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

This paper develops a generalized q-model in which a monopolist with perfect foresight holds inventories. This model permits an analysis of the dynamics of inventories in the presence of various types of deterministic demand and supply shocks. The results suggest that if only positive inventories are allowed, inventories are more successful in smoothing expected upward than downward variations in demand. If unfilled orders are permitted, then production smoothing accompanies any type of demand shock, but inventories are generally negative. The estimation of the linear quadratic model on data generated using the two versions of the generalized q-model shows that incentives to smooth production appear only when the firm is allowed to have negative inventories.