According to the production-smoothing buffer stock model, inventories of a firm’s
products allow it to supply unexpected demand without having to adjust output
immediately. When costs per additional unit produced are increasing, using
inventory to smooth production is efficient as long as the savings from not
adjusting production exceed the cost of holding inventory. Inventory acts as a
buffer stock, absorbing increases or decreases in demand while production
remains relatively steady.
If firms are smoothing production, then sales should vary more than
production. If inventories are used as a buffer stock, then high-frequency
changes in inventory should be in the opposite direction to sales. Empirical
research using aggregate data does not confirm this expectation, however;
production varies more than sales, and changes in inventory and sales tend to
vary in the same direction. Thus either the production-smoothing buffer stock
model is incorrect, or other factors ere preventing empirical confirmation of the
smoothing effect.
Most of the research that finds contradictions of production smoothing uses
seasonally adjusted aggregate data concerning inventory and sales. It is possible
that firms actually do use inventory to smooth production, but the research has
failed to detect signs of this activity because the data are too highly aggregated
over many firms. But even research at the level of individual companies has
failed to confirm the model.
