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Concept
Newsvendor model
Summary
The newsvendor (or newsboy or single-period or salvageable) model is a mathematical model in operations management and applied economics used to determine optimal inventory levels. It is (typically) characterized by fixed prices and uncertain demand for a perishable product. If the inventory level is , each unit of demand above is lost in potential sales. This model is also known as the newsvendor problem or newsboy problem by analogy with the situation faced by a newspaper vendor who must decide how many copies of the day's paper to stock in the face of uncertain demand and knowing that unsold copies will be worthless at the end of the day.
The mathematical problem appears to date from 1888 where Edgeworth used the central limit theorem to determine the optimal cash reserves to satisfy random withdrawals from depositors.
According to Chen, Cheng, Choi and Wang (2016), the term "newsboy" was first mentioned in an example of the Morse and Kimball (1951)'s book. The modern formulation relates to a paper in Econometrica by Kenneth Arrow, T. Harris, and Jacob Marshak.
More recent research on the classic newsvendor problem in particular focused on behavioral aspects: when trying to solve the problem in messy real-world contexts, to what extent do decision makers systematically vary from the optimum? Experimental and empirical research has shown that decision makers tend to be biased towards ordering too close to the expected demand (pull-to-center effect) and too close to the realisation from the previous period (demand chasing).
This model can also be applied to period review systems.
Products are separable
Planning is done for a single period
Demand is random
Deliveries are made in advance of demand
Costs of overage or underage are linear
The standard newsvendor profit function is
where is a random variable with probability distribution representing demand, each unit is sold for price and purchased for price , is the number of units stocked, and is the expectation operator.
Official source
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