Question

True or False. Real GDP is more volatile (variable) than gross investment.

Short answer

The statement is false.

Step-by-step solution

Variability in gross investment

Gross investment is highly variable due to several factors like future expectations, present profits, irregular innovations, and durability.

• Future expectations like war, natural disasters, political influences, judiciary laws and regulations, trade barriers, exchange rates, and other phenomena alter business conditions. Thus, the business expectations fluctuate the gross investment.

• Similarly, the present profits influence the expectation of profit in the future. If current yields are low, firms expect lower earnings in the future and the gross investment contracts and vice versa.

• Innovations like different generations of computers, self-driving vehicles, upgradation in train engines, aeroplanes, and others stimulate investments, income, and economic development. However, these innovations occur very irregularly, making the investment more volatile.

• The durability of capital goods decides the need for investment. If capital goods can be overused for more time without any upgradation or replacement, the investment delays; otherwise, it takes place. Therefore, the volatility of investment depends on the durability of capital goods.

Reason for the false statement

Gross investment is one of the components of real GDP.It is volatile due to the factors mentioned earlier. Compared to this, GDP is less volatile due to the presence of automatic stabilizers like taxes, unemployment allowance, and others. These automatic stabilizers are instruments of fiscal policy that try to stabilize the consumption of individuals.

The automatic stabilizers in the form of government expenditure inject or suck more money from the economy according to the need during the business cycles and reduce the fluctuation effect on income. Hence, real GDP is less volatile than gross investment.