What Inventory Behavior Tells Us about Business Cycles

Mark Bils, James A. Kahn
1999 Social Science Research Network  
The countercyclical pattern of inventory-sales ratios is a striking feature of inventory behavior. In a model where inventories are productive for sales, both the markup of price over marginal cost and expected changes in marginal cost are key determinants of that ratio. This paper argues that costly variation in factor utilization gives rise to countercyclical markups in production-to-stock manufacturing industries. The markup turns out to be more important than intertemporal substitution in
more » ... l substitution in explaining the behavior of inventory-sales ratios. JEL ( E22, E32) Researchers have studied inventory behavior because it provides clues to the nature of business cycles. Many have viewed the procyclical behavior of inventory investment as evidence that costs of producing are lower in an expansion because it suggests that firms bunch production more than is necessary to match the fluctuations in sales. If short-run marginal cost curves were fixed and upward sloping (the argument goes), firms would smooth production relative to sales, making inventory investment countercyclical. Countercyclical marginal cost 1
doi:10.2139/ssrn.935322 fatcat:dm34em26ybbmtjaqcoby6xg2pu