Question

An article in the Wall Street Journal states that a change in inventories​ "dragged down the overall growth in GDP by nearly a full percentage​ point" below what it otherwise would have been.

​Source: Josh​ Mitchell, "U.S. GDP Growth Slowed on Tepid​ Consumer," Wall Street Journal​, April​ 28, 2017.

For this result to​ occur, is it likely that inventories increased or​ decreased? Briefly explain.

Answer 1

Inventories likely decreased if the change in inventories negatively impacted GDP growth by a full percentage point. A decrease in inventories leads to a reduction in the 'I' component of the GDP equation, thus lowering the overall GDP. This indicates that businesses are selling more than they are restocking, common during economic slowdowns.

Step-by-step explanation:

If an article states that a change in inventories dragged down the overall GDP growth by nearly a full percentage point, inventories likely decreased. In the context of the GDP equation, which is GDP = C + I + G + (X - M) where C is consumption, I is investment (which includes changes in business inventories), G is government spending, and (X - M) is net exports, a decrease in inventories means businesses are selling more goods than they are producing or restocking, leading to a reduction in the 'I' component. This reduction consequently lowers the overall GDP figure.

During economic downturns or periods of tepid consumer spending, businesses might reduce production, leading to lower inventory levels. A reduction in inventories might reflect cautious business behavior in anticipation of reduced consumer demand. Conversely, increased inventories could potentially add to GDP if firms are producing more in expectation of future sales.