An Opportunity Cost View of Basestock Optimality for the Warehouse Problem

This work considers the so called warehouse problem, which is a prototypical problem of the trading activity of a merchant in a commodity market. It is known that the merchant’s optimal trading policy for this problem has a basestock structure. The exiting proofs of this result hinge on marginal analysis, and may not be easily accessible to managers. This work provides an elementary derivation of the optimality of this structure relying almost exclusively on geometric arguments based on the notion of opportunity cost of a trade, a concept familiar to commodity merchants. Some aspects of managerial relevance associated with this structure are also discussed. It is hoped that the material presented in this work would be of interest to manages involved in the merchant management of commodity storage.