Probabilistic Inventory Models

(Part III)

Sasadhar Bera, IIM Ranchi

Outline
Probabilistic Model
Single period Discrete demand

Single period Continuous demand

Sasadhar Bera, IIM Ranchi

Introduction
The major influencing factors for the inventory decisions
are price, demand, and lead time.
Other factors such as ordering cost, carrying cost, and
stock-out cost are also affecting the inventory decisions but
their nature is not so much disturbing.
Sometimes price fluctuations are too much in the market
and hence it influences inventory decisions. Similarly,
variability in demand or consumption of an item as well as
the variability in lead time influence the overall inventory
policy.

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Probabilistic Inventory Models

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Probabilistic Inventory Models

Probabilistic inventory models:
I.

Single period probabilistic models: The single period

inventory model applies to inventory situations in which
only one order is placed for goods in anticipation of a
future selling season where demand is uncertain. At the
end of the period the product has either sold out or
there is a surplus of unsold items to sell at salvage
value.

II. Multi-period probabilistic models: Multi-period

inventory models are usually addressed in finding the
minimum expected cost over N periods. In these
models both demand and lead time are uncertain.
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Single Period Probabilistic Models

In single period inventory situation, the only question is
how much of the product to order at the start of the period.
Newspaper sales are a typical example of the single period
model. Thus the single period inventory problem is
sometimes referred to as the newsvendor problem.

These models deal with inventory situation of the items

such as perishable goods, spare parts, and seasonal goods
requiring one time purchase only.

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Single Period Probabilistic Models (Contd.)

Applications of single period model:
i.

Order size of Periodicals, such as newspapers and magazines.

ii.

Order size seasonal greeting cards.

iii. Order size Christmas trees.

iv. Seasonal clothing, such as winter coats, where any goods

remaining at the end of the season must be sold at highly
discounted prices to clear space for the next season.
v.

Vital spare parts that must be produced during the last

production run of a certain model of a product (e.g., an airplane)
for use as needed throughout the lengthy field life of that model.

vi. Reservations provided by an airline for a particular flight.

vii. Reservations of hotel room.

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Single Period Probabilistic Models (Contd.)

The demand for such item may be discrete or continuous.
Since for a given period, purchase of item is made only once,
the lead time factor is least important in these models. In
such cases, there are two types of costs involved:
Over-stocking cost: Loss due to excess stocks
Under-stocking cost: Opportunity losses due to high demand
D = Demand of an item in units (a random variable)
Q = the number of units stocked (or to be purchased)
P = Purchase price per unit
S = Selling price per unit
Ch = Carrying cost or holding cost per unit for entire period
Cs = Shortage cost per unit
V = Salvage value per unit
Sasadhar Bera, IIM Ranchi

Single Period Probabilistic Models (Contd.)

Co = Over-stocking cost per unit
= Loss associated with each unit left unsold
= P + Ch V
Cu = Under-stocking cost per unit
= Loss due to not meeting demand
= S P + Cs
The single period can be solved using a technique called
marginal economic analysis, which compares the cost or
loss of ordering one additional item with the cost or loss of
not ordering one additional item.
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Single Period Discrete Demand Model

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Single Period Discrete Probabilistic Models

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Single Period Discrete Probabilistic Models (Contd.)

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Example: Discrete Demand Probability

Example: Demand follows discrete distribution
A newspaper boy buys papers for Rs. 2 each and sells them
for Rs. 2.50 each. He cannot return unsold newspapers.
Daily demand has the following distribution
Nos of
customers
Probability

230 240 250 260 270 280 290 300 310 320
0.01 0.03 0.06 0.10 0.2 0.25 0.15 0.1 0.05 0.05

If each days demand is independent of the previous days

demand, how many papers should he order each day?

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Example: Discrete Demand Probability (Contd.)

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Single Period Continuous Demand Model

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Single Period Continuous Probabilistic Models

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Single Period Continuous Probabilistic Models (Contd.)

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Example: Continuous Demand Probability

Example: Demand follows uniform distribution
An item sells for Rs. 20 per unit and cost Rs. 10. Unsold
items can be sold for Rs. 4 each. It is assumed that there
is no shortage penalty cost besides the lost revenue. The
demand is known to be any value between 500 and 1200
items. Determine the optimal number of units to the
item to be stocked.

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Example: Continuous Demand Probability (Contd.)

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Example: Continuous Demand Probability (Contd.)

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