Part I is here.
The Economic Order Quantity (EOQ) model is a simple inventory-control technique. It is based on several assumptions:
- Demand is known and constant.
- Receipt of inventory is instantaneous and complete, i.e. the inventory from an order arrives in one batch at one time.
- No quantity discount.
- The only variable costs are inventory holding cost and ordering cost (or setup cost).
With these assumptions, the graph of inventory usage over time has a sawtooth shape, as shown in the diagram below:
The optimum order quantity is the quantity which results in lowest variable costs (inventory holding cost plus ordering cost). It is given by this formula:
Q* = optimal order quantity
D = annual demand in units for the inventory item
S = setup or ordering cost for each order
H = inventory holding cost per unit per year
The annual demand for an inventory item is 1,000 units; the setup or ordering cost is $10 per order; and the holding cost per unit per year is $0.50. Solving for optimal order quantity:
Jay Heizer & Barry Render, “Operations Management”, 8th edition