Inventory investment

Inventory investment is a component of gross domestic product (GDP). What is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather than in the year they were produced. Conversely, some of the goods sold in a given year might have been produced in an earlier year. The difference between goods produced (production) and goods sold (sales) in a given year is called inventory investment. The term can be applied to the economy as a whole or to an individual firm.

Thus, if production per unit time exceeds sales per unit time, then inventory investment per unit time is positive; as a result, at the end of that period of time the of inventories on hand will be greater than it was at the beginning. The reverse is true if production is less than sales.

In discrete time, the end-of-period stock of inventories minus the beginning-of-period stock of inventories equals the flow of inventory investment per time period.

In continuous time, the time derivative of the stock of inventories equals the instantaneous flow of inventory investment.

A positive of Intended inventory investment occurs when a firm expects that sales will be high enough that the current level of inventories on hand may be insufficient—perhaps because in the presence of very short-term fluctuations in the timing of customer purchases, there is a risk of temporarily being unable to supply the product when a customer demands it. To avoid that prospect, the firm deliberately builds up its inventories—that is, engages in positive intended inventory investment by deliberately producing more than it expects to sell. Economists view this positive intended inventory investment as a form of spending—in effect, the firm is buying inventories from itself.

Conversely, if a firm decides that its current level of inventories is unjustifiably high—some of the inventories are taking up costly warehouse space while exceeding what is needed to prevent stock-outs—then it will engage in a negative flow of intended inventory investment. It does this by deliberately producing less than what it expects to sell.

Positive or negative unintended inventory investment occurs when customers buy a different amount of the firm's product than the firm expected during a particular time period. If customers buy less than expected, inventories unexpectedly build up and unintended inventory investment turns out to have been positive. If customers buy more than expected, inventories unexpectedly decline and unintended inventory investment turns out to have been negative.

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