Economic Order Quantity Model

Table of content

Sr Content Page
No No
1 Introduction 2
2 The EOQ formula derivation 3
3 Assumptions Of EOQ Model 4
4 Advantages of EOQ 5
5 Limitations of Using EOQ 6

6 Conclusion 7
7 Reference 8

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 Economic Order Quantity Model

INTRODUCTION

The EOQ has been previously defined by Dervitsiotis (1981), Monks (1996), Lucey
(1992), and Schroeder (2000) as the ordering quantity which minimizes the balance of
cost between inventory holding cost and reorder costs. Lucey (1992) stressed further
that to be able to calculate a basic EOQ.

What Would Holding and Ordering Costs Look Like for the Years?

A = Demand for the year

Cp = Cost to place a single order

Ch = Cost to hold one unit inventory for a year

Total Relevant* Cost (TRC)

Yearly Holding Cost + Yearly Ordering Cost

* “Relevant” because they are affected by the order quantity Q

Economic Order Quantity (EOQ)

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 Economic Order Quantity Model

The EOQ formula is given below; it’s derivation

EOQ = 2CoD/ Cc … (1)

Where Co, Cc and D denote the ordering costs, carrying cost and annual demand
respectively.
Annual Stock = Q/2,

Total annual carrying cost = CcQ/2,

Number of orders per annum = D/Q,

Annual Ordering Costs = CoD/Q

And
Total Cost = CcQ/2 + CoD/Q … (2)

In the above formula, Q is defined as the result of the calculated EOQ.The order quantity,
which makes the total cost (TC) at a minimum, is obtained by differentiating with respect to
Q and equating the derivative to zero the above total cost equation 2. Thus,

dTc/dQ = Cc/2 – CoD/Q2 and when dTc/dQ = 0 cost

is at minimum.

DCo/Q2 = Cc/2

Q2 = 2DCo / Cc and Q which represent the EOQ formula

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 Economic Order Quantity Model
Assumptions Of EOQ Model

I. Constant or uniform demand– although the EOQ model assumes constant demand,
demand may vary from day to day. If demand is not known in advance- the model must
be modified through the inclusion of safe stock.

II. Constant unit price– the EOQ model assumes that the purchase price per unit of material
will remain unaltered irrespective of the order offered by the suppliers to include variable
costs resulting from quantity discounts, the total costs in the EOQ model can be
redefined.

III. Constant carrying costs– unit carrying costs may very substantially as the size of the
inventory rises, perhaps decreasing because of economies of scale or storage efficiency or
increasing as storage space runs out and new warehouses have to be rented.

IV. Constant ordering cost– this assumption is generally valid. However any violation in this
respect can be accommodated by modifying the EOQ model in a manner similar to the
one used for variable unit price.

V. Instantaneous delivery– if delivery is not instantaneous, which is generally the case; the
original EOQ model must be modified through the inclusion of a safe stock.

VI. Independent orders– if multiple orders result in cost saving by reducing paper work and
the transportation cost, the original EOQ model must be further modified. While this
modification is somewhat complicated, special EOQ models have been developed to deal
with it.

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 Economic Order Quantity Model
Advantages of EOQ
1. Avoids over purchasing

2. Devoted attention on only thse items that are required

3. Positive control can be easily exerted to maintain tota inventory investment at a desired
level, simply by manipulating the plant maximum and minimum levels

4. Unnecessary storage of the raw material is avoided

5. EOQ avoids running out of stock

6. Ensues pre-decided delivery dates

7. EOQ avoids effects like proce fluctuations and shortage of material in the market

8. Material shortage and excess material situation can be avoided

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 Economic Order Quantity Model
Limitations of Using EOQ

The EOQ formula inputs make an assumption that consumer demand is constant. The
calculation also assumes that both ordering and holding costs remain constant, which makes
it difficult or impossible for the formula to account for business events such as changing
consumer demand, seasonal changes in inventory costs, lost sales revenue due to inventory
shortages, or purchase discounts a company might get for buying inventory in larger
quantities.

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 Economic Order Quantity Model

Conclusion

Inventory management helps to meet the rising challenges in most corporate companies.
Through a wellbuiltpolicy organization is able to handle its idle stock without incurring
unnecessary costs. A basis forinventory planning and control was also provided in this study.
The study suggests to rectify certain defects in the company inventory policy and if these
suggestion are implemented, the company's inventory management situation will attain a
greater height. Economic order quantity model useful to maintain an optimal level of
materials in store, the level that minimizes total cost of investment in inventory. Inventory
levels can be a useful indication of what level of sales to expect

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 Economic Order Quantity Model

Reference

 Erlenkotter, D. (1989) “An Early Classic Misplaced: Ford W. Harris's Economic Order
Quantity Model of 1915,” Management Science 35:7, pp. 898–900.

 Federgruen, A. and Y. S. Zheng. (1992) “An Efficient Algorithm for Computing an

Optimal (r,Q) Policy in Continuous Review Stochastic Inventory Systems,” Operations
Research 40:4, pp. 808–813.

 Gallego, G. (1998) “New Bounds and Heuristics for (Q,r) Policies,” Management Science
44:2, 219–233.

 Harris, F. M. (1913) “How Many Parts to Make at Once,” Factory, The Magazine of
Management 10:2, 135–136, 152. Reprinted in Operations Research 38:6 (1990), 947–950.

 Lowe, T. J. and L. B. Schwarz. (1983) “Parameter Estimation for the EOQ Lot-Size
Model: Minimax and Expected-Value Choices,” Naval Research Logistics Quarterly, 30,
367–376.

 Schwarz, L. B. (1972) “Economic Order Quantities for Products with Finite Demand
Horizons,” AIIE Transactions 4:3, 234–237.

 Zheng, Y. S. (1992) “On Properties of Stochastic Inventory Systems,” Management

Science 38:1, 87–103

 Zipkin, P. (2000) Foundations of Inventory M

anagement, McGraw-Hill Higher Education, New York, New York.

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