This paper presents a model in which inventories are used by a duopoly to deter deviations from an implicitly collusive arrangement. Higher inventories allow firms to punish cheaters more strongly and can thus help to maintain collusion. The authors show that when demand is high, the incentive to deviate increases so that increases in inventories may be optimal for the duopoly. This rationalizes the observed positive correlation between inventories and sales. In their empirical section, the authors show that, as their model predicts, this correlation is more important in concentrated industries. They also provide several examples where inventories have been a factor in cartel behavior. Copyright 1989, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
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