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How larger demand variability may lead to lower costs in the Newsvendor Problem

By Ad Ridder, Erwin Van Der Laan and Marc Salomon

Abstract

In this paper we consider the Newsvendor Problem. Intuition may lead to the hypothesis that in this stochastic inventory problem a higher demand variability results in larger variances and in higher costs. In a recent paper, Song (1994a) has proved that the intuition is correct for many demand distributions that are commonly used in practice, such as for the Normal distribution function. However, this paper shows that there exist demand distributions for which the intuition is misleading, i.e., for which larger variances occur in combination with lower costs. To characterize these demand distributions we use stochastic dominance relations. Keywords: Newsvendor problem, demand variability, stochastic dominance. We consider the traditional single-item single-period Newsvendor Problem with continuous product demand. Let the demand D be randomly distributed with distribution function F (\Delta), finite mean ¯ and variance oe 2 . There is an underage cost p and an overage cost h per unit ..

Topics: Newsvendor problem, demand variability
Year: 1996
OAI identifier: oai:CiteSeerX.psu:10.1.1.32.1527
Provided by: CiteSeerX
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