An analysis of the inventory behavior in a q-theoretic framework

This paper develops a generalized q-model in which a monopolist with perfec t foresight holds inventories. This model permits an analysis of the dynami cs of inventories in the presence of various types of deterministic demand and supply shocks. The results suggest that if only positive inventories ar e allowed, inventories are more successful in smoothing expected upward tha n downward variations in demand. If unfilled orders are permitted, then pro duction smoothing accompanies any type of demand shock, but inventories are generally negative. The estimation of the linear quadratic model on data g enerated using the two versions of the generalized q-model shows that incen tives to smooth production appear only when the firm is allowed to have neg ative inventories. (C) 1999 Elsevier Science B.V. All rights reserved.