Inventory and Investment.

Inventories are treated as capital. Addition to stock of capital of a firm is known as investment. There can be three major categories of investment. Change in inventories may be planned or unplanned. In case, of an unexpected fall in sales, firm will have unsold stock of goods which it had not anticipated. Hence, there will be unplanned accumulation of inventories. In opposite case, where there is unexpected rise in sales, there will be unplanned decumulation of inventories.

What can be examples of planned accumulation or decumulation of inventories? Suppose firm wants to raise inventories from 100 shirts to 200 shirts during year. Expecting sales of 1100 shirts (1000 shirts during year as before), firm produces 1100 shirts (1000 + 100 =1100 shirts). If sales, are actually 1100 shirts (1000 shirts), then firm indeed ends up with a rise in inventories. The new stock of inventories is 200 shirts, which was indeed planned by firm. This rise is an example of planned accumulation of inventories. On the other hand, if firm had wanted to reduce inventories from 100 to 25, then it would produce 1100 shirts (1000-75 =925 shirts. This is because it plans to sell 75 shirts out of inventory of 100 shirts it started with ( so that inventory at ends of year becomes 100 -75 =25 shirts, which firm wants.). If sales, indeed turn out to be 1100 shirts (1000 as expected by firm, firm will be left with planned, reduced inventory of 25 shirts.