What is the role of inventories in keeping actual expenditures equal to real GDP?
Answer:
Actual expenditure in the aggregate will always equal real GDP. However, there may be a deviation between actual and planned expenditure. With aggregate planned expenditure less than real GDP, inventories will begin to accumulate, and the corresponding unplanned investment (since inventory changes are part of investment) will add to planned expenditure to reach actual real GDP. The inventory accumulation will induce firms to decrease production subsequently, and reduce real GDP.
If planned expenditure exceeds real GDP, inventories will be reduced. This case in which actual investment is less than planned investment will adjust planned expenditure back into line with real GDP. At the same time, the inventory depletion will be a prompt to increased planned production subsequently, and increase real GDP.
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