On the relationship between entropy, demand uncertainty, and expected loss

• DOI: 10.1016/j.ejor.2015.03.014
• Publication Date: 2015-03-18T17:21:53Z
• Authors: Adam J. Fleischha...; Pak-Wing Fok
• Keywords: 0211 other engineering and technologies; 02 engineering and technology

Abstract We analyze the effect of demand uncertainty, as measured by entropy, on expected costs in a stochastic inventory model. Existing models studying demand variability’s impact use either stochastic ordering techniques or use variance as a measure of uncertainty. Due to both axiomatic appeal and recent use of entropy in the operations management literature, this paper develops entropy’s use as a demand uncertainty measure. Our key contribution is an insightful proof quantifying how costs are non-increasing when entropy is reduced.