Final answer:
Investment in the context of GDP refers to the spending on capital goods, including unsold inventories produced within the year. If inventories decline by $1 billion, it indicates that businesses sold more than they produced, resulting in a decrease in both gross investment and GDP by $1 billion.
Step-by-step explanation:
In the context of calculating GDP (Gross Domestic Product), the term investment has a specific meaning different from the common usage related to financial markets. Economists refer to investment as spending on capital goods including new commercial real estate, equipment, residential construction, and inventories. These inventories, even if not sold within the year, are considered products that companies have effectively invested in, adding to the GDP for that year.
When inventories decline, as in the example of a $1 billion decrease, it affects the gross investment measurement for that year. Specifically, it would decrease the business investment segment of the GDP computation by $1 billion. This reduction indicates that businesses had sold more than they produced, thus leading to a decrease in the stock of unsold goods. Consequently, the size of gross investment and GDP would both decrease due to this inventory reduction.