[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

without waiting; otherwise, they may seek those goods elsewhere. Finally, because
gearing up a production facility and then closing it down as sales fluctuate can be costly,
firms find it profitable to produce at a relatively constant rate, adding to inventories
when sales weaken and selling out of inventories when sales strengthen.
Inventory investment is the most volatile component of aggregate expenditures.
One reason for this variability may again be the impact of the availability of credit
on naturally risk-averse firms. When the economy enters a recession, firms often
find that their net worth is decreased. This can make it harder for them to obtain credit
to finance their inventory investment. They may also become less willing to make any
kind of investment, in inventories or otherwise. Indeed, when possible, they would
like to disinvest, or convert their assets back into cash. By far, the easiest method of
disinvestment is to sell off inventories.
As the economy goes into a recession or simply slows down, inventories often
build up involuntarily. Retail stores, for instance, base their orders on expected sales;
if the sales fail to materialize, the store holds the unsold merchandise as “inventories.”
This unintended accumulation of inventory can rapidly affect production, as
stores respond by reducing their factory orders. Lower orders, in turn, lead quickly
to cutbacks in production. The cutbacks in production as firms try to restore their
inventories to a normal size relative to sales are referred to as inventory corrections.
Cyclical variability induced by inventories is called inventory cycles.
Wrap-Up
DETERMINANTS OF INVESTMENT
1. Investment spending will depend negatively on the real interest rate.
2. Shifts in the investment schedule can be caused by changing assessments of
risk or changes in expectations about future returns.
3. Fluctuations in current economic conditions can affect current investment by
altering firms’ expectations about future sales.
MACROECONOMIC IMPLICATIONS
OF INVESTMENT
Three important macroeconomic implications can be drawn from this discussion
of investment spending. First, we have identified another reason for the positive
slope of the aggregate expenditures schedule: as current output rises, firms will
increase investment spending, while if current output falls, they will scale back their
investment plans. Because both consumption and investment expenditures will rise
as income increases, the slope of the AE schedule is positive.
Second, investment depends on the real interest rate: at each level of income, a
rise in the real interest rate will lower investment. A higher real interest rate lowers
total aggregate expenditures, shifting the AE schedule down. Conversely, a reduction
in the real interest rate will shift the AE schedule up.
INVESTMENT ∂ 675