A rational expectations equilibrium model of inventories of finished goods and employment

A critical roadblock to modeling inventories of finished goods has been the claim that the production and inventory decisions of a perfectly competitive firm are determined independently of each other. A basic goal of this study is to specify fundamental preferences of economic agents, technologies, constraints and market structures that are, in a rough way, capable of generating patterns of serial correlations and cross correlations between inventories and employment of factors of production that are consistent with those observed in the data. The claim is made that the time series for inventories, output and employment can, in principle, be interpreted as emerging from a well-specified dynamic, stochastic competitive equilibrium in which economic agents are assumed to form rational expectations about variables not included in their information sets. Inventories and employment will not be related in a direct way if and only if the price elasticity of demand for output is equal to infinity.