Essay on Firm Inventory and Innovation Behavior

This dissertation studies firm’s decisions on inventory investment and innovation activities. The first chapter examines firm inventory behavior. It resolves and simulates the production smoothing/buffer stock model using different sets of parameters. It shows that the relationship between a sales shock and inventory investment could be ambiguous which is different from previous predictions. The production smoothing/buffer stock model and the (S, s) model of inventory are tested using a rich Chinese firm-level dataset covering 769 manufacturing firms from 1980 to 1989, and I find that sales are positively correlated with inventory for raw materials, but negatively correlated with finished goods inventory in most cases. These findings are consistent with the theoretical predictions from the production smoothing/buffer stock model and the (S, s) model, contradicting previous test results. The second chapter examines the relationship between process innovation and market competition. I find that increased competition will shrink the demand facing each firm, and firms will have less incentive for process innovation whether the innovation outcome is deterministic or stochastic. However, when the number of firms in the market is proportional to the demand and both increase, then increased price elasticity will induce firms to devote more effort to conduct process innovation when innovation is deterministic; and under the stochastic case an inverted-U shape relation between innovation effort and market competitiveness is identified. Furthermore, when the number of firms is endogenous, the innovation incentive grows with the size of the market.