An Equilibrium Search Model of Inventory Management

Abstract

We present an equilibrium search model with dynamic inventory and revenue management. Buyers purchase goods produced by sellers through intermediaries. The presence of search frictions creates demand uncertainty and makes instantaneous replenishment impossible. To avoid the risk of stockout, intermediaries hold inventory and employ inventory-based pricing and order strategies. In equilibrium, when its inventory is high, the dealer posts a lower retail price to speed up sales and depresses wholesale price to slow down purchases, generating unimodal steady-state distributions of both inventory holdings and retail prices. Using a dataset that contains detailed information on used car listings, we examine the dynamics of car dealers' inventory, new orders, sales, and retail prices and find evidence supporting the theory. We calibrate the model and show that the proposed mechanism can generate a non-trivial proportion of observed price dispersion.

Keywords: Directed Search, Inventory Management, Revenue Management, Price Dispersion, Used Car, Dealers, Intermediary

JEL Classification: D82, D83, L15, L62