Four reasons for firms to hold inventories are given in the text. For

Four reasons for firms to hold inventories are given in the text. For each reason, indicate briefly whether and how it helps to explain the high volatility of inventory investment.

What will be an ideal response?

ANSWER

The role of inventories as a factor of production and as work in process does not vary much in the short run. Inventories of finished goods that result from production smoothing and stock-out avoidance are a source of short-run volatility, because expected demand is procyclical. Optimistic expectations cause inventories to swell in anticipation of robust sales. When demand slumps, inventories grow even larger, until production is cut back. Then pessimistic forecasts imply inventory reduction, and inventories can fall precipitously as demand recovers, until production accelerates.