Optimal production management when there is regime switching and production constraints

Abstract

AbstractWe study a production problem in which the cumulative consumer demand for an item follows a Brownian motion with drift, with both the drift and the variance parameters modulated by a continuous-time Markov chain that represents the regime. The company wants to maintain the inventory level as close as possible to a target inventory level, but there is a linear cost of production. We assume that the production rate is nonnegative. The company is penalized for deviations from the inventory target level and the cost of production, and the objective is to minimize the total discounted penalty costs. We consider two models. In the first model, there is no upper bound for the production rate, and in the second model there is an upper bound for the production rate. We solve both problems analytically and obtain the optimal production policy and the minimal total expected discounted cost. Our solutions allow us to obtain interesting managerial insights.