Economic order quantity

In inventory management, economic order quantity

(EOQ) is the order quantity that minimizes the total
holding costs and ordering costs. It is one of the oldest
classical production scheduling models. The model was
developed by Ford W. Harris in 1913,[1] but R. H. Wil-
son, a consultant who applied it extensively, and K. An-
dler are given credit for their in-depth analysis.[2]

1 Overview
Classic EOQ model: trade-off between ordering cost (blue) and
EOQ applies only when demand for a product is constant holding cost (red). Total cost (green) admits a global optimum.
over the year and each new order is delivered in full when Purchase cost is not a relevant cost for determining the optimal
inventory reaches zero. There is a fixed cost for each or- order quantity.
der placed, regardless of the number of units ordered.
There is also a cost for each unit held in storage, com-
monly known as holding cost, sometimes expressed as a 1.2 The Total Cost function and derivation
percentage of the purchase cost of the item. of EOQ formula
We want to determine the optimal number of units to or-
The single-item EOQ formula finds the minimum point
der so that we minimize the total cost associated with the
of the following cost function:
purchase, delivery and storage of the product.
Total Cost = purchase cost or production cost + ordering
The required parameters to the solution are the total de-
cost + holding cost
mand for the year, the purchase cost for each item, the
fixed cost to place the order and the storage cost for each Where:
item per year. Note that the number of times an order is
placed will also affect the total cost, though this number • Purchase cost: This is the variable cost of goods:
can be determined from the other parameters. purchase unit price × annual demand quantity. This
is P × D

1.1 Variables • Ordering cost: This is the cost of placing orders:

each order has a fixed cost K, and we need to order
D/Q times per year. This is K × D/Q
• P = purchase unit price, unit production cost.
• Holding cost: the average quantity in stock (between
• Q = order quantity. fully replenished and empty) is Q/2, so this cost is h
× Q/2
• Q∗ = optimal order quantity.
DK hQ
TC = PD + Q + 2 .
• D = annual demand quantity.
To determine the minimum point of the total cost curve,
calculate the derivative of the total cost with respect to Q
• K = fixed cost per order, setup cost (not per unit,
(assume all other variables are constant) and set it equal
typically cost of ordering and shipping and handling.
to 0:
This is not the cost of goods)
0 = − DKQ2 + 2
h

• h = annual holding cost per unit, also known as car- Solving for Q gives Q* (the optimal order quantity):
rying cost or storage cost (capital cost, warehouse ∗2 2DK
space, refrigeration, insurance, etc. usually not re- Q = h
lated to the unit production cost) Therefore:

1
2 4 SEE ALSO

up cost $26 each. So when 150 units are ordered,

the total cost is $30*100 + $28*50.
Q* is independent of P; it is a function of only K, D, h.
• All units discount: an order of 1–1000 units costs
The optimal value Q* may also be found by recognising $50 each; an order of 1001–5000 units costs $45
that[3] each; an order of more than 5000 units costs $40
√ each. So when 1500 units are ordered, the total cost
T C = DK + hQ + P D = 2Q h
(Q − 2DK/h)2 +
√ Q 2
is $45*1500.
2hDK + P D, where√ the non-negative quadratic term
disappears for Q = √2DK/h, which provides the cost
minimum T Cmin = 2hDK + P D. 2.2 Design of optimal quantity discount
schedules
1.3 Example In presence of a strategic customer, who responds opti-
mally to discount schedule, the design of optimal quantity
• annual requirement quantity (D) = 10000 units
discount scheme by the supplier is complex and has to be
• Cost per order (K) = 2 done carefully. This is particularly so when the demand
at the customer is itself uncertain. An interesting effect
• Cost per unit (P)= 8 called the “reverse bullwhip” takes place where an in-
crease in consumer demand uncertainty actually reduces
• Carrying cost percentage (h/P)(percentage of P) =
order quantity uncertainty at the supplier.[6]
0.02
• Yearly carrying cost per unit (h) = 0.16
2.3 Backordering costs and multiple items
√ √
2D∗K 2∗10000∗2
Economic order quantity = h = = Several extensions can be made to the EOQ model devel-
8∗0.02
500 units oped by Mr. Pankaj Mane, including backordering costs
10000 and multiple items. Additionally, the economic order in-
Number of orders per year (based on EOQ) = 500 =
terval can be determined from the EOQ and the economic
20
production quantity model (which determines the optimal
Total cost = P ∗ D + K(D/EOQ) + h(EOQ/2) production quantity) can be determined in a similar fash-
Total cost = 8∗10000+2(10000/500)+0.16(500/2) = ion.
R80080 A version of the model, the Baumol-Tobin model, has
If we check the total cost for any order quantity other also been used to determine the money demand function,
than 500(=EOQ), we will see that the cost is higher. For where a person’s holdings of money balances can be [7]
seen
instance, supposing 600 units per order, then in a way parallel to a firm’s holdings of inventory.
[8]
Total cost = 8∗10000+2(10000/600)+0.16(600/2) = Malakooti (2013) has introduced the multi-criteria
R80081 EOQ models where the criteria could be minimizing the
total cost, Order quantity (inventory), and Shortages.
Similarly, if we choose 300 for the order quantity then
A version taking the time-value of money into account
Total cost = 8∗10000+2(10000/300)+0.16(300/2) = was developed by Trippi and Lewin.[9]
R80091
This illustrates that the economic order quantity is always
in the best interests of the firm. 3 For improving fuel economy of
internal combustion engines
2 Extensions of the EOQ model
Recently an interesting similarity between EOQ of Melon
picking and fuel injection in Gasoline Direction Injection
2.1 Quantity discounts has been proposed.[10]

An important extension to the EOQ model is to accom-

modate quantity discounts. There are two main types of 4 See also
quantity discounts: (1) all-units and (2) incremental.[4][5]
Here is a numerical example:
• Constant fill rate for the part being produced:
Economic production quantity
• Incremental unit discount: Units 1–100 cost $30
each; Units 101–199 cost $28 each; Units 200 and • Demand is random: classical Newsvendor model
 3

• Demand varies over time: Dynamic lot size model
• Several products produced on the same machine:
Economic lot scheduling problem
• Reorder point
• Revised Wilson Formula by Daniel CRETOIS []
5 References
[1] Harris, Ford W. (1990). “How Many Parts to Make
at Once”. Operations Research. 38 (6): 947.
doi:10.1287/opre.38.6.947.
[2] Hax, AC; Candea, D. (1984), Production and Operations
Management, Englewood Cliffs, NJ: Prentice-Hall, p. 135
[3] Grubbström, Robert W. (1995). “Modelling produc-
tion opportunities — an historical overview”. Inter-
national Journal of Production Economics. 41: 1–14.
doi:10.1016/0925-5273(95)00109-3.
[4] Nahmias, Steven (2005). Production and operations anal-
ysis. McGraw Hill Higher Education.
• Wilson, R. H. (1934). “A Scientific Routine for
Stock Control”. Harvard Business Review. 13: 116–
28.
• Plossel, George. Orlicky’s Material Requirement’s
Planning. Second Edition. McGraw Hill. 1984.
(first edition 1975)
• Andriolo, Alessandro; Battini, Daria; Grubbström,
Robert W.; Persona, Alessandro; Sgarbossa, Fabio
(2014). “A century of evolution from Harris‫׳‬s basic
lot size model: Survey and research agenda”. In-
ternational Journal of Production Economics. 155:
16–38. doi:10.1016/j.ijpe.2014.01.013.
• Erlenkotter, Donald (2014). “Ford Whitman Har-
ris’s economical lot size model”. International
Journal of Production Economics. 155: 12–15.
doi:10.1016/j.ijpe.2013.12.008.
• Tsan-Ming Choi (Ed.) Handbook of EOQ Inven-
tory Problems: Stochastic and Deterministic Mod-
els and Applications, Springer’s International Series
in Operations Research and Management Science,
2014. doi:10.1007/978-1-4614-7639-9.

[5] Zipkin, Paul H, Foundations of Inventory Management,
McGraw Hill 2000
[6] Altintas, Nihat; Erhun, Feryal; Tayur, Sridhar
(2008). “Quantity Discounts Under Demand Un-
certainty”. Management Science. 54 (4): 777–92.
doi:10.1287/mnsc.1070.0829. JSTOR 20122426.
• Ventura, Robert; Samuel, Stephen (2016). “Op-
timization of fuel injection in GDI engine using
economic order quantity and Lambert W func-
tion”. Applied Thermal Engineering. 101: 112–20.
doi:10.1016/j.applthermaleng.2016.02.024.

[7] Caplin, Andrew; Leahy, John (2010). “Economic Theory 7 External links
and the World of Practice: A Celebration of the (S, s)
Model”. The Journal of Economic Perspectives. 24 (1):
183–201. doi:10.1257/jep.24.1.183. JSTOR 25703488. • The EOQ Model

[8] Malakooti, B (2013). Operations and Production Systems • http://www.inventoryops.com/economic_order_

with Multiple Objectives. John Wiley & Sons. ISBN 978- quantity.htm
1-118-58537-5.
• http://www.scmfocus.com/supplyplanning/2014/
[9] Trippi, Robert R.; Lewin, Donald E. (1974). “A Present 04/10/economic-order-quantity-calculator/
Value Formulation of the Classical Eoq Problem”. De-
cision Sciences. 5 (5): 208–11. doi:10.1111/j.1540-
5915.1974.tb00592.x. PMC 4020723 . PMID
24843434.

[10] Ventura, Robert; Samuel, Stephen (2016). “Op-

timization of fuel injection in GDI engine using
economic order quantity and Lambert W func-
tion”. Applied Thermal Engineering. 101: 112–20.
doi:10.1016/j.applthermaleng.2016.02.024.

6 Further reading
• Harris, Ford W. Operations Cost (Factory Manage-
ment Series), Chicago: Shaw (1915)

• Camp, W. E. “Determining the production order

quantity”, Management Engineering, 1922
4 8 TEXT AND IMAGE SOURCES, CONTRIBUTORS, AND LICENSES

8 Text and image sources, contributors, and licenses

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