Determining Optimal Price and Order Quantity Under the Uncertainty in Demand and Supplier’s Wholesale Price

Manufacturers in a high-tech durable product industry may have to make operational decisions in the presence of uncertainties associated with product demand and supplier’s wholesale price. In this paper, the authors investigate the impact of such uncertainties on the activities of a manufacturer and its supplier and develop an optimization model that describes how the manufacturers should reflect the uncertainty issues in their pricing and order quantity policy to achieve a desirable profit. In the modeling process, three important managerial problems are discussed, i.e., the effect of coordination between a manufacturer and its supplier in dealing with uncertainties on product demand and supplier’s wholesale price, strategies for mitigating both errors in demand forecasting and supply risk, and modeling frameworks to determine the optimal solution for price and order quantity based on the varying levels of coordination. To identify best operational decisions under market uncertainty, the authors use the stochastic optimal control theory.