ARTICLE IN PRESS

Int. J. Production Economics 120 (2009) 139–150

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Int. J. Production Economics

journal homepage: www.elsevier.com/locate/ijpe

Joint inventory allocation and pricing decisions for

perishable products
Ek Peng Chew a, Chulung Lee b,, Rujing Liu a
a
Department of Industrial and Systems Engineering, National University of Singapore, 10 Kent Ridge Crescent, Singapore 119260, Singapore
b
Division of Information Management Engineering, Korea University, Anamdong 5-ga, Seongbuk-gu, Seoul 136-713, Republic of Korea

a r t i c l e in fo abstract

Article history: We jointly determine the price and the inventory allocation for a perishable product
Received 1 September 2007 with a predetermined lifetime. We assume that the price of the product increases as the
Accepted 1 July 2008 time when it perishes approaches as in the airline industry. Demand for the product is
Available online 17 October 2008
price sensitive. To maximize the expected revenue, we developed a discrete time
Keywords: dynamic programming model to obtain the optimal prices and the optimal inventory
Pricing allocations for the product with a two period lifetime. We, then, proposed three
Inventory allocation heuristics when the lifetime is longer than two periods. The computational results
Revenue management showed that the expected revenues from the proposed heuristics were very close to that
Perishable products
of the optimal solution. We extended these results to (i) the case where the price for the
Periodic review
product consistently decreases; and (ii) the case where the price for the product first
increases and later decreases.
& 2008 Elsevier B.V. All rights reserved.

1. Introduction Studies of pricing strategies in revenue management

There has been very little published research on joint
capacity allocation and pricing decisions in revenue
management literature. Traditional approaches have as-
sumed that prices are fixed and only the optimal
allocation quantities are computed. For example, airlines
charge different prices for seats on the same flight. Given
the fixed prices, the booking limit for each fare class is
determined and implemented in airline reservation
systems. An effective application of fare class booking
limits allows airlines to generate incremental revenues
(Belobaba, 1989). However, the prices charged for different
fare classes would influence demand and should be
considered decision variables. The integration of pricing
and inventory allocation decisions should receive more
attention (McGill and van Ryzin, 1999).
 Corresponding author. Tel.: +82 2 3290 3395; fax: +82 2 929 5888.
E-mail address: leecu@korea.ac.kr (C. Lee).
were motivated by research on production-pricing pro-
blems. Single period pricing models have been developed
by Whitin (1955), Mills (1959), Karlin and Carr (1962),
Hempenius (1970), Teng et al. (2007) and Abad (2008), Li
(1988) proposed a continuous time model where demand
is a controlled Poisson process. Gallego and van Ryzin
(1994) developed a continuous time model for perishable
products under the assumption of no inventory replen-
ishment. They obtained an upper bound for the expected
revenue from the deterministic demand and used this
bound to prove that a simple static pricing strategy is
asymptotically optimal as the volume of expected sales
goes to infinity. Feng and Gallego (1995) investigated the
optimal timing of a single price change from a given initial
price to either a given lower or higher second price.
They also discussed Markovian demand and fares (Feng
and Gallego, 2000). Feng and Xiao (1999, 2000a) gene-
ralized the two-price model to consider risk preference
and multiple prices. Independently, Chatwin (2000) and
Feng and Xiao (2000b) considered a continuous-time,

0925-5273/$ - see front matter & 2008 Elsevier B.V. All rights reserved.
doi:10.1016/j.ijpe.2008.07.018
 ARTICLE IN PRESS
140 E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150

dynamic pricing problem where prices have to be and full-price reservations, lost or turned-down
selected from a finite set of prices and provided reservations, no group reservations, no diversion or
a systematic analysis of the pricing policy and the displacement, no bumping procedure (there is no over-
expected revenue. booking), effectively nested asset control, and a dynamic
The literature on capacity allocation decisions assumes decision rule.
that prices are exogenously determined and consider The remainder of this paper is organized as follows: In
a pure inventory problem. A two class, single leg Section 2, we present the assumptions and notation.
seat inventory control problem was considered by Little- A discrete time dynamic programming model is then
wood, 1972. He proposed a marginal seat revenue developed. In Section 3, we first consider the product with
principle where booking requests from a lower fare class a two period lifetime. The optimal price and the optimal
can be rejected if the seat can be sold later in a higher inventory allocation are obtained. For the product with a
fare class. Bhatia and Parekh (1973) and Richter (1982) lifetime of longer than two periods, three heuristics are
employed the marginal seat revenue principle to proposed to determine the prices and the inventory
determine the optimal booking limits in a nested fare allocations. Computational results are provided in
inventory system. Belobaba (1987, 1989) extended Little- Section 4. Two different extensions for the model are
wood’s principle to multiple-fare classes and proposed discussed in Section 5.
an expected marginal seat revenue (EMSR) method.
The EMSR method did not produce the optimal booking
limits except for two fare classes; however, more 2. A discounted stochastic dynamic programming model
classes are easy to implement. The methods for obtain-
ing the optimal booking limits for a single flight leg
We consider a perishable product with an M period
were developed by Curry (1990), Wollmer (1992) and
lifetime where MX2. Index k ¼ 1,y,M denotes the ages of
Brumelle and McGill (1993). These studies also showed
the products. A periodic review policy is assumed. The
that Belobaba’s heuristics is sub-optimal. A through
initial inventory level Q (e.g. the seat capacity in an
review for perishable assets revenue management
airplane) is given at the beginning of Period 1. No
can be founded in Weatherford and Bodily (1992).
replenishment is allowed throughout the lifetime. At
Independently, Liang (1999) and Feng and Xiao
Period k, only the product of age k is sold. The price for
(2001) studied a continuous-time, dynamic seat inven-
the product at Period k is represented by pk. Demand for
tory control problem. They proved that a threshold
the product in Period k is denoted by tk following a
control policy is optimal. Zhao and Zheng (2000)
stochastic additive demand function t k ¼ mðpk Þ þ k for
considered a more general airline seat allocation
k ¼ 1,y,M.
model that allows diversion upgrade and no-shows.
m(pk) is the mean demand at Period k and
They showed that a similar threshold control policy
mðpk Þ ¼ bk  ak pk , where ak ; bk X0. ek is an i.i.d. random
is optimal.
variable with a known probability density function f k ðk Þ
In this paper, we describe the development of a
and is bounded in ½min max
k ; k . In addition Eðk Þ ¼ 0.
discrete time dynamic programming model to deter-
The linear demand function has its limitations because
mine the price and the capacity allocation for a perishable
it assumes that the expected demand is a strictly linear
product without replenishment. A periodic review
function of the price. However, this demand function has
policy is employed. The price for the product is assumed
been employed extensively in literature relating to pricing
to increase as the time when the product perishes
and inventory problems (Abad, 1996; Birge et al., 1998;
approaches, as in the airline industry. Similar assum-
Lau and Lau, 1988; Polatoglu, 1991; Thowsen, 1975).
ptions apply to rooms at hotels, cabins on cruise
The additional notation employed in this paper is:
liners, and cars at rental agencies (McGill and van
Ryzin, 1999; Weatherford and Bodily, 1992). In order
Sk inventory assigned to satisfy demand in Period k
to consider more general cases, this assumption is
xk inventory level at the beginning of Period k,
relaxed in Section 5. The expected demand for the product
x1 ¼ Q
is a linear function of the price. At the beginning of
a one period discounted factor
each period, given the inventory level of the product,
the optimal price and the optimal capacity allocation
pk is confined to the finite interval ½pmin max
k ; pk  where
are determined for the objective of maximizing the
pk obk þ k =ak . The upper bound pk prevents nega-
max min
 max
expected revenue.
tive demands. Moreover, price intervals at different
In the context of the taxonomy of revenue manage-
periods are non-overlapping with p1 o    opM .
ment problems, proposed by Weatherford and Bodily
If tk 4Sk , the excessive demand is lost.
(1992), the problem, we studied and described in this
We developed a dynamic programming model that
paper, is considered an A1-B1-C3-D1-En-F3-G1-H1-I1-
computes the expected revenue over M periods.
J1-K1-L1-M2-N3 PRAM problem, i.e., discrete resource,
Vk(xk) the maximum expected revenue for the remain-
fixed capacity, prices that are set jointly with the
ing periods when starting at Period k and with the
allocation decision, buildup willingness to pay (relaxed
inventory xk, is computed:
in the extension), as many discount price classes as
there are prices, random and independent reservation V k ðxk Þ ¼ Max½jk ðxk ; pk ; Sk Þ þ aEðV kþ1 ðxkþ1 ÞÞ
demand, a certain show-up of people with discount pk ;Sk
 ARTICLE IN PRESS
E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150 141

where jk ðxk ; pk ; Sk Þ represents the expected revenue at Proof.

Period k and jk ðxk ; pk ; Sk Þ ¼ pk E½minðt k ; Sk Þ.
J 1 ðx1 ; p1 ; S1 Þ ¼ j1 ðx1 ; p1 ; S1 Þ þ aE½V 2 ðx2 Þ
The recursive function for the inventory level is Z 1
xkþ1 ¼ ½xk  Sk þ ðSk  tk Þþ . ¼ p1 Eðt 1 Þ  p1 ðt 1  S1 Þf ðt 1 Þ dt
xk and Vk(xk) are computed recursively backward in "Z
S1

time starting from Period M to Period 1. The boundary S1

þa V 2 ðQ  t 1 Þf ðt 1 Þ dt
condition V M ðxM Þ ¼ MaxpM ½jM ðxM ; pM Þ is the maximum 0
expected revenue at Period M for a given xM where Z 1 
SM ¼ xM. Conversely, V 1 ðx1 Þ ¼ Maxp1 ;S1 ½j1 ðx1 ; p1 ; S1 Þ þ þ V 2 ðQ  S1 Þf ðt 1 Þ dt p1 Eðt 1 Þ
S1
aEðV 2 ðx2 ÞÞ is the maximum expected revenue over M Z max
periods when the initial inventory in Period 1 is Q, ¼  p1 ðb1  a1 p1 þ 1  S1 Þf ð1 Þ d
i.e., x1 ¼ Q. S b þa p
"Z 1 1 1 1
S1 b1 þa1 p1
þa V 2 ðQ  b1 þ a1 p1  1 Þf ð1 Þ d
min
3. Joint pricing and inventory allocation decisions Z max #
þ V 2 ðQ  S1 Þf ð1 Þ d
In this section, we first consider a product with a two S1 b1 þa1 p1
period lifetime. We obtain the optimal prices and the
The first order derivative of J 1 ðx1 ; p1 ; S1 Þ with respect to
optimal inventory allocations. After that, we analyze a
S1 is computed as follows:
more general problem, where the lifetime of the product
Z max
is longer than two periods. qJ 1
¼ ½p1  V 02 ðQ  S1 Þf ð1 Þ d1
qS1 S1 b1 þa1 p1

3.1. When the lifetime of the product is two periods
The optimal prices and the optimal inventory alloca-
tions are obtained by solving the dynamic programming
model developed in Section 2. We start from the last
period and employ backward recursive induction.
For Period 2, the noise variable e2 is assumed to follow
an IFR distribution (has an increasing hazard rate), where
the hazard rate l(e2) is defined by f 2 ð2 Þ=ð1  F 2 ð2 ÞÞ. The
unsold products at the end of the last period are of no
salvage value. The optimal price p2* satisfies the following
optimality properties:
Lemma 1. At Period 2,
From Lemma 1, V 2 ðx2 Þ is monotonically increasing with
respect to x2. In addition, V 2 ð0Þ ¼ 0 can be obtained from
(A.12) (see Appendix A). Hence, there exists a unique S1*
that satisfies p1  V 02 ðQ  S1 Þ ¼ 0, given a particular
p1. &
From Theorem 1, the optimal allocation S1* is unique for
a given p1. We assume that only a finite set of prices is
applicable (in practice, prices usually take discrete values
in a bounded interval). A procedure to compute the
optimal p1* and S1* is provided:
(1) Compute the S1* that maximizes J 1 ðx1 ; p1 ; S1 Þ for every
p1 in ½pmin max
1 ; p1 .

(i) The expected revenue J2 ðx2 ; p2 Þ is concave with respect
to p2 for a given x2.
(ii) The optimal price p2* is a non-increasing function of x2
under the condition that lð2 ÞX1=a2 pmin2 .
(iii) The maximum expected revenue V2(x2) is concave with
respect to x2.
(iv) The maximum expected revenue V2(x2) monotonically
increasing with respect to x2.
Proof. See Appendix A.
The concavity of J2 ðx2 ; p2 Þ with respect to p2 for a given
x2 enables efficient algorithms such as a gradient search to
be employed to obtain p2*.
Let V 02 ðx2 Þ denote the first order derivative of V2(x2)
with respect to x2; J 1 ðx1 ; p1 ; S1 Þ stands for the total
expected revenue for the two periods. Once p2*
and V2(x2) are obtained, the following theorem computes
the optimal inventory allocation S1* to maximize
J 1 ðx1 ; p1 ; S1 Þ.
Theorem 1. Given p1, there exists a unique S1* that
maximizes the expected revenue J 1 ðx1 ; p1 ; S1 Þ.
Select p1* and S1* with the maximum J 1 ðx1 ; p1 ; S1 Þ.
3.2. Proposed heuristics for MX3
When the lifetime of the product is longer than two
periods, it is hard to efficiently obtain optimal prices and
the optimal inventory allocation from the dynamic
programming model. As the concavity of J 1 ðx1 ; p1 ; S1 Þ with
respect to S1 does not always hold, the optimal solutions
have to be computed by enumeration. Thus, the solution
time may be too long to be of practical interest. To
overcome this problem, we propose three heuristics to
compute the prices and the inventory allocations.
3.2.1. Heuristic 1 (H1)
In order to develop simple heuristics, we first assume
that the inventory allocated to a period is not carried
forward to the next period even if there is an excess of
inventory. Under this assumption, the revenue at each
period is independent and determined by the amount of
the inventory allocation for the period and its prices. Thus,
the problem is to determine how much inventory to be
allocated for each period and how to price it. The optimal
 ARTICLE IN PRESS
142 E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150
inventory allocation and the optimal price at each period
can be obtained from Lemma 1. Denote Rk ðxk Þ as the
optimal revenue for a given inventory level xk at Period k.
The solution approach is:
(1) Compute Rk ðxk Þ for each xk ¼ 1,y,Q and k ¼ 1,y,M.
P PM
(2) Solve Maxx1 ;...;xM M 
k¼1 Rk ðxk Þ subject to k¼1 xk ¼ Q and
the solution xk* (k ¼ 1,y,M) is the optimal inventory
allocation Sk for the corresponding period.
(3) Compute the optimal price pk* (k ¼ 1,y,M) that
maximizes the expected revenue at each period from
Lemma 1.
Note that the above mathematical programming pro-
blem can be solved efficiently by dynamic programming.
To obtain a better solution, we can implement these
heuristics on a rolling time horizon basis; after the end of
each period when demand has been realized, given the
known remaining inventory level, the mathematical
programming problem is solved again to obtain the new
prices and inventory allocations for the remaining periods.
3.2.2. Heuristic 2 (H2)
Drawing on insights from the two period problem
analyzed in Section 3.1, simple heuristics are provided to
determine the allocation and the price at each period. The
algorithm starts from the last period. This is because the
customers at the last period will pay a higher price and
this demand should be satisfied with a higher priority. The
inventory allocation and the price for Period M, pM, and SM
are first computed by solving a two period problem for
Periods M1 and M. With the remaining capacity QSM,
the inventory allocation and the price for Period M1 are
determined then again by solving a two period problem
for Periods M2 and M1. Similarly, Sk and pk for Period k,
where k ¼ M2,y,3 are computed by solving a two
period problem for Periods k1 and k. Finally, S1, S2, p1,
and p2 are simultaneously determined.
3.2.3. Heuristic 3 (H3)
Denote Bjk as the optimal protection level for Period j
from Period k and Gk(  ) as the cumulative density
function for tk, where t k ¼ mk ðpk Þ þ k and ek has a known
probability density function f k ðk Þ.
At the beginning of Period k (k ¼ 1,y,M), we first
obtain the prices for the remaining Mk+1 periods
(pk,y,pM) from H2 where pko?opM. Given the prices,
the inventory allocation at Period k is then computed:
(1) Start from j ¼ M.
Compute Bjk that satisfies Bjk ¼ G1 j ½1  pk =pj  for all
koj.
Similarly, for j ¼ M  1; :::; k þ 1, compute Bjk for all
koj.
(2) From Bjk obtained in (1), the inventory allocation for
P j
Period k is obtained from Sk ¼ Maxð0; Q  M j¼kþ1 Bk Þ.
At the end of Period k (after tk has been realized), with
the remaining inventory, the above procedure is repeated
to determine the price and the inventory allocation for the
next period.
The proposed methodology is motivated by the EMSR
method (Belobaba, 1989). However, in the EMSR method,
the price at each period is predetermined and given, while
in our heuristics, the price is dynamically obtained from
H2 at the beginning of each period.
3.2.4. Computational complexity of the proposed algorithm
The computational complexity of the exact algorithm
(the dynamic programming model) is determined by
the number of stages and the number of states to be
considered in each stage. In each stage, all the possible
inventory allocations must be considered to compute
the corresponding revenue. Thus, the number of states in
each stage is O(Q). We repeat this for every stage where
the number of stages is M (product’s lifetime). Thus, the
computational complexity of the exact algorithm is O(QM).
The computational complexity of H1 (the first heuristic
algorithm) is O(MQ). The computational complexity of H2
is O(MQ2), since the algorithm requires O(Q2) computa-
tions for each of the neighboring lifetime pairs (M1).
Lastly, the computational complexity of H3 is O(MQ2)
since H3 requires an execution of H2 for pre-processing.
4. Performance analysis of the proposed heuristics
In this section, we compute the expected revenue from
the proposed heuristics and the optimal revenue from the
dynamic programming model. A comparison of both ways
for the expected revenue is provided to study the
performance of the proposed heuristics. However, the
computation time of the dynamic programming model
increases exponentially with an increase of the product’s
lifetime M (in fact, for a single parameter combination
when M ¼ 3, it took more than 8 hours to run the
numerical experiment using a AMD Dual Core 2.5 GHz
computer with 2 GB RAM). In order to examine (measure)
the performance of the proposed heuristics for a large M,
an upper bound for V1(Q) is also computed in Section 4.3
and compared with the maximum expected revenue.
4.1. The experimental design
In this numerical study, demand at Period k is price-
sensitive and follows an additive stochastic demand
function, i.e., t k ¼ mðpk Þ þ k , where mðpk Þ ¼ bk  ak pk . The
noise variable ek follows a truncated normal distribution
and is bounded by ½3sk ; 3sk  where sk is the standard
deviation of the normal distribution.
We are particularly interested in the effects of demand
variability on the revenue increase. Thus, sk is set to
different levels referring to different levels of demand
variability.
Table 1 summarizes the experimental variables and
their respective values employed in this study. Seven
constants and their respective values are also provided in
Table 2.
For each scenario, we replicated the numerical ex-
periments 100 times. We computed the maximum
 ARTICLE IN PRESS
E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150 143

Table 1 Table 4
Variables used in the numerical studya The total demand during the product’s lifetime

Parameters Low level () High Level (+) (s1, s2, s3) Total demand during the product’s lifetime

s1 0.1*b1 0.2*b1 (,,) ½18; 30 þ Nð0; 12Þ

s2 0.1*b2 0.2*b2 (,,+) ½22; 30 þ Nð0; 24Þ
s3 0.1*b3 0.2*b3 (,+,) ½22; 30 þ Nð0; 24Þ
Q Feng and Xiao (2001), Mahajan et al. (1990) (+,,) ½22; 30 þ Nð0; 24Þ
(,+,+) ½26; 30 þ Nð0; 36Þ
a
The numerical study assumed that the normal distribution for ek is (+,,+) ½26; 30 þ Nð0; 36Þ
truncated at [3sk,3sk] to prevent negative demands, and thus the (+,+,) ½26; 30 þ Nð0; 36Þ
resultant distribution’s standard deviation is not sk . (+,+,+) 30 þ Nð0; 48Þ

Table 2
Constants used in the numerical study Table 5
The average demand when n-N
Parameters Values
(s1, s2, s3) Average demand
b1 20
b2 20 (,,) ½18; 30
b3 20 (,,+) ½22; 30
M 3 (,+,) ½22; 30
a1 4 (+,,) ½22; 30
a2 2 (,+,+) ½26; 30
a3 1 (+,,+) ½26; 30
(+,+,) ½26; 30
(+,+,+) 30

Table 3
½pmin max
k ; pk  in each period shown in Table 5. The order quantity Q must be within the
interval of the average demand to avoid excessive
Low level () High Level (+)
inventories and stockouts. The numerical results for such
Period 1 ½2:5; 3:5 ½2:5; 2:5 order quantities are obtained, and they are summarized in
Period 2 ½5; 7 ½5; 5 Tables 6, 7 and 8.
Period 3 ½10; 14 ½10; 10 The expected revenues from the proposed heuristics
are close to that from the dynamic programming model.
H2 provides near-optimal solutions (in the practical point
revenues under the three proposed heuristics. The
of view: the difference in the expected revenue is less than
Common Random Number technique was employed for
1%, except for few cases). H1 also provides good solutions,
synchronization.
and H3 provides similar results except for low sk levels.

4.2. Expected revenue from the heuristics and the dynamic

4.3. The upper bound for the maximum expected revenue
programming model

An upper bound VUP for the maximum expected

The performance of the proposed heuristics is mea-
sured by comparing the revenues obtained from the
proposed heuristics with that from the dynamic program-
ming model.
We first compute an average demand to determine Q
for the experiment. The demand in each period is
determined by the price in each period (pk). Since pk is
confined to the interval of ½pmin max
 where pmin
k ; pk
bk =2ak and pmax k ¼ max½p min
k ; ðbk þ  min
k Þ=a k , the price
intervals are obtained, as shown in Table 3. ek, k ¼ 1,2,3,
follows Nð0; s2k Þ and they are i.i.d. Thus, e1+e2+e3 follows
Nð0; s21 þ s22 þ s23 Þ. The total demand during the product’s
lifetime is computed accordingly, as shown in Table 4.
Since the numerical experiments are repeated 100 times
in this study, the average for the demand variance term
e1+e2+e3 follows Nð0; ðs21 þ s22 þ s23 Þ=100Þ from the Central
Limit Theorem. Therefore, the variance is less than 1 (0.12,
0.24, 0.36, 0.48) and becomes negligible when the number
of replications n-N. When n-N, the (long-term)
average demand is confined to the fixed intervals, as
revenue V1(Q) is computed:
(1) Compute Rk ðxk Þ for each xk ¼ 1; . . . ; bk  ak pmin
k þ max
k
and k ¼ 1,y,M.
(2) The optimal inventory level xk for Period k
(k ¼ 1,y,M) is obtained by Maxfor all xk ½Rk ðxk Þ.
P
(3) V UP ¼ M 
k¼1 fMaxxk ½Rk ðxk Þg.
k ¼
In the above, an M period problem is reduced to M
independent news-vendor problems. It is obvious that VUP,
the sum of the maximum expected revenues among M
PM 
periods, is strictly greater than V1(Q) and k¼1 xk is not
less than Q.
As the order quantity Q increases, the difference
between the optimal revenue from the dynamic program-
ming model and the upper bound decreases, as shown in
Table 9. In actual practices such as airline revenue
management (where 80% is considered a ‘‘very high’’ load
factor), Q is determined (considered a fleet assignment
 ARTICLE IN PRESS
144 E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150

Table 6
Revenue comparison between Heuristic 1 and dynamic programming

%Difference in revenuea (s1, s2, s3)

Q level (,,) (,,+) (,+,) (+,,) (,+,+) (+,,+) (+,+,) (+,+,+)

Q ¼ 18 3.9
Q ¼ 19 1.6
Q ¼ 20 1.8
Q ¼ 21 1.4
Q ¼ 22 1.3 0.4 3.1 0.5
Q ¼ 23 1.5 0.5 2 0.3
Q ¼ 24 1.4 1.2 1.6 0.2
Q ¼ 25 1.3 1.1 1.4 0.1
Q ¼ 26 1.3 1.3 1.5 0.3 2.6 0.8 0.9
Q ¼ 27 1.1 0.8 1.1 0.4 2.8 0.6 0.8
Q ¼ 28 1.3 0.9 1 0.2 2.3 2 1.6
Q ¼ 29 1.5 0.4 0.8 0.3 2.2 0.9 0.5
Q ¼ 30 1.3 0.7 0.8 0.4 2.5 1.1 0.5 1.5

a
Difference in revenue ¼ jrevenue from H1revenue from dynamic programmingj
revenue from H1
 100%.

Table 7
Revenue comparison between Heuristic 2 and dynamic programming

%Difference in revenuea (s1, s2, s3)

Q level (,,) (,,+) (,+,) (+,,) (,+,+) (+,,+) (+,+,) (+,+,+)

Q ¼ 18 3.4
Q ¼ 19 1.4
Q ¼ 20 1.5
Q ¼ 21 1
Q ¼ 22 0.7 0.2 2.7 0.3
Q ¼ 23 0.8 0.3 1.3 0.5
Q ¼ 24 0.8 0.5 0.7 1
Q ¼ 25 1.1 0.3 0.7 0.9
Q ¼ 26 1.1 0.5 0.6 0.8 1 1.9 0.1
Q ¼ 27 0.8 0.6 0.8 0.9 1.4 1.5 0.1
Q ¼ 28 0.9 0.8 0.6 0.8 1 1.5 1.1
Q ¼ 29 1.1 0.3 0.2 1.1 1.1 1.6 0.4
Q ¼ 30 0.9 0.5 0.4 1.1 0.9 1.7 0.4 0.5

a
Difference in revenue ¼ jrevenue from H2revenue from dynamic programmingj
revenue from H2
 100%.

Table 8
Revenue comparison between Heuristic 3 and dynamic programming

%Difference in revenuea (s1, s2, s3)

Q level (,,) (,,+) (,+,) (+,,) (,+,+) (+,,+) (+,+,) (+,+,+)

Q ¼ 18 10.9
Q ¼ 19 7.9
Q ¼ 20 8.3
Q ¼ 21 6.7
Q ¼ 22 5.3 4.9 2.3 5.1
Q ¼ 23 3.8 3.4 1.1 3.8
Q ¼ 24 2.9 2.4 0.7 2.3
Q ¼ 25 4.1 3.7 2 3.5
Q ¼ 26 2.1 2.1 0.4 0.6 0.8 0.5 0.1
Q ¼ 27 2.3 1.6 0.5 0.5 1.1 0.7 0.5
Q ¼ 28 2.8 1.7 0.8 1.1 1 3.2 1.4
Q ¼ 29 3.2 2.1 0.9 1.4 1.2 0 0
Q ¼ 30 3.7 2.4 1.2 1.9 1.7 0.3 0.3 1.1

a
Difference in revenue ¼ jrevenue from H3revenue from dynamic programmingj
revenue from H3
 100%.
 ARTICLE IN PRESS
E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150 145

Table 9
Revenue comparison between V1(Q) and VUP

%Difference in revenuea (s1, s2, s3)

Q level (,,) (,,+) (,+,) (+,,) (,+,+) (+,,+) (+,+,) (+,+,+)

Q ¼ 18 13.2
Q ¼ 19 12.6
Q ¼ 20 10.8
Q ¼ 21 9.2
Q ¼ 22 7.6 9.6 6.8 8.8
Q ¼ 23 6.3 8 6.6 8.6
Q ¼ 24 5.1 6.7 5.9 7.4
Q ¼ 25 3.9 5.5 4.7 6.2
Q ¼ 26 3.1 4.3 3.7 5 3.5 4.7 4.1
Q ¼ 27 2.2 3.5 2.9 4 2.6 3.8 3.2
Q ¼ 28 1.6 2.6 2.1 3.2 1.9 2.9 2.4
Q ¼ 29 1.1 1.9 1.6 2.4 1.4 2.2 1.9
Q ¼ 30 0.6 1.4 1.1 1.8 0.9 1.7 1.3 2.1

a
Difference in revenue ¼ ðthe upper boundthe maximum revenueÞ
the upper bound
 100%.

problem) to be significantly higher than the average
demand. For such large values of Q, the upper bound
obtained in this study is reasonably close to the optimal
revenue from the dynamic programming model. Hence,
this upper bound can effectively be applied to analyze the
performance of heuristics solutions.
5. Extensions
The model we developed in Section 3 can be applied to
the airline industry where prices for tickets typically rise
as the flight time approaches. However, this clearly does
not apply to all circumstances of perishable product
pricing, e.g., (i) monotonically marked down prices for
fashion apparel which perish when the appropriate
season passes by; and (ii) the price for a product first
increases and later decreases following an increase–
decrease pattern. For example, consider a food product
for a special holiday; some of the customers are willing to
pay a higher price closer to the holiday. This behavior
disappears immediately after the target day.
5.1. Markdown pricing
In the fashion industry, consumers are unwilling to pay
higher prices toward the end of a season because they will
enjoy the product for a shorter period of time. Hence, the
companies often employ successive markdowns to sell
season appropriate fashion apparel as the appropriate
season passes. Similar examples can also be found in the
consumer electronics industry.
Bitran and Mondschein (1997) considered a periodic
pricing review policy where the revisions of prices are
allowed only at a given finite set of opportunities (times)
and the prices do not increase. This policy can be applied
for seasonal products in the retail industry where prices
are successively discounted as the season progresses. The
authors considered a Poisson demand process and
provided empirical results to develop conjectures as to
the structure of an optimal policy and the optimal
revenue. However, no theoretical result was presented.
Recently, Chew et al. (2005) developed a discrete time
dynamic programming model for perishable products
with a lifetime of multiple periods. Under the assumption
of ‘‘alternative’’ source, the optimal expected profit is
concave with respect to the inventory level. From this
property, they computed the optimal expected profit
efficiently and employed this value as an upper bound
for the optimal expected profit under the assumption of
lost sales. The computational results showed that the ratio
of the optimal profit, under the lost sales assumption, to
the optimal profit under the ‘‘alternative’’ source assump-
tion, was between 91% and 97% under different levels of
demand variability.
5.2. When the product price follows an
increase–decrease pattern
In this section, the price for a product is assumed to
first increase and later decrease following an increase–
decrease pattern. Demand for the product is price
sensitive. At the beginning of each period, given the
inventory of the product, the optimal price and the
optimal allocation are determined for the objective of
maximizing the total revenue. Again, we employed a
periodic review policy.
The proposed model stems from many real problems in
industries. For example, the prices of a product for a
specified holiday will follow an increase–decrease pattern.
Because customers are willing to pay a higher price closer
to the holiday, continuing lower prices may hurt potential
revenues. Thus, retailers will employ higher prices. After
the holiday, retailers employ discounted prices to attract
customers and to reduce the inventory. Consequently,
markup and markdown prices are mixed in the selling
periods. This price pattern can also be seen in the airline
industry which often introduces a cheaper ‘‘last minute
discount’’ airfare.
 ARTICLE IN PRESS
146 E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150

Customers will hardly be willing to buy a product where jk ðxk ; pk ; Sk Þ represents the expected revenue at
whose price oscillates, from their point of view, randomly Period k.
over the season (Bitran and Mondschein, 1997). Thus, we (
pk E½minðt k ; Sk Þ koR
assume that only one switch is allowed during the selling jk ðxk ; pk ; Sk Þ ¼
periods. pk E½minðt k ; xk Þ RpkpM
Compared with previous models which allow the The recursive function for the inventory level is shown:
movement of price in one direction only (either markup (
or markdown), the proposed model permits price to move ½xk  Sk þ ðSk  t k Þþ  koR
xkþ1 ¼
in both directions. This gives management flexibility in ½xk  t k þ RpkpM
obtaining the higher revenues. If only the markdown
policy is allowed, once a higher price is forfeited, it will no We denote J k ðxk ; pk ; Sk Þ as the total expected revenue for
longer be offered even if the product is being sold the last k periods.
successfully. J k ðxk ; pk ; Sk Þ ¼ jk ðxk ; pk ; Sk Þ þ aEV kþ1 ½ðxkþ1 Þ
This pricing pattern has also been considered for new
Note that Sk ¼ xk when k ¼ R,y,M. Hence, jk ðxk ; pk ; Sk Þ
products’ introductions (Dolan and Jeuland, 1981; Jeuland
and Jk ðxk ; pk ; Sk Þ can be simplified and written as jk ðxk ; pk Þ
and Dolan, 1982; Kalish, 1983). Kalish and Sen’s (1986)
and J k ðxk ; pk Þ, respectively, for k ¼ R,y,M.
intuitive explanation for such a pricing pattern is that if
The values xk and Vk(xk) are computed recursively
early adopters have a strong positive effect on late
backward in time starting from Period M to Period 1.
adopters, a low introductory price should encourage them
The boundary condition V M ðxM Þ ¼ MaxpM ½jM ðxM ; pM Þ
to adopt this product. Once a product is established, the
is the maximum expected revenue at Period M for a
rises in price are attributed to strong demand. Subse-
given xM where SM ¼ xM. Conversely, V 1 ðx1 Þ ¼ Maxp1 ;S1 ½j1
quently, when demand saturates and begins to decrease,
ðx1 ; p1 ; S1 Þ þ aEðV 2 ðx2 ÞÞ is the maximum expected revenue
the price is also decreased in order to increase the sales
over M periods when the initial inventory at Period 1 is Q,
and reduce the remaining inventories.
i.e., x1 ¼ Q.
Under the above mentioned pattern, the prices for
the new products during their life times must be
5.2.2. Joint allocation and pricing decisions
determined carefully. It is profitable to reserve enough
In this section, we determine the inventory allocation
inventories of a new product for future customers (late
and the price for a perishable product with an M period
adopters) who will pay a higher price; however, when the
lifetime where the price for the product increases during
price begins to fall, the remaining inventory accelerates
the first R periods and decreases during the remaining
the reduction of price (and the expected revenue).
MR periods. First, we consider a special case of R ¼ 2 and
Thus, the price and the inventory allocation for the
then we discuss more general cases for RX3.
products at each period must simultaneously be deter-
(i) When R ¼ 2: In order to solve the dynamic
mined in order to maximize the total revenue over the
programming model developed in Section 5.2.1,
selling periods.
J k ðxk ; pk ; Sk Þ must be shown to be concave with respect to
pk for a given xk. In addition, Vk(xk) must be concave with
5.2.1. A dynamic programming model respect to xk and monotonically increasing with respect to
We consider a perishable product with an M period xk for k ¼ 2,y,M. We start from the last period and
lifetime. Let k ¼ 1,y,M denote the ages of the product. At employ the backward recursive function to show that
Period k (k ¼ 1,y,M), only products of age k are sold. The these properties hold. At the last period, J M ðxM ; pM Þ is
price for such a product increases during the first R concave with respect to pM for a given xM and VM(xM) is
periods and then decreases in the remaining MR periods. concave with respect to xM as shown in Lemma 1. For
Hence, for the first R1 periods, some capacities have to Period k ¼ M1,y,2, the optimality properties are proven
be reserved for future customers who will pay a higher by Lemma 2.
price. During the remaining MR+1 periods, older pro-
Lemma 2. When k ¼ M1,y,2 we have the following:
ducts will be offered at discounted prices and the
capacities will not be reserved. This implies that Sk ¼ xk
(i) The expected revenue J k ðxk ; pk Þ is concave with respect
when k ¼ R,y,M.
to pk for a given xk.
pk is confined to the finite interval ½pmin k ; pk
max
where
(ii) The optimal price pk is a non-increasing function of xk
pmax
k oðb k þ min
k Þ=a k . The upper bound p max
k prevents
under the condition that lðtÞX1=ak ðpmin  apmax
kþ1 Þ.
negative demands. We also assume that pmax i opmin
iþ1 for
k
(iii) The maximum expected revenue Vk(xk) is concave with
i ¼ 1; :::; R  1 and pmax j op min
jþ1 for j ¼ R; :::; M  1.
respect to xk.
If tk4Sk, the excessive demand is lost.
(iv) The maximum expected revenue Vk(xk) monotonically
We developed a dynamic programming model to
increasing with respect to xk.
compute the expected revenue over M periods.
The Vk(xk), the maximum expected revenues for the
remaining periods, starting from Period k and with the Proof. See Appendix A.
inventory xk, are computed: The concavity of Jk ðxk ; pk Þ with respect to pk for a given
xk enables efficient algorithms such as the gradient
V k ðxk Þ ¼ Max½jk ðxk ; pk ; Sk Þ þ aEðV kþ1 ðxkþ1 ÞÞ
pk ;Sk search method to be employed to obtain pk at Period k
 ARTICLE IN PRESS
E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150 147

(k ¼ M,y,2). Furthermore, the optimal price p1 and the The first and second partial derivatives of J 2 ðx2 ; p2 Þ with
optimal inventory allocation S1 at Period 1 are obtained respect to p2 are shown:
from Theorem 1. Z x2 b2 þa2 p2
(ii) When RX3: The computation time for dynamic qJ 2
¼ ðb2  2a2 p2 þ 2 Þf 2 ðx2  b2 þ a2 p2 Þ
programming increases significantly with the increase of qp2 min
2

the product’s lifetime M since enumerations are required þ x2 ½1  F 2 ðx2  b2 þ a2 p2 Þ (A.2)

to obtain the optimal prices and the optimal inventory
allocations when RX3. Hence, heuristics are applied to q2 J2
determine the prices and the inventory allocations. One ¼ 2a2 F 2 ðx2  b2 þ a2 p2 Þ  a22 p2 f 2 ðx2  b2 þ a2 p2 Þ
qp22
possible implementation of these heuristics is: For the
(A.3)
first R periods, one of the three heuristics proposed in
Section 3.3 is employed to determine the inventory Hence, J 2 ðx2 ; p2 Þ is concave with respect to p2 for a given
allocation and the price at each period. For the remaining inventory level x2.
MR periods, the optimal discounted prices for a given (ii) Let p^ 2 denote the value of price p2 which satisfies
inventory level can be computed from Lemma 2. qJ 2 =qp2 ¼ 0 for a given x2.
 Z x2 b2 þa2 p^ 2
6. Conclusions qJ 2 
 ¼ ½b2  2a2 p^ 2 þ 2 f 2 ð2 Þ d2
qp2 p2 ¼p^ 2 min
2
Z max
In this paper, we jointly determined the price and the 2
þ x2 f 2 ð2 Þ d2 ¼ 0 (A.4)
inventory allocation for a perishable product with a x2 b2 þa2 p^ 2
predetermined lifetime. We first developed a discrete
time dynamic programming model to determine the Note that (A.4) expresses the stationary point p^ 2 as a
optimal inventory allocations and the optimal prices for function of x2 denoted as p^ 2 ðx2 Þ. Since p^ 2 is bounded in
a perishable product with a two period lifetime. The price ½pmin max
2 ; p2 , the optimal price p2 in the last period is
for the product was first assumed to increase as the time determined as follows:
when it perished approached. This assumption was 8
relaxed in an extension to the model. Several optimality >
> pmin p^ 2 ppmin
< 2 2

2 op2 op2
pmin
 max
properties were obtained. Since such properties did not p2 ¼ p^ 2 ^ (A.5)
>
>
hold when the lifetime of the product was longer than two : pmax p^ 2 Xpmax
2 2
periods, we proposed three heuristics to obtain the
inventory allocations and the prices. The computational Taking the first order derivative of p^ 2 ðx2 Þ with respect to x2
results showed that the expected revenues from the based on (A.4) and rearranging the terms, we obtain
proposed heuristics were very close to the maximum  
dp^ 2 ðx2 Þ
total revenue from the dynamic programming model. For a2
the numerical study, an upper bound for the maximum dx2
total revenue was also provided. The difference between 1  F 2 ½x2  b2 þ a2 p^ 2 ðx2 Þ  a2 p^ 2 ðx2 Þf 2 ½x2  b2 þ a2 p^ 2 ðx2 Þ
¼
the upper bound and the maximum total revenue 2F 2 ½x2  b2 þ a2 p^ 2 ðx2 Þ þ a2 p^ 2 ðx2 Þf 2 ½x2  b2 þ a2 p^ 2 ðx2 Þ
decreased when the initial inventory level increased. (A.6)
Finally, we considered two different extensions of the
Given that
model. In the first extension, the price for the product was
assumed to decrease during the product’s lifetime. The f 2 ðx2  b2 þ a2 p^ 2 ðx2 ÞÞ
lðx2  b2 þ a2 p^ 2 ðx2 Þ ¼
optimal markdown prices can be obtained from Chew et 1  F 2 ðx2  b2 þ a2 p^ 2 ðx2 ÞÞ
al. (2005). In the second extension, we assumed that the 1
X
price for the product first increased and later decreased. a2 pmin
2
The optimal inventory allocation and the optimal price at
each period were obtained when the price increased p^ 2 Xpmin
2 and the denominator of (A.6) is non-positive,
during the first two periods and then decreased. hence 1pa2 ðdp^ 2 ðx2 Þ=dx2 Þp0. Therefore, it follows
that p2 is a non-increasing function of the inventory
level x2.
Acknowledgment (iii) Next, we prove that V2(x2) is concave with respect to
x2.
This work was supported by the Korea University Grant
Let V2(x2) be defined as follows:
K0715071 and Jungseok Logistics Foundation Grant.
8 min

< V 2;1 ðx2 Þ obtained when p2 ¼ p2
> x2 Xxn2
2 ox2 ox2
xm
 ^ n
Appendix A V 2 ðx2 Þ ¼ V 2;2 ðx2 Þ obtained when p2 ¼ p2
>
: V ðx Þ obtained when p ¼ pmax x pxm
2;3 2 2 2 2 2

Proof of Lemma 1. (i) The expected profit during the last

where the thresholds xn2 and xm 2 are calculated by
period is
setting (A.2) to zero under the conditions p2 ¼ pmin
2 and
J 2 ðx2 ; p2 Þ ¼ j2 ðx2 ; p2 Þ ¼ p2 E½Minðx2 ; t 2 Þ (A.1) p2 ¼ pmax
2 .
 ARTICLE IN PRESS
148 E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150

Consider the following cases: for cases (1) and (2) are the same. The same is true for the
(1) x2 Xxn2 gradients at xm N for cases (2) and (3). Hence V2(x2) is
Z x2 b2 a2 pmin
concave with respect to x2.
2
V 2;1 ðx2 Þ ¼ pmin min
2 ðb2  a2 p2 þ 2 Þf 2 ð2 Þ d2 Property (iv) is directly obtained from (A.8), (A.10), and
min
2
Z max (A.13). &
2
þ pmin
2 x2 f 2 ð2 Þ d2 (A.7)
x2 b2 a2 pmin
2
Proof of Lemma 2. We show by induction that J k ðxk ; pk Þ is
concave with respect to pk and then prove that Vk(xk) is
The first and second order derivatives with respect to x2 concave with respect to xk.
are shown: First we assume that V kþ1 ðxkþ1 Þ is a continuous function
dV 2;1 and concave with respect to xkþ1 . The first derivative of
¼ pmin min
2 ½1  F 2 ðx2  b2  a2 p2 ÞX0 (A.8)
dx2 V kþ1 ðxkþ1 Þ with respect to xkþ1 is assumed to be positive.
V kþ1 ðxkþ1 Þ is represented as follows:
2
d V 2;1
¼ pmin min
2 f 2 ðx2  b2  a2 p2 Þp0 V kþ1 ðxkþ1 Þ
dx22 8
>
> V ðx  t k Þ obtained when pkþ1 ¼ pmin xk Xt k þ xnkþ1
> kþ1;1 k
> kþ1
Thus, V 2;1 ðx2 Þ is concave with respect to x2 when x2 Xxn2 . >
>
kþ1 oxk ot k þ xkþ1
t k þ xm
< V kþ1;2 ðxk  t k Þ obtained when pkþ1 ¼ p^ kþ1 n

(2) xn2 ox2 oxm 2

¼
>
> V kþ1;3 ðxk  t k Þ obtained when pkþ1 ¼ pmax t k oxk pt k þ xm
>
> kþ1 kþ1
>
>
Z x2 b2 a2 p^ 2 ðx2 Þ :V kþ1;3 ð0Þ obtained when p ¼ pmax kþ1 kþ1 xk pt k
V 2;2 ðx2 Þ ¼ p^ 2 ðx2 Þðb2  a2 p^ 2 ðx2 Þ þ 2 Þf 2 ð2 Þ d2
min
2 where xkþ1 ¼ ½xk  tk þ and t k ¼ bk  ak pk þ k .
Z max 2
þ
2
p^ 2 ðx2 Þx2 f 2 ð2 Þ d2 (A.9) (1) It suffices to show that q Jðxk ; pk Þ=qp2k p0.
x2 b2 a2 p^ 2 ðx2 Þ "Z
xk xnkþ1 bk þak pk
J k ðxk ; pk Þ ¼ jk ðxk ; pk Þ þ a V kþ1;1 ðxk  bk þ ak pk
The first and second order derivatives with respect to x2 min
k

are given: Z xk xm bk þak pk

kþ1
 k Þf k ðk Þ dk þ V kþ1;2 ðxk  bk þ ak pk
Z max xk xnkþ1 bk þak pk
dV 2;2 2
Z
¼ p^ 2 ðx2 Þf 2 ð2 Þ d2 X0 (A.10) xk bk þak pk
dx2 x2 b2 a2 p^ 2 ðx2 Þ  k Þf k ðk Þ dk þ V kþ1;3 ðxk  bk þ ak pk
xk xm
kþ1
bk þak pk
Z max #
2 k
d V 2;2 dp^ 2 ðx2 Þ  k Þf k ðk Þ dk þ V kþ1;3 ð0Þf k ðk Þ dk
¼ ½1  F 2 ðx2  b2  a2 p^ 2 ðx2 ÞÞ xk bk þak pk
dx22 dx2
  (A.15)
dp^ ðx2 Þ
 1 þ a2 2 p^ 2 ðx2 Þf 2 ðx2  b2  a2 p^ 2 ðx2 ÞÞ
dx2
(A.11) q2 J k
¼  2ak Fðxk  bk þ ak pk Þ  a2k pk f k ðxk  bk þ ak pk Þ
qp2k
Since 1pa2 ðdp^ 2 ðx2 Þ=dx2 Þp0, (A.11) is negative. There- "Z
xk xnkþ1 bk þak pk
fore, V 2;2 ðx2 Þ is concave with respect to x2 when þ aa2k V kþ1;100 ðxk  bk þ ak pk  k Þf k ðk Þ dk
min
xn2 ox2 oxm 2. Z xk xm
k

bk þak pk
kþ1
(3) x2 pxm2 þ V 00kþ1;2 ðxk  bk þ ak pk  k Þf k ðk Þ dk
xk xnkþ1 bk þak pk
Z x2 b2 a2 pmax Z xk bk þak pk
2
V 2;3 ðx2 Þ ¼ pmax
2 ðb2  a2 pmax
2 þ 2 Þf 2 ð2 Þ d2 þ V 00kþ1;3 ðxk  bk þ ak pk  k Þf k ðk Þ dk
 min xk xm bk þak pk
2 kþ1
Z max #
2
þ pmax
2 x2 f 2 ð2 Þ d2 (A.12) þV 0kþ1;3 ð0Þf k ðxk  bk þ ak pk Þ
x2 b2 a2 pmax
2

Since x2 is independent of pmax

2 , the first and second order Note that V 0kþ1;3 ð0Þ ¼ dV kþ1;3 ðxk Þ=dxk jxk ¼0 ¼ pmax kþ1 .
derivatives with respect to x2 are given: Since pk Xpmax kþ1 , the sum of the 1st, 2nd, and 6th terms is
negative. Furthermore, the 3rd, 4th and 5th terms are less
dV 2;3
¼ pmax
2 ½1  F 2 ðx2  b2  a2 pmax
2 ÞX0 (A.13) than zero, based on the assumption that V kþ1 ðxkþ1 Þ is
dx2
concave with respect to xkþ1 . Therefore, J k ðxk ; pk Þ is
2 concave with respect to pk.
d V 2;3
¼ pmax
2 f 2 ðx2  b2  a2 pmax
2 Þp0 (A.14) (2) Let p^ k denote the value of price pk that satisfies the
dx22
stationary condition qJk =qpk ¼ 0.
Thus, V 2;3 ðx2 Þ is concave with respect to x2 when x2 pxm 2.  Z xk bk þak p^ k
Finally, we focus on the boundary conditions at the qJk 
 ¼ ðbk  2ak p^ k þ k Þf k ðk Þdk
threshold values xn2 and xm qpk pk ¼p^ k
2 in order to show overall
min
k

concavity. At the thresholds xn2 and xm 2 , V2(x2) is contin- þ xk ½1  F k ðxk  bk þ ak p^ k Þ

"Z
uous, which can be obtained from (A.7), (A.9), and (A.12). n
xk xkþ1 bk þak p^ k
þ aak V 0kþ1;1 ðxk  bk þ ak p^ k  k Þf k ðk Þ dk
Furthermore, we can easily show that the gradients at xnN min
k
 ARTICLE IN PRESS
E.P. Chew et al. / Int. J. Production Economics 120 (2009) 139–150 149

Z xk xm bk þak p^ k

kþ1 where the thresholds xm and xnk are calculated by
þ V 0kþ1;2 ðxk  bk þ ak p^ k  k Þf k ðk Þ dk k
xk xnkþ1 bk þak p^ k satisfying qJk =qpk ¼ 0 under the conditions that pk ¼
Z #
xk bk þak p^ k
pmin
k and pk ¼ pmax
k .
þ V 0kþ1;3 ðxk  bk þ ak p^ k  k Þf k ðk Þ dk ¼ 0
xk xm
kþ1
bk þak p^ k Finally, we focus on the boundary conditions at the
(A.16) threshold values xm n
k and xk in order to show overall

Note that (A.16) expresses the stationary point p^ k as a concavity. At the thresholds xm n
k and xk , V k ðxk Þ is contin-

function of xk denoted by p^ k ðxk Þ. Since p^ k is bounded in uous because

½pmin max
k ; pk , we determine the optimal discounted price at V k;1 ðxnk Þ ¼ V k;2 ðxnk Þ and V k;2 ðxm m
k Þ ¼ V k;3 ðxk Þ
Period k, pk , as follows:
8 Furthermore, we can easily prove that
>
> pmin p^ k ppmin  
< k k
dV k;1 ðxk Þ dV k;2 ðxk Þ

pk ¼ p^ k pmin o p^ k opmax ¼ X0
>
>
k
: pmax p^ k Xpmax
k
dxk xk ¼ðxn Þþ dxk xk ¼ðxn Þ
k k
k k

Taking the first order derivative of p^ k ðxk Þ with respect and

 
to xk based on (A.16) and rearranging the terms, we obtain dV k;2 ðxk Þ dV k;3 ðxk Þ
 ¼ X0
dp^ k ðxk Þ N dxk xk ¼ðxm Þþ dxk xk ¼ðxm Þ
k k
ak ¼
dxk D
Therefore, we draw the conclusion that the continuous
where profit function V k ðxk Þ is not only monotonically increasing
N ¼ 1  F k ðxk  bk þ ak p^ k Þ  ak ðp^ k  apmax kþ1 Þf k ðxk  bk
but also concave with respect to xk.
Z xk bk þak p^ k
þ ak p^ k Þ þ a V 00kþ1 ðxk  bk þ ak p^ k  k Þf k ðk Þ dk References
min
k

Abad, P.L., 1996. Optimal pricing and lot-sizing under conditions of

D ¼ 2F k ðxk  bk þ ak p^ k Þ þ ak ðp^ k  apmaxkþ1 Þf k ðxk  bk þ ak pk Þ
^
perishability and partial backordering. Management Science 42,
Z xk bk þak p^ k
1093–1104.
a V 00kþ1 ðxk  bk þ ak p^ k  k Þf k ðk Þ dk Abad, P.L., 2008. Optimal price and order size under partial backordering
min
k incorporating shortage, backorder and lost sale costs. International
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