STORY:

Let us say that your friend Joseph wants to buy ballpens from a factory & sell them to his classmates.

Joseph can buy the ballpens at P10 each from the factory and he plans to sell it in his classmates for P20.
He estimates he’ll sell about 1,200 basketballs/year.

At first, Joseph thought of just buying around 100 ballpens per month from a factory, which will equal
1,200 ballpens by the end of the year.

However, Bob is kinda irritated at the factory because aside from the P10 cost of basketball, the factory
charges him a P90 “ordering fee” every time he makes an order. (Ordering Cost or Set up Cost).

So if he orders every month, then he’ll have an added ordering fee cost of P90/month or P1,080/year.

So Bob comes up with a clever plan…

I’ll just order all 1,200 ballpens only once for the whole year, so I’ll just pay the P90 ordering fee one
time.

So he pays P90/year in ordering fee instead of P1,080..

Just Bob thought he had the problem solved, he sees another problem.

He doesn’t have any space in his shop to keep the basketballs.

He needs to rent extra space from his neighbor who has big garage. For any extra space just enough to
store 1 basketball, his neighbor charges P3 per year. (Holding Cost per unit per year)

In other words, its expensive for Joseph if he orders few basketballs at a time because of the “ordering
fee or setup cost” (P90)

And its also expensive for Bob if he orders only a lot of basketballs at one time; because of the “storage
rental fee or holding cos” (P3/unit/year)

So what should Joseph do now?

What is the best number of basketballs that Joseph should order at one time? “Economic Order
Quantity” EOQ.

To find out the best or “optimal number of basketballs (EOQ) that Joseph should order at one time, we
use this simple formula:

EOQ= √2(1,200)(90) EOQ= √ 2 x D x S EOQ= √p216,000 EOQ= √72,000

P3 H P3

=268.33 OR 269 JOSEPH SHOULD ORDER 269 BASKETBALL AT A TIME

TIPS: At this number setup/order cost per year = holding/rent cost per year
Total cost is more expensive when the setup costs and holding costs are uneven.