Optimal Capacity Management With Stochastic Market Demand and Imperfect Information

Abstract

Over-capacity has been a major problem in the world economy over the past decade. Reconfigurable capacity, and optimal capacity management policies, can contribute to increased economic stability. This research introduces a new approach to optimal capacity management for a firm faced with uncertainties and imperfect information of the market demand. It presents an optimal policy for the capacity management problem in a firm facing stochastic market demand, based on Markov decision theory. To make the approach more realistic, it is assumed that the firm has imperfect information of its stochastic market demand, and can only observe its previous sales. Optimal policies are presented as boundaries representing the optimal capacity expansion and reduction levels.