Optimal lot size, inventories, prices and JIT under monopolistic competition

Abstract

This paper attempts to demonstrate that the disciplines of operations research/management science (OR/MS) and economics are complementary by drawing on both in analyzing the effects of the introduction of just in time (JIT) on prices and product variety. From the discipline of OR/MS I draw on the Optimal Lot Size Model. From the discipline of economics I borrow the theory of monopolistic competition. The model of monopolistic competition recognizes the significance of product differentiation: Because no two firms in a monopolistic competitive industry produce exactly the same product, the demand curve confronting each producer is downward sloping, like monopoly. Because of free entry and exit, economic profits are driven to zero in the long run, like perfect competition. This paper introduces inventories into the model of monopolistic competition by incorporating optimized setup and inventory carrying costs into the representative firm's total cost function. I show that the adoption of JIT, implemented by reengineering the product so as to drastically reduce or eliminate setup costs, benefits consumers, at least in the long run: competitive forces mean that the adoption of JIT leads to both a reduction in price and an increase in the variety of products offered in the marketplace. But alas, the rewards to the innovating business firm are only transitory. Free entry drives economic profits back to zero for both the innovating and the imitating firms.