What Is Average Inventory?

Average inventory is a calculation that estimates the value or number of a particular good or set of goods during two or more specified time periods. Average inventory is the mean value of inventory within a certain time period, which may vary from the median value of the same data set, and is computed by averaging the starting and ending inventory values over a specified period.

Understanding Average Inventory

Inventory is the value of all the goods ready for sale or all of the raw materials to create those goods that are stored by a company. Successful inventory management is a key focal point for companies as it allows them to better manage their overall business in terms of sales, costs, and relationships with their suppliers.

Since two points do not always accurately represent changes in inventory over different time periods, average inventory is frequently calculated by using the number of points needed to more accurately reflect activities across a certain amount of time.

For instance, if a business was attempting to calculate the average inventory over the course of a fiscal year, it may be more accurate to use the inventory count from the end of each month, including the base month. The values associated with each point are added together and divided by the number of points, in this case, 13, to determine the average inventory.

The average inventory figures can be used as a point of comparison when looking at overall sales volume, allowing a business to track inventory losses that may have occurred due to theft or shrinkage, or due to damaged goods caused by mishandling. It also accounts for any perishable inventory that has expired.

The formula for average inventory can be expressed as follows:

Average Inventory = (Current Inventory + Previous Inventory) / Number of Periods

Average inventory is used often in ratio analysis; for instance, in calculating inventory turnover.

Moving Average Inventory

A company may choose to use a moving average inventory when it’s possible to maintain a perpetual inventory tracking system. This allows the business to adjust the values of the inventory items based on information from the last purchase.

Effectively, this helps compare inventory averages across multiple time periods by converting all pricing to the current market standard. This makes it similar to adjusting historical data based on the rate of inflation for more stable market items. It allows simpler comparisons on items that experience high levels of volatility.

Example of Average Inventory

A shoe company is interested in better managing its inventory. The current inventory in its warehouse is equal to $10,000. This is in line with the inventory for the three previous months, which were valued at $9,000, $8,500, and $12,000.

When calculating a three-month inventory average, the shoe company achieves the average by adding the current inventory of $10,000 to the previous three months of inventory, recorded as $9,000, $8,500 and $12,000, and dividing it by the number of data points, as follows:

Average Inventory = ($10,000 + $9,000 + $8,500 + $12,000) / 4

This results in an average inventory of $9,875 over the time period being examined.

What Is Applied Economics?

Applied economics applies the conclusions drawn from economic theories and empirical studies to real-world situations with the desired aim of informing economic decisions and predicting possible outcomes. The purpose of applied economics is to improve the quality of practice in business, public policy, and daily life by thinking rigorously about costs and benefits, incentives, and human behavior. Applied economics can involve the use of case studies and econometrics, which is the application of real-world data to statistical models and comparing the results against the theories being tested.

Understanding Applied Economics

Applied economics is the application of economic theory to determine the likely outcomes associated with various possible courses of action in the real world. By better understanding the likely consequences of choices made by individuals, businesses, and policy makers, we can help them make better choices. If economics is the science of studying how people use various, limited means available to them to achieve given ends, then applied economics is the tool to help choose the best means to reach those ends. As a result, applied economics can lead to “to do” lists for steps that can be taken to increase the probability of positive outcomes in real-world events.

The use of applied economics may first involve exploring economic theories to develop questions about a circumstance or situation and then draw upon data resources and other frames of reference to form a plausible answer to that question. The idea is to establish a hypothetical outcome based on the specific ongoing circumstances, drawn from the known implications of general economic laws and models.

Applied Economics Relevance in the Real World

Applied economics can illustrate the potential outcomes of financial choices made by individuals. For example, if a consumer desires to own a luxury good but has limited financial resources, an assessment of the cost and long-term impact such a purchase would have on assets can compare them to the expected benefit of the good. This can help determine if such an expense is worthwhile. Beyond finances, understanding the meaning of the economic theories of rational choice, game theory, or the findings of behavioral economics and evolutionary economics can help a person make better decisions and plan for success in their personal life and even relationships. For example, a person who wants to quit smoking might recognize that they are prone to hyperbolic discounting and might choose to employ precommitment strategies to support their long-term preference to quit over more powerful short-term preferences to smoke. Or a group of friends sharing a large bowl of popcorn might explicitly or implicitly agree to limits or shares on how much popcorn each will take in order to avoid a tragedy of the commons situation.

Applied economics can also help businesses make better decisions. Understanding the implications of economic laws of supply and demand combined with past sales data and marketing research regarding their target market can help a business with pricing and production decisions. Awareness of economic leading indicators and their relationship to a firm’s industry and markets can help with operational planning and business strategy. Understanding economic ideas such as principal-agent problems, transaction costs, and the theory of the firm can help businesses design better compensation schemes, contracts, and corporate strategies. 

Applied economics is an invaluable tool for public policy makers. Many economists are employed to predict both the macro- and microeconomic consequences of various policy proposals or to evaluate the effects of ongoing policy. Applied macroeconomic modeling is routinely used to project changes in unemployment, economic growth, and inflation at the national, regional, and state level. Understanding the way the economic incentives and compensating behaviors created by public policy impact real-world trends in things like job growth, migration, and crime rates is critical to implementing effective policy and avoiding unintended consequences. For example, understanding what the application of the laws of supply and demand imply about the effects of price floors, along with case studies and empirical research, can inform better policy regarding minimum wage laws.

What Is Aggregate Demand?

Aggregate demand is a measurement of the total amount of demand for all finished goods and services produced in an economy. Aggregate demand is commonly expressed as the total amount of money exchanged for those goods and services at a specific price level and point in time.

Understanding Aggregate Demand

Aggregate demand is a macroeconomic term and can be compared with the gross domestic product (GDP). GDP represents the total amount of goods and services produced in an economy while aggregate demand is the demand or desire for those goods. Aggregate demand and GDP commonly increase or decrease together.

Aggregate demand equals GDP only in the long run after adjusting for the price level. Short-run aggregate demand measures total output for a single nominal price level without adjusting for inflation. Other variations in calculations can occur depending on the methodologies used and the various components.

Aggregate demand consists of all consumer goods, capital goods, exports, imports, and government spending programs. All variables are considered equal if they trade at the same market value.

Aggregate Demand Components

Aggregate demand is determined by the overall collective spending on products and services by all economic sectors on the procurement of goods and services by four components:

Consumption Spending

Consumer spending represents the demand by individuals and households within the economy. While there are several factors in determining consumer demand, the most important is consumer incomes and the level of taxation.

Investment Spending

Investment spending represents businesses’ investment to support current output and increase production capability. It may include spending on new capital assets such as equipment, facilities, and raw materials.

Government Spending

Government spending represents the demand produced by government programs, such as infrastructure spending and public goods. This does not include services such as Medicare or social security, because these programs simply transfer demand from one group to another.

Net Exports

Net exports represent the demand for foreign goods, as well as the foreign demand for domestic goods. It is calculated by subtracting the total value of a country’s exports from the total value of all imports.

Aggregate Demand Formula

The equation for aggregate demand adds the amount of consumer spending, investment spending, government spending, and the net of exports and imports. The formula is shown as follows:

$\begin{aligned} &\text{Aggregate Demand} = \text{C} + \text{I} + \text{G} + \text{Nx} \\ &\textbf{where:}\\ &\text{C} = \text{Consumer spending on goods and services} \\ &\text{I} = \text{Private investment and corporate spending on} \\ &\text{non-final capital goods (factories, equipment, etc.)} \\ &\text{G} = \text{Government spending on public goods and social} \\ &\text{services (infrastructure, Medicare, etc.)} \\ &\text{Nx} = \text{Net exports (exports minus imports)} \\ \end{aligned}$​Aggregate Demand=C+I+G+Nxwhere:C=Consumer spending on goods and servicesI=Private investment and corporate spending onnon-final capital goods (factories, equipment, etc.)G=Government spending on public goods and socialservices (infrastructure, Medicare, etc.)Nx=Net exports (exports minus imports)​

The aggregate demand formula above is also used by the Bureau of Economic Analysis to measure GDP in the U.S.

What Affects Aggregate Demand?

Interest Rates

Interest rates affect decisions made by consumers and businesses. Lower interest rates will lower the borrowing costs for big-ticket items such as appliances, vehicles, and homes and companies will be able to borrow at lower rates, often leading to capital spending increases. Higher interest rates increase the cost of borrowing for consumers and companies and spending tends to decline or grow at a slower pace.

Income and Wealth

As household wealth increases, aggregate demand typically increases. Conversely, a decline in wealth usually leads to lower aggregate demand. When consumers are feeling good about the economy, they tend to spend more and save less.

Inflation Expectations

Consumers who anticipate that inflation will increase or prices will rise tend to make immediate purchases leading to rises in aggregate demand. But if consumers believe prices will fall in the future, aggregate demand typically falls.

Currency Exchange Rates

When the value of the U.S. dollar falls, foreign goods will become more expensive. Meanwhile, goods manufactured in the U.S. will become cheaper for foreign markets. Aggregate demand will, therefore, increase. When the value of the dollar increases, foreign goods are cheaper and U.S. goods become more expensive to foreign markets, and aggregate demand decreases.

Economic Conditions and Aggregate Demand

Economic conditions can impact aggregate demand whether those conditions originated domestically or internationally. The financial crisis of 2007-08, sparked by massive amounts of mortgage loan defaults, and the ensuing Great Recession, offer a good example of a decline in aggregate demand due to economic conditions.

With businesses suffering from less access to capital and fewer sales, they began to lay off workers and GDP growth contracted in 2008 and 2009, resulting in a total production contraction in the economy during that period. A poor-performing economy and rising unemployment led to a decline in personal consumption or consumer spending. Personal savings also surged as consumers held onto cash due to an uncertain future and instability in the banking system.

In 2020, the COVID-19 pandemic caused reductions in both aggregate supply or production, and aggregate demand or spending. Social distancing measures and concerns about the spread of the virus caused a significant decrease in consumer spending, particularly in services as many businesses closed. These dynamics lowered aggregate demand in the economy. As aggregate demand fell, businesses either laid off part of their workforces or otherwise slowed production as employees contracted COVID-19 at high rates.

Aggregate Demand vs. Aggregate Supply

In times of economic crises, economists often debate as to whether aggregate demand slowed, leading to lower growth, or GDP contracted, leading to less aggregate demand. Whether demand leads to growth or vice versa is economists’ version of the age-old question of what came first—the chicken or the egg.

Boosting aggregate demand also boosts the size of the economy regarding measured GDP. However, this does not prove that an increase in aggregate demand creates economic growth. Since GDP and aggregate demand share the same calculation, it only indicates that they increase concurrently. The equation does not show which is the cause and which is the effect.

Early economic theories hypothesized that production is the source of demand. The 18th-century French classical liberal economist Jean-Baptiste Say stated that consumption is limited to productive capacity and that social demands are essentially limitless, a theory referred to as Say’s Law of Markets.

Say’s law, the basis of supply-side economics, ruled until the 1930s and the advent of the theories of British economist John Maynard Keynes. By arguing that demand drives supply, Keynes placed total demand in the driver’s seat. Keynesian macroeconomists have since believed that stimulating aggregate demand will increase real future output and the total level of output in the economy is driven by the demand for goods and services and propelled by money spent on those goods and services.

Keynes considered unemployment to be a byproduct of insufficient aggregate demand because wage levels would not adjust downward fast enough to compensate for reduced spending. He believed the government could spend money and increase aggregate demand until idle economic resources, including laborers, were redeployed.

Other schools of thought, notably the Austrian School and real business cycle theorists stress consumption is only possible after production. This means an increase in output drives an increase in consumption, not the other way around. Any attempt to increase spending rather than sustainable production only causes maldistribution of wealth or higher prices, or both.

As a demand-side economist, Keynes further argued that individuals could end up damaging production by limiting current expenditures—by hoarding money, for example. Other economists argue that hoarding can impact prices but does not necessarily change capital accumulation, production, or future output. In other words, the effect of an individual’s saving money—more capital available for business—does not disappear on account of a lack of spending.

The Bottom Line

Aggregate demand is a concept of macroeconomics that represents the total demand within an economy for all kinds of goods and services at a certain price point. In the long term, aggregate demand is indistinguishable from GDP. However, aggregate demand is not a perfect metric and it is the subject of debate among economists.

What Is an Asset Class?

An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. Asset classes are thus made up of instruments that often behave similarly to one another in the marketplace.

Understanding Asset Classes

Simply put, an asset class is a grouping of comparable financial securities. For example, IBM, MSFT, AAPL are a grouping of stocks. Asset classes and asset class categories are often mixed together. There is usually very little correlation and in some cases a negative correlation, between different asset classes. This characteristic is integral to the field of investing.

Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies in the asset class mix. Investment assets include both tangible and intangible instruments which investors buy and sell for the purposes of generating additional income, on either a short- or a long-term basis.

Financial advisors view investment vehicles as asset class categories that are used for diversification purposes. Each asset class is expected to reflect different risk and return investment characteristics and perform differently in any given market environment. Investors interested in maximizing return often do so by reducing portfolio risk through asset class diversification.

Financial advisors will help investors diversify their portfolios by combing assets from different asset classes that have different cash flows streams and varying degrees of risk. Investing in several different asset classes ensures a certain amount of diversity in investment selections. Diversification reduces risk and increases your probability of making a return.

Asset Class and Investing Strategy

Investors looking for alpha employ investment strategies focused on achieving alpha returns. Investment strategies can be tied to growth, value, income, or a variety of other factors that help to identify and categorize investment options according to a specific set of criteria. Some analysts link criteria to performance and/or valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio. Other analysts are less concerned with performance and more concerned with the asset type or class. An investment in a particular asset class is an investment in an asset that exhibits a certain set of characteristics. As a result, investments in the same asset class tend to have similar cash flows.

Asset Class Types

Equities (stocks), bonds (fixed-income securities), cash or marketable securities, and commodities are the most liquid asset classes and, therefore, the most quoted asset classes.

There are also alternative asset classes, such as real estate, and valuable inventory, such as artwork, stamps, and other tradable collectibles. Some analysts also refer to an investment in hedge funds, venture capital, crowdsourcing, or cryptocurrencies as examples of alternative investments. That said, an asset’s illiquidity does not speak to its return potential; It only means it may take more time to find a buyer to convert the asset to cash.