Problem: You all hear on TV every day or so that the US consumer has been holding up and kept our economy going. Conversely, you have heard that the major cause of the current economic weakness has been the rapid decline in business investment.
Business inventories are a large component of business investments.
In the 3rd and 4th quarter of 2001, a drastic reduction of business inventories occurred, as it did in the 4th quarter of 2000 before the recession started. These are two examples of many in economic history where inventory drawdowns have preceded the low point of the economic cycle.
Since Inventories are not a large component of GDP, how can they affect GDP so sharply? Currently, Inventories are at an extremely low level by historical standards. How do you expect the replenishment cycle will affect GDP in the near future? Be focused on the definition of GDP (Expenditures Approach and Income Approach), the relationship between consumption expenditures and inventories as well as their interdependence, and think in terms of the Multiplier.