Page 211 - Krugmans Economics for AP Text Book_Neat

their inventories carefully. However, sales fluctuate.
Positive unplanned inventory
And because firms cannot always accurately pre-
investment occurs when actual sales
dict sales, they often find themselves holding larger
are less than businesses expected, leading
or smaller inventories than they had intended. to unplanned increases in inventories.
When a firm’s inventories are higher than intended Sales in excess of expectations result in
due to an unforeseen decrease in sales, the result is negative unplanned inventory investment.
unplanned inventory investment. An unex- Actual investment spending is the
pected increase in sales depletes inventories and sum of planned investment spending and
causes the value of unplanned inventory invest- unplanned inventory investment.
ment to be negative. Section 4 National Income and Price Determination
So in any given period, actual investment
spending is equal to planned investment spend- Getty Images
ing plus unplanned inventory investment. If we let
I Unplanned represent unplanned inventory invest-
ment, I Planned represent planned investment spending, and I represent actual invest-
ment spending, then the relationship among all three can be represented as:

(16-10) I = I Unplanned + I Planned

fyi

Interest Rates and the U.S. Housing Boom
Interest rates dropped from roughly 7.5% to States. Panel (a), which shows the mortgage flected in a surge of housing starts, shown in
5.5% between the late 1990s and 2003, helping rate, gives you an idea of how much interest panel (b). This rise in investment spending
set off a housing boom. The housing boom was rates fell. In the second half of the 1990s, mort- drove an overall economic expansion, both
part of a broader housing boom in the country gage rates generally fluctuated between 7% through its direct effects and through the mul-
as a whole. There is little question that this and 8%; by 2003, they were down to between tiplier process.
housing boom was caused, in the first instance, 5% and 6%. These lower rates were largely the Unfortunately, the housing boom eventually
by low interest rates. result of Federal Reserve policy: the Fed cut turned into too much of a good thing. By 2006,
The figure shows the interest rate on 30-year rates in response to the 2001 recession and it was clear that the U.S. housing market was
home mortgages—the traditional way to bor- continued cutting them into 2003 out of concern experiencing a bubble: people were buying
row money for a home purchase—and the that the economy’s recovery was too weak to housing based on unrealistic expectations
number of housing starts, the number of homes generate sustained job growth. about future price increases. When the bubble
for which construction is started per month, The low interest rates led to a large in- burst, housing—and the U.S. economy—took
from 1995 to the end of 2009 in the United crease in residential investment spending, re- a fall.

(a) The Interest Rate on 30-Year Mortgages (b) Housing Starts
30-year Housing
mortgage starts
rate (thousands)
10% 2,500
9 2,000
8
7 1,500
6 1,000
5 500
4
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

(Federal Reserve Bank of St. Louis) Year Year

module 16 Income and Expenditure 169