Impact of Uncertainty and Risk Aversion on Price and order Quantity in the Newsvendor Problem

Vipul Agrawal, Sridhar Seshadri

Research output: Contribution to journalArticlepeer-review

Abstract

We consider a single-period inventory model in which a risk-averse retailer faces uncertain customer demand and makes a purchasing-order-quantity and a selling-price decision with the objective of maximizing expected utility. This problem is similar to the classic newsvendor problem, except: (a) the distribution of demand is a function of the selling price, which is determined by the retailer; and (b) the objective of the retailer is to maximize his/her expected utility. We consider two different ways in which price affects the distribution of demand. In the first model, we assume that a change in price affects the scale of the distribution. In the second model, a change in price only affects the location of the distribution. We present methodology by which this problem with two decision variables can be simplified by reducing it to a problem in a single variable. We show that in comparison to a risk-neutral retailer, a risk-averse retailer in the first model will charge a higher price and order less; whereas, in the second model a risk-averse retailer will charge a lower price. The implications of these findings for supply-chain strategy and channel design are discussed. Our research provides a better understanding of retailers' pricing behavior that could lead to improved price contracts and channel-management policies.

Original languageEnglish (US)
Pages (from-to)410-423
Number of pages14
JournalManufacturing and Service Operations Management
Volume2
Issue number4
StatePublished - Dec 1 2000
Externally publishedYes

Keywords

  • Demand Uncertainty
  • Inventory
  • Pricing
  • Risk Aversion

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research

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