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Inventories, Stock-Outs, and Production Smoothing

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  • Andrew B. Abel

Abstract

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.

Suggested Citation

  • Andrew B. Abel, 1985. "Inventories, Stock-Outs, and Production Smoothing," NBER Working Papers 1563, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1563
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    1. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-681, September.
    2. Schutte, David P, 1983. "Inventories and Sticky Prices: Note," American Economic Review, American Economic Association, vol. 73(4), pages 815-816, September.
    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 334-348, June.
    4. 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.
    5. 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.
    6. Zabel, Edward, 1972. "Multiperiod monopoly under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 524-536, December.
    7. Patricia B. Reagan, 1982. "Inventory and Price Behaviour," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 137-142.
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    Cited by:

    1. Ward Brown, 2000. "Financing Constraints and Inventories," FMG Discussion Papers dp367, Financial Markets Group.
    2. GĂ©rard P. Cachon & Taylor Randall & Glen M. Schmidt, 2007. "In Search of the Bullwhip Effect," Manufacturing & Service Operations Management, INFORMS, vol. 9(4), pages 457-479, April.
    3. Di Ubaldo, Mattia, 2016. "Firms and trade in downturns," Economics PhD Theses 0416, Department of Economics, University of Sussex.
    4. Kenneth D. West, 1993. "Inventory Models," NBER Technical Working Papers 0143, National Bureau of Economic Research, Inc.
    5. Hau L. Lee & V. Padmanabhan & Seungjin Whang, 2004. "Information Distortion in a Supply Chain: The Bullwhip Effect," Management Science, INFORMS, vol. 50(12_supple), pages 1875-1886, December.
    6. Marcel Fafchamps Jan Willem Gunning & Remco Oostendorp, "undated". "Inventories, Liquidity, and Contractual Risk in African Manufacturing," Working Papers 97020, Stanford University, Department of Economics.
    7. Zhiwei Xu & Yi Wen & pengfei Wang, 2012. "When Do Inventories Destabilize the Economy? ---A Tractable Approach to (S,s) Policies," 2012 Meeting Papers 288, Society for Economic Dynamics.
    8. Mattia Di Ubaldo, 2015. "Product Cost-Share: a Catalyst of the Trade Collapse," Working Paper Series 8015, Department of Economics, University of Sussex.
    9. Guariglia, Alessandra, 1999. "An analysis of the inventory behavior in a q-theoretic framework," International Journal of Production Economics, Elsevier, vol. 58(2), pages 131-146, January.
    10. Sreekumar Bhaskaran & Karthik Ramachandran & John Semple, 2010. "A Dynamic Inventory Model with the Right of Refusal," Management Science, INFORMS, vol. 56(12), pages 2265-2281, December.

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