Question

Why are changes in inventories included as part of investment spending? Suppose investors declined by $1 billion during 2014. How would this affect the size of gross private domestic investment investment and gross domestic product of 2014? Explain

Answer 1

When anything produced by business which has not been sold during the accounting period will be categorised something in which business has invested. Although such investment is involuntary, as it often occurs with inventories, however all inventories in the business hands are assumed to be eventually used by business. Therefore, changes in inventories included as part of investment spending

If inventories declined by $1 billion in 2014 then, $1 billion will be reduced from both gross private domestic investment and gross domestic product. A reduction in inventories reflects that goods produced in a previous year have been used up in the current year’s production. If we don’t reduced $1 billion, then this amount of goods produced in a previous year would be counted as having been produced in 2014, resulting to an overstatement of production of year 2014