Why hold inventories

It may not be possible for the company to procure the raw material whenever necessary. There may be a time lag between the demand for the material and its supply. Hence it is needed to hold the raw material inventory. Similarly, it may not be possible to produce the goods immediately after they are demanded by the customers. Hence it is needed to hold the finished goods inventory. Many businesses hold excess stock not because they wish to, but as a side effect of bulk buying.

These discounts will only be worthwhile if the amount of the discount is greater than the increased holding costs from the bulk purchase. Seasonality is another reason for businesses to hold extra inventory. Some industries like tourism and recreation are particularly affected by seasonality, but most businesses will experience some degree of seasonal demand due to the seasonal nature of consumer spending.

Due to this effect, businesses tend to increase their inventory levels ahead of busy periods, as their suppliers need time to meet the increased orders. Inventory is ultimately an investment. Any return on an investment will be greater if the initial price paid for that investment is lower, and therefore your business will be more profitable if you buy inventory at the lowest cost. This means that it may be best to buy and consequently hold more inventory now if the cost is low, rather than risk the price rising in future.

As with bulk buying, this involves some risk: the benefit you receive from buying at the lower cost should exceed any increase in your holding costs. Each of the above is an important consideration when determining your inventory needs.

When taking these into account, be aware that different operations and industries have different needs. If your business operates in an industry with typically volatile or large seasonal change this must be factored into your purchasing decisions.

If you keep the four above considerations in mind, while at the same time taking any specific factors into account, you will give yourself a solid base to plan a sensible level of inventory for your business. Most of the inventory literature has focused on whether the 2nd moment properties of models with these and other motives are consistent with stylized 2nd moment facts in the data.

That literature has largely abstracted from the implications of these motives for the level of inventory holdings. The objective of this paper is to determine if the motives listed above are strong enough to quantitatively account for the observed aggregate level of inventories held in the economy. To address this issue we construct a general equilibrium model of heterogeneous firms. We calibrate the shocks in our model by requiring that the model be consistent with the key 2nd moment properties of the microeconomic data that have been emphasized in the inventory literature.

These include the volatility of sales, the covariance between production and inventory investment, and the volatility and serial correlation of production, all at the industry level.

The model is also calibrated to be consistent with standard growth observations. We estimate the degree of idiosyncratic variation experienced at a fine level of disaggregation. We document that volatility in production increases consistently as data is disaggregated, and that there is considerable diversity in volatility across industries.

We find that: i the average standard deviation of output at the finest digit SIC codes level of aggregation lies in the range of 8 to 20 percent; and ii the average fraction of production variance due to idiosyncratic shocks lies in the range of 78 to 97 percent. Lawrence J.

Christiano, Handle: RePEc:red:sed as. Download full text from publisher To our knowledge, this item is not available for download.