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Chapter 23: Problem 6

In reporting on real GDP growth in the second quarter of \(2016,\) an article on Reuters news noted that "U.S. economic growth unexpectedly remained tepid in the second quarter as inventories fell" and also that the "inventory drawdown was almost across the board." a. If companies are drawing down inventories, is aggregate expenditure likely to have been larger or smaller than GDP? b. The chief economist at UniCredit Research was quoted in the article as stating, "The U.S. economy just went through a meaningful inventory correction cycle." What would an "inventory correction cycle" be, and why would companies need to go through one? c. The article stated, "Though the inventory drawdown weighed on GDP growth, that is likely to provide a boost to output in the coming quarters." Why would an inventory drawdown boost output in the coming quarters?

Short Answer

Expert verified
a. Aggregate expenditure is likely to have been larger than GDP if companies are drawing down inventories.b. An 'inventory correction cycle' is a business strategy where companies adjust inventory levels in response to changes in demand, ensuring efficient resource management.c. An inventory drawdown can boost output in future quarters because low inventories would eventually necessitate an increase in production to meet demand, thus potentially increasing GDP.

Step by step solution

01

The Relationship Between Aggregate Expenditure and GDP

When companies draw down inventories, it implies that they are selling more goods than they are producing. This means the aggregate expenditure, which is the sum of consumption, investment, government spending, and net exports, will be larger than the GDP, as more goods are being sold than being produced.
02

Understanding 'Inventory Correction Cycle'

An 'Inventory correction cycle' refers to a business strategy where companies adjust inventory levels in response to changes in demand. Companies need to go through an inventory correction cycle to manage their resources efficiently and respond appropriately to market demand. If there is less demand than expected, inventories will build up, and the company will reduce production to allow the surplus to sell off, and vice versa.
03

The Impact of Inventory Drawdown on Future Output

The inventory drawdown might weigh on current GDP growth because it suggests companies are selling more than they produce, reducing the output, which is a significant part of the GDP calculation. However, this is also likely to provide a boost to output in the coming quarters. The reason is that the decrease in inventories will likely lead to an increase in production in the future once the inventories are too low, hence increasing GDP.

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Most popular questions from this chapter

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