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Chapter 23: Problem 4

What is likely to happen if firms accumulate large amounts of unplanned inventory at the beginning of a recession?

Short Answer

Expert verified
Accumulating large amounts of unplanned inventory at the beginning of a recession will likely lead to an increase in storage and management costs, reduced profitability due to potential price reductions, and in the worst case scenario, business failure if the costs can not be managed.

Step by step solution

01

Understanding Inventory and Market Demand

Inventory refers to goods that a firm holds but has not yet sold. Market demand is the total demand for a product or service in the market. During a recession, market demand generally falls since consumers tend to cut back on spending.
02

Impact of Accumulating Unplanned Inventory

If a firm accumulates large amounts of unplanned inventory at the beginning of a recession, it implies that the firm's production exceeded its sales, which means there is less demand for its goods. The firm will have to carry the costs of storing and managing unsold inventory which can be expensive.
03

The Likely Consequences

If this situation continues, firms may have to sell their products at significantly reduced prices to clear the inventory, leading to reduced profitability. In the worst case, if the firm cannot cover the costs associated with the accumulated inventory, it may lead to business failure.

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Most popular questions from this chapter

What are the five main determinants of consumption spending? Which of these is the most important? How would a rise in stock prices or housing prices affect consumption spending?

Which of the following does the aggregate expenditure model seek to explain: long-run economic growth, the business cycle, inflation, or cyclical unemployment?

An article published in an economics journal found the following: "For the poorest households, the marginal propensity to consume was close to \(70 \% .\) For the richest households, the MPC was only \(35 \%\)." Assume that the macroeconomy can be divided into three sections. Section A consists of the poorest households, Section \(\mathrm{B}\) consists of the richest households, and Section C consists of all other households. a. Compute the value of the multiplier for Section A. b. Compute the value of the multiplier for Section \(\mathrm{B}\). c. Assume that there was an increase in planned investment of \(\$ 4\) billion. Compute the change in equilibrium real GDP if the \(M P C\) for the economy was 70 percent (or 0.70\()\). Compute the change in equilibrium real GDP if the \(M P C\) for the economy was 35 percent (or 0.35\()\).

Explain whether you agree with the following statement: "The reason the aggregate demand curve slopes downward is that when the price level is higher, people cannot afford to buy as many goods and services."

According to an article in the Wall Street Journal, in late 2014, the Japanese economy experienced a large increase in business inventories. The article noted, "The large buildup of inventories is a reflection that the \(\ldots\) drop in demand was bigger than expected." Does it matter that Japanese firms didn't expect the drop in demand? Won't a decline in demand always lead to an increase in firms' holdings of inventories? Briefly explain.
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