AbstractThis paper presents a one‐period two‐echelon inventory model with one warehouse in the first echelon andnwarehouses in the second echelon. At the beginning of the period the stock levels at all facilities are adjusted by purchasing or disposing of items at the first echelon, returning or shipping items between the echelons and transshipping items within the second echelon. During the period, demands (which may be negative) are placed on all warehouses in the second echelon and an attempt is made to satisfy shortages either by an expedited shipment from the first echelon to the second echelon or an expedited transshipment within the second echelon. The decision problem is to choose an initial stock level at the first echelon (by a purchase or a disposition) and an initial allocation so as to minimize the initial stock movement costs during the period plus inventory carrying costs and system shortage costs at the end of the period.It is shown that the objective function takes on one of four forms, depending on the relative magnitudes of the various shipping costs. All four forms of the objective function are derived and proven to be convex.Several applications of this general model are considered. We also consider multi‐period extensions of the general model and an important special case is solved expli