Final answer:
The true reason why firms increase inventory is to buffer against unpredictable fluctuations in market demand, not because of opportunity costs, damage risks, inventory-related expenses, or material movements.
Step-by-step explanation:
The true statement about why firms increase inventory is D. Firms increase inventory because there is a risk of significant and unpredictable fluctuations in downstream demand. When businesses face uncertain and potentially volatile demand, they may hold more inventory as a buffer to ensure that they can meet consumer needs without the risk of stockouts which could lead to lost sales. This cautious approach helps mitigate the risks associated with unpredictable changes in the market demand.
Options A, B, and E are typically considered drawbacks or costs associated with holding inventory. Holding inventory indeed has an opportunity cost, and there are increased risks of damage, errors, and obsolescence, as well as higher inventory-related expenditures. Nonetheless, these are negative aspects that firms often try to minimize, rather than reasons to increase inventory. As for Option C, the movement of materials is typically more about logistics and does not inherently justify increasing inventory levels.
According to the concept of quantity supplied, when the cost of production increases, the price of a product generally needs to rise as well to cover the higher costs and maintain the desired profit margin. This explains why higher production quantities, which require more inputs and thus more dollars to produce, result in increased costs for the firm.