ECONOMIC ORDER QUANTITY (EOQ) MODEL
Inventories concern about important functions such as meeting anticipated demand, smoothing production requirements, taking advantageof quantity discounts, minimizing the effects of production and delivery disruptions, and hedging against price increases. However, inventories cost money to obtain and keep around. Therefore, twosimultaneous pursuits of inventory control are to provide the right material at the right time and to minimize the cost of providing that service.
The economic order quantity is the order quantity thatminimizes total holding and ordering costs for the year. This model has some assumptions such as:
Relatively uniform & known demand rate
Fixed item cost Fixed ordering and holding cost
Constant lead time
We want to determine the optimal number of units of the product to order so that we minimize the total cost associated with thepurchase, delivery and storage of the product. The required parameters to the solution are the total demand for the year, the purchase cost for each item, the fixed cost to place the order and thestorage cost for each item per year.
The variables included in the formula are represented this way:
Q = order quantity
Q * = optimal order quantity
D = annual demand quantity of the product
P =purchase cost per unit
S = fixed cost per order (not per unit, in addition to unit cost)
H = annual holding cost per unit (storage cost)
EOQ formula finds the minimum point of the following costfunction:
Total Cost = purchase cost + ordering cost + holding cost
- Purchase cost: This is the variable cost of goods: purchase unit price × annual demand quantity. This is P×D
- Ordering cost: Thisis the cost of placing orders: each order has a fixed cost S, and we need to order D/Q times per year. This is S × D/Q
- Holding cost: the average quantity in stock (between fully replenished and...