Policy Analysis: Stabalizing the Firm

C. Policy Analysis: Stabilizing the Firm

a.

Generally speaking, stability in terms of the firm is simply consistency. Most firms base major decisions on some of the key parameters in this model. To maintain stability, a firm desires to keep standard deviations of these parameters low. Additionally, a stable firm wants to be able to maintain real numbers that are close to desired or projected numbers. For example, how much warehouse space needs to be rented may depend on what the inventory levels are predicted to be for the next year. Or perhaps how many employees to keep employed might rely on the model’s projected labor force – after all, it is expensive for a company to keep too many employees but could be even more costly not to have enough on hand to fulfill production requirements. It is a firm’s nightmare to see dramatic fluctuations in key parameters. The table below lists the effect that discrepancies in some of the more important parameters might have on a firm that is striving for stability.

Parameter Effect on Firm

Inventory If inventory strays significantly from desired inventory, the firm will be continually making production adjustments. As mentioned above, inventory levels have a dramatic impact on the firm. If inventory levels are higher than desired, the firm will have to pay for costly warehouse space. If inventory levels are much lower than desired, the firm will lose revenue in the form of lost orders. Additionally, the production rate and labor force are impacted by inventory levels.

Production vs. Customer Orders If the order rate fluctuates, the production rate will fluctuate as well. However, the issue becomes that due to the delays in the system, the production rate fluctuations are magnified. Discrepancies in customer order rate can have a significant impact on the inventory levels, production rate, and labor force. Depending on the level of sensitivity in the adjustment times, these changes could lead to product shortages/overages and end up being very costly to the firm.

Periodicity of Flucuations The amount of time it takes for a period of a fluctuation, that is how frequent the fluctuations are, will certainly impact the stability of a firm. After all, long-term fluctuations are merely trends. It is the fluctuations with short periodicity that should be of a concern to a firm. If the firm is seeing that key parameters have extremely high standard deviations, it will have a huge impact on the consistency of the system and could be quite harmful to the firm. The worst example of this is an oscillating parameter, in which the average value may be where the firm wants it to be, but the real values are all over the charts. This makes planning and predicting such as budgeting nearly impossible.

Equilibrium The longer it takes the firm to return to equilibrium, the more trouble that particular firm is. Clearly, a short amount of time to return to equilibrium will allow a firm to maintain stability. If it takes a significant amount of time to return to equilibrium the firm’s key parameters are likely out of alignment and a change needs to be made somewhere.

b.

In order to stabilize the system, the Time to Adjust Inventory should be increased. We predict that if the firm is more flexible about bringing its inventory in balance with the desired level – that is, if the time to adjust inventory is higher – it will stabilize the firm. A shorter time to adjust inventory means that the firm must act more dramatically and at a higher