This project examines the behavior of finished goods inventories both from a theoretical, as well as from an empirical perspective. The purpose of this research is to account for the importance of inventory movements in the overall economy and also in specific sectors of the economy. The research is based on an inventory model in which the primary source of uncertainty for producers is the fluctuation in demand for their products. In the model inventories arise because of the need to produce goods in advance of sales, and because of the need to hold some positive level of inventories. This research is important because it will provide a better understanding of inventory and output fluctuations of the firm. The theoretical part of this project will extend the results of the inventory model to a general equilibrium setting that would allow for varying cost structures, intertemporal substitution on the part of consumers, different source and types of shocks to the economy, and the transmission of shocks across sectors of the economy. The empirical work involves testing different versions of the model on inventory, production, and sales data from the U.S. automobile industry, under the assumption of rational expectations. The work will test the implications of the motive to avoid running out of inventories including the basic prediction that beginning inventory stocks are based on efficient forecasts of demand. The model is also useful for identifying the effects of interest rates and other factor prices on inventory investment.
