Resumen de Inventories and Price Volatility in a Dynamic Cournot Duopoly

Henry Thille

• Inventories can have strategic effects on sales and production in a Cournot duopoly with convex production costs. I examine the feedback equilibrium of an infinite horizon game in which firms face uncertain demand and supply.

  They can use inventories to buffer the effects of the random variables. The strategic use of inventories can lead to more or less volatile prices depending on the source of the uncertainty. In particular, prices are more volatile when the uncertainty is primarily due to randomness in demand and less volatile when the uncertainty is primarily due to randomness in costs.

  Inventories have strategic value because they can represent a relatively inexpensive source of supply for a firm that faces increasing marginal costs of production. Inventories are not costless, they must have been produced at some point in the past, and the firm incurs a cost to store them. As these costs are sunk at the beginning of a period, a firm that holds inventories lowers its cost of sales in that period by selling from inventories. In a Cournot game, this lower cost of sales results in increased sales and profit for the firm using the inventories and reduced sales and profit for the other firm.

  The game is a Linear Quadratic one in which firms observe the current state of demand and cost at the beginning of a period. Once the current demand and cost is known, firms choose that period�s production and sales quantities with the residual production added to the firms stock of inventories to carry to the next period. I show that the average level of sales and output price are the same as occur in the static Cournot game. This occurs because the strategic effects manifest themselves through changes in inventories, which are zero on average.

  However, the inventories do not respond as strongly to the random demand and cost realizations as they do when strategic considerations are absent (such as with perfectly competitive firms or a two-plant monopolist). This reduces smoothing of random fluctuations leads to increased price response to demand shocks and decreased price respond to cost shocks.