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Business inventories

You all hear on TV every day or so that the US consumer has been holding up and kept our economy going. Conversely, you have heard that the major cause of the current economic weakness has been the rapid decline in business investment.

Business inventories are a large component of business investments.
In the 3rd and 4th quarter of 2001, a drastic reduction of business inventories occurred, as it did in the 4th quarter of 2000 before the recession started. These are two examples of many in economic history where inventory drawdowns have preceded the low point of the economic cycle.

Since Inventories are not a large component of GDP, how can they affect GDP so sharply? Currently, Inventories are at an extremely low level by historical standards. How do you expect the replenishment cycle will affect GDP in the near future? Be focused on the definition of GDP (Expenditures Approach and Income Approach), the relationship between consumption expenditures and inventories as well as their interdependence, and think in terms of the Multiplier.

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Inventories are not a very large part of the GDP, however, low inventory levels do not so much act as a cause of the downturn, rather they are an indicator. Inventory appears as a current asset on an organization's balance sheet because the organization can turn it into cash by selling it. Some organizations hold larger inventories than their operations require in order inflating their apparent asset value and their perceived profitability.
So when a business is hard pressed for cash it tries to reduce its inventory levels.In addition to the money tied up by acquiring inventory, inventory also brings associated costs for space, for utilities, and for insurance to cover staff to handle and protect it, fire and other disasters, obsolescence, shrinkage (theft and errors), and others. Such holding costs can mount up: between a third and a half of its acquisition value per year.
Businesses that stock too little inventory cannot take advantage of large orders from customers if they cannot deliver. The conflicting objectives of cost control and customer service often pit an organization's financial and operating managers against its sales and marketing departments. Sales people, in particular, often receive commission payments, so unavailable goods may reduce their potential personal income. These businesses are thus in a vulnerable position.

GDP is defined as the total value of all goods and services produced within that territory during a specified period (or, if not specified, annually, so that "the UK GDP" is the UK's annual product). GDP differs from gross national product (GNP) in excluding inter-country income transfers, in effect attributing to a territory the product generated within it rather than the incomes received in it. The indicators are that if the businesses are short of finances, that is indicated by the low inventory levels and the businesses are vulnerable because they cannot take advantage of inventories, the GDP is likely to be under tremendous pressure.
The inventories form a part of the real GDP. Whereas nominal GDP refers to the total amount of money spent on GDP, real GDP refers to an effort to correct this number for the effects of inflation in order to estimate the sum of the actual quantity of goods and services making up GDP. The former is sometimes called "money GDP," while the latter is termed "constant-price" or "inflation-corrected" GDP -- or "GDP in base-year prices" (where the base year is the reference year of the index used). See real vs. nominal in economics.
A common equation for GDP is:
GDP = consumption + investment + exports - imports
Economists (since Keynes) ...

Solution Summary

Business inventories are studied.