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Inventories, Stock-Outs, and Production Smoothing

  • Andrew B. Abel

If stock-outs are ignored and if demand shocks are additive, then optimal behavior requires that the marginal cost of production (MC) be equated with the expected marginal revenue of increasing expected sales by one unit (EMR). However,with more general demand shocks (and still ignoring stock-outs), the excess of MC over EMP has the same signas the covariance of the slope of the demand curve and the marginal valuation of inventory. The equality of EMR and MC is also broken by taking account of stock-outs, even if demand shocks are additive. If there is a production lag, then taking account of stock-outs implies that optimal behavior will be characterized by production smoothing even if the cost of production is linear. Two alternative definitions of production smoothing are presented and optimal behavior in the presence of stock-outs displays each type of smoothing.

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File URL: http://www.nber.org/papers/w1563.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1563.

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Date of creation: Feb 1985
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Publication status: published as Abel, Andrew B. "Inventories, Stock-Outs, and Production Smoothing." Review of Economic Studies, Vol. 52, (1985), pp. 283-293.
Handle: RePEc:nbr:nberwo:1563
Note: EFG
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  1. Reagan, Patricia B, 1982. "Inventory and Price Behaviour," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 137-42, January.
  2. Zabel, Edward, 1972. "Multiperiod monopoly under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 524-536, December.
  3. Blinder, Alan S, 1982. "Inventories and Sticky Prices: More on the Microfoundations of Macroeconomics," American Economic Review, American Economic Association, vol. 72(3), pages 334-48, June.
  4. Martin Feldstein & Alan Auerbach, 1976. "Inventory Behavior in Durable-Goods Manufacturing: The Target-Adjustment Model," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(2), pages 351-408.
  5. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
  6. Schutte, David P, 1983. "Inventories and Sticky Prices: Note," American Economic Review, American Economic Association, vol. 73(4), pages 815-16, September.
  7. Gould, John P, 1978. "Inventories and Stochastic Demand: Equilibrium Models of the Firm and Industry," The Journal of Business, University of Chicago Press, vol. 51(1), pages 1-42, January.
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