Production and Price Smoothing by Inventory Adjustment?

The present paper examines the role of inventories for the short run adjustment behavior of firms. A theoretical model of a monopolistic firm carrying inventories that includes costs of adjusting output is examined. The model is tested empirically by using business survey data collected by the IFO-Institute, Munich. It is shown, that if data on individual firms are used and econometric estimation techniques are applied that properly take into account, the estimates derived are fully compatible with the appealing idea of production smoothing by inventories.