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On the relationship between entropy, demand uncertainty, and expected loss

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  • Fleischhacker, Adam J.
  • Fok, Pak-Wing

Abstract

We analyze the effect of demand uncertainty, as measured by entropy, on expected costs in a stochastic inventory model. Existing models studying demand variability’s impact use either stochastic ordering techniques or use variance as a measure of uncertainty. Due to both axiomatic appeal and recent use of entropy in the operations management literature, this paper develops entropy’s use as a demand uncertainty measure. Our key contribution is an insightful proof quantifying how costs are non-increasing when entropy is reduced.

Suggested Citation

  • Fleischhacker, Adam J. & Fok, Pak-Wing, 2015. "On the relationship between entropy, demand uncertainty, and expected loss," European Journal of Operational Research, Elsevier, vol. 245(2), pages 623-628.
  • Handle: RePEc:eee:ejores:v:245:y:2015:i:2:p:623-628
    DOI: 10.1016/j.ejor.2015.03.014
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    References listed on IDEAS

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    1. Z. Jemai & F. Karaesmen, 2005. "The influence of demand variability on the performance of a make-to-stock queue," Post-Print hal-00126137, HAL.
    2. Terry A. Taylor & Wenqiang Xiao, 2010. "Does a Manufacturer Benefit from Selling to a Better-Forecasting Retailer?," Management Science, INFORMS, vol. 56(9), pages 1584-1598, September.
    3. Jing-Sheng Song, 1994. "The Effect of Leadtime Uncertainty in a Simple Stochastic Inventory Model," Management Science, INFORMS, vol. 40(5), pages 603-613, May.
    4. Jemai, Zied & Karaesmen, Fikri, 2005. "The influence of demand variability on the performance of a make-to-stock queue," European Journal of Operational Research, Elsevier, vol. 164(1), pages 195-205, July.
    5. Andersson, Jonas & Jörnsten, Kurt & Nonås, Sigrid Lise & Sandal, Leif & Ubøe, Jan, 2013. "A maximum entropy approach to the newsvendor problem with partial information," European Journal of Operational Research, Elsevier, vol. 228(1), pages 190-200.
    6. Shuiabi, Eyas & Thomson, Vince & Bhuiyan, Nadia, 2005. "Entropy as a measure of operational flexibility," European Journal of Operational Research, Elsevier, vol. 165(3), pages 696-707, September.
    7. Kwak, Jin Kyung & Gavirneni, Srinagesh, 2011. "Retailer policy, uncertainty reduction, and supply chain performance," International Journal of Production Economics, Elsevier, vol. 132(2), pages 271-278, August.
    8. Xu, Minghui & Chen, Youhua (Frank) & Xu, Xiaolin, 2010. "The effect of demand uncertainty in a price-setting newsvendor model," European Journal of Operational Research, Elsevier, vol. 207(2), pages 946-957, December.
    9. Ebrahimi, Nader & Maasoumi, Esfandiar & Soofi, Ehsan S., 1999. "Ordering univariate distributions by entropy and variance," Journal of Econometrics, Elsevier, vol. 90(2), pages 317-336, June.
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    Cited by:

    1. repec:eee:ejores:v:270:y:2018:i:2:p:723-733 is not listed on IDEAS
    2. repec:eee:proeco:v:193:y:2017:i:c:p:663-676 is not listed on IDEAS

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