Quality and inventory issues within the newsboy problem

Most inventory models assume that the production lot size does not contain any defectives. Clearly, this assumption does not reflect the reality of most manufacturing systems. The number of defects in a production lot depends on the manufacturing technology implemented by the firm. In this paper the authors study the decision of a firm seeking to replace its existing manufacturing technology with an improved one. Furthermore, they study the effect the quality of the technology has on the optimal production lot size. In this paper, the authors formulate a two-stage stochastic programming problem. In the second stage, the optimal production lot size is derived for a given manufacturing technology and a given demand forecast. This derivation is provided under the framework of the one-period inventory problem while maintaining a minimal service level. In the first stage, and using the optimal production lot size of the second stage problem, an optimal manufacturing technology that minimizes the total expected cost to the firm is implemented. An algorithm to find an optimal solution is presented. A numerical example illustrates the results.