What correctly defines change of inventories of a firm during a year?

Correct — C. Inventory is the stock a firm holds: unsold output, raw material and work in progress.

What it adds to that stock over a year is simply what it made minus what it sold.
change in inventories = production during the year − sale during the year

Produce 100 units and sell 80, and inventories rise by 20. Sell 120 by running stock down, and the change is −20.

Both directions come out right only with option (c).

Why the others are wrong

• (a)
  Sale of the firm during the year – Production of the firm during the year — This reverses the subtraction. Sale minus production returns the change with the wrong sign, so a firm piling up unsold goods would appear to be running its inventories down.
• (b)
  Production of the firm during the previous year – Sale of the firm during the year — Setting last year's production against this year's sale measures nothing real. The change in one year's stock has to compare quantities from that same year.
• (d)
  Production of the firm during the year – Sale of the firm during the previous year — Using the previous year's sale has the same defect from the other side. Production and sale must be taken over one and the same year.

Inventory is a stock variable, a quantity held at a point in time. The change in inventories over a year is a flow, and national income accounting treats that flow as part of the firm's investment.

Accumulation may be planned, when a firm builds stock for demand it expects, or unplanned, when goods simply do not sell. Unplanned accumulation is the signal that demand has fallen short of output.

Because the change counts as investment, output that is produced and never sold still enters GDP for the year in which it was produced.

Key facts

• Change in inventories equals production of the firm during the year minus sale of the firm during the year.
• Inventory is a stock variable, while the change in inventory over a period is a flow variable.
• Change in inventories is counted as part of a firm's investment in national income accounting.
• Unplanned accumulation of inventories signals that sales have fallen short of production.

Common traps

• Reversing the subtraction and writing sale minus production.
• Pulling one of the two quantities from the previous year.

No directly related past PYQ was found.