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(Part III)

Outline

Probabilistic Model

Single period Discrete demand

Introduction

The major influencing factors for the inventory decisions

are price, demand, and lead time.

Other factors such as ordering cost, carrying cost, and

stock-out cost are also affecting the inventory decisions but

their nature is not so much disturbing.

Sometimes price fluctuations are too much in the market

and hence it influences inventory decisions. Similarly,

variability in demand or consumption of an item as well as

the variability in lead time influence the overall inventory

policy.

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Probabilistic inventory models:

I.

inventory model applies to inventory situations in which

only one order is placed for goods in anticipation of a

future selling season where demand is uncertain. At the

end of the period the product has either sold out or

there is a surplus of unsold items to sell at salvage

value.

inventory models are usually addressed in finding the

minimum expected cost over N periods. In these

models both demand and lead time are uncertain.

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In single period inventory situation, the only question is

how much of the product to order at the start of the period.

Newspaper sales are a typical example of the single period

model. Thus the single period inventory problem is

sometimes referred to as the newsvendor problem.

such as perishable goods, spare parts, and seasonal goods

requiring one time purchase only.

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Applications of single period model:

i.

ii.

remaining at the end of the season must be sold at highly

discounted prices to clear space for the next season.

v.

production run of a certain model of a product (e.g., an airplane)

for use as needed throughout the lengthy field life of that model.

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The demand for such item may be discrete or continuous.

Since for a given period, purchase of item is made only once,

the lead time factor is least important in these models. In

such cases, there are two types of costs involved:

Over-stocking cost: Loss due to excess stocks

Under-stocking cost: Opportunity losses due to high demand

D = Demand of an item in units (a random variable)

Q = the number of units stocked (or to be purchased)

P = Purchase price per unit

S = Selling price per unit

Ch = Carrying cost or holding cost per unit for entire period

Cs = Shortage cost per unit

V = Salvage value per unit

Sasadhar Bera, IIM Ranchi

Co = Over-stocking cost per unit

= Loss associated with each unit left unsold

= P + Ch V

Cu = Under-stocking cost per unit

= Loss due to not meeting demand

= S P + Cs

The single period can be solved using a technique called

marginal economic analysis, which compares the cost or

loss of ordering one additional item with the cost or loss of

not ordering one additional item.

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Example: Demand follows discrete distribution

A newspaper boy buys papers for Rs. 2 each and sells them

for Rs. 2.50 each. He cannot return unsold newspapers.

Daily demand has the following distribution

Nos of

customers

Probability

230 240 250 260 270 280 290 300 310 320

0.01 0.03 0.06 0.10 0.2 0.25 0.15 0.1 0.05 0.05

demand, how many papers should he order each day?

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Example: Demand follows uniform distribution

An item sells for Rs. 20 per unit and cost Rs. 10. Unsold

items can be sold for Rs. 4 each. It is assumed that there

is no shortage penalty cost besides the lost revenue. The

demand is known to be any value between 500 and 1200

items. Determine the optimal number of units to the

item to be stocked.

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