Question

A company uses Newsvendor formula to order a product. Keeping everything else the same, if the cost of product increases, how would this change the cost of overstocking (Co) and the cost of understocking (Cu)?

A. Both decrease
B. Co increases and Cu decreases
C. Co decreases and Cu increases
D. Both increase

Answer 1

When the cost of a product increases, the cost of overstocking (Co) increases because unsold goods become more expensive, and the cost of understocking (Cu) decreases as the opportunity cost of lost sales diminishes. Therefore correct option is B

Step-by-step explanation:

The Newsvendor formula is used to determine the optimal order quantity in order to balance the costs of overstocking and understocking. When the cost of a product increases, it affects the cost of overstocking (Co) and the cost of understocking (Cu) differently. The cost of overstocking is concerned with the expenses associated with unsold goods, which will increase as the cost of the product rises.

Conversely, the cost of understocking refers to the opportunity cost of not meeting demand, which will decrease because the lost profit per unit from not selling an additional unit is reduced when the cost increases. Thus, the correct answer is B: Co increases and Cu decreases.