Question

You learn from a magazine article that most firms decreased their production in the previous quarter. Also, these firms sold from their inventories during the previous quarter. How will this affect the GDP?

Answer 1

A decrease in firm production and selling from inventories would likely result in a reduction of GDP in the short term, as less production leads to a lower equilibrium GDP and could potentially increase the price level due to scarcity.

Step-by-step explanation:

When firms decrease their production and sell from their inventories, it affects the Gross Domestic Product (GDP). Since GDP is a measure of the country's economic activity, reduced production implies a lower GDP. Selling from inventories indicates that less production is happening, which means the investment component of GDP that includes inventory levels might decline. Therefore, if businesses are selling old inventories without replenishing them through new production, GDP would likely decrease in the short term.

Additionally, the shifts in Aggregate Demand (AD) and Short-Run Aggregate Supply (SRAS) can illustrate these changes in economic activity. A decrease in production and the sale of inventories without corresponding new production would shift the SRAS curve to the left. This leftward shift suggests a lower equilibrium GDP and potentially a higher price level due to scarcity of products.

In summary, this scenario of decreasing production and depleting inventories typically results in a reduction of the nation's GDP as a reflection of decreasing economic output.