investment will reduce by $1 billion. There will be a deduction of $1 billion from the GDP and the gross private domestic investment. The decline in inventories means that those items were sold. Since these all are included in the previous year鈥檚 GDP, the $1 billion should be deducted.

Step by step solution

Inventories

Inventories refer to those items which were held in the market without selling. These items are considered an investment in business because these materials have not been sold and accounted for. These produced goods and services can be used for future use. That鈥檚 why they are considered an investment.

Impact in GDP and Gross domestic private investment

The decline in inventories by $1 billion will impact both GDP and gross domestic private investment. The $1 billion will be subtracted from both of the variables in 2022. This is because inventory is the output produced that is not sold and accounted for.

Inventories are those products produced in the previous year, and this cannot be added to this year鈥檚 product. Adding of this will result in an overstatement of GDP.

The declines in inventories are considered negative investments. So this should be deducted from the gross domestic private investment. So there will be a $1 billion decline in domestic private investment.