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EOQ

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Clawback

Economic order quantity (EOQ) is the order quantity that minimizes total inventory holding costs and ordering

costs. It is one of the oldest classical production scheduling models. The framework used to determine this

order quantity is also known as Wilson EOQ Modelor Wilson Formula. The model was developed by Ford W.

Harris in 1913,[1] but R. H. Wilson, a consultant who applied it extensively, is given credit for his in-depth

analysis.[2]

Contents

[hide]

1 Overview

2 Variables

4 Quantity Discounts

o

5 Other Extensions

6 Example

7 Multi-Criteria EOQ

8 See also

9 References

10 Further reading

11 External links

Overview[edit]

EOQ applies only when demand for a product is constant over the year and each new order is delivered in full

when inventory reaches zero. There is a fixed cost for each order placed, regardless of the number of units

ordered. There is also a cost for each unit held in storage, commonly known as holding cost, sometimes

expressed as a percentage of the purchase cost of the item.

We want to determine the optimal number of units to order so that we minimize the total cost associated with

the purchase, 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 the storage cost for each item per year. Note that the number of times an

order is placed will also affect the total cost, though this number can be determined from the other parameters.

Variables[edit]

= order quantity

= fixed cost per order, setup cost (not per unit, typically cost of

ordering and shipping and handling. This is not the cost of goods)

storage cost (capital cost, warehouse space, refrigeration, insurance, etc.

usually not related to the unit production cost)

Classic EOQ model: trade-off between ordering cost (blue) and holding cost (red). Total cost (green) admits aglobal

optimum. Purchase cost is not a relevant cost for determining the optimal order quantity.

The single-item EOQ formula finds the minimum point of the following cost function:

Total Cost = purchase cost or production 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: This is the cost of placing orders: each order has a fixed cost K, and we need to order D/Q

times per year. This is K D/Q

- Holding cost: the average quantity in stock (between fully replenished and empty) is Q/2, so this cost is h

Q/2

.

To determine the minimum point of the total cost curve, partially differentiate the total cost with respect to Q

(assume all other variables are constant) and set to 0:

Therefore:

Economic Order Quantity

The optimal value Q* may also be found by recognising that [3]

Quantity Discounts[edit]

An important extension to the EOQ model of Wilson is to accommodate

quantity discounts. There are two main types of quantity discounts: (1) allunits and (2) incremental. [4]Here is a numerical example.

Incremental unit discount: Units 1-100 cost $30 each; Units 101-199

cost $28 each; Units 200 and up cost $26 each. So when 150 units

are ordered, the total cost is $30*100 + $28*50.

All units discount: An order of 1-1000 units costs $30 each; an order of

1001-5000 units costs $45 each; an order of more than 5000 units

costs $40 each. So when 1500 units are ordered, the total cost is

$45*1500.

In presence of a strategic customer, who responds optimally to discount

schedule, the design of optimal quantity discount scheme by the supplier is

complex and has to be done carefully. This is particularly so when the

demand at the customer is itself uncertain. An interesting effect called the

reverse bullwhip takes place where an increase in consumer demand

uncertainty actually reduces order quantity uncertainty at the supplier.[5]

Other Extensions[edit]

Several extensions can be made to the EOQ model developed by Mr.

Pankaj Mane, including backordering costs and multiple items. Additionally,

the economic order intervalcan be determined from the EOQ and

the economic production quantity model (which determines the optimal

production quantity) can be determined in a similar fashion.

A version of the model, the Baumol-Tobin model, has also been used to

determine the money demand function, where a person's holdings of

money balances can be seen in a way parallel to a firm's holdings of

inventory.[6]

Example[edit]

= 500 units

Total cost

Total cost

If we check the total cost for any order quantity other than 500(=EOQ), we

will see that the cost is higher. For instance, supposing 600 units per order,

then

Total cost

Total cost

This illustrates that the Economic Order Quantity is always in the best

interests of the entity.

Multi-Criteria EOQ[edit]

Malakooti (2013) [7] has introduced the multi-criteria EOQ models where the

criteria could be minimizing the total cost, Order quantity (inventory), and

Shortages.

See also[edit]

Costant fill rate for the part being produced: Economic Production

Quantity

Scheduling Problem

Reorder point

References[edit]

1.

Jump up^ Harris, Ford W. (1990) [Reprint from 1913]. "How Many Parts

to Make at Once". Operations Research (INFORMS) 38 (6): 947

950. doi:10.1287/opre.38.6.947. JSTOR 170962. Retrieved Nov

21, 2012. edit

2.

Management, Prentice-Hall, Englewood Cliffs, NJ, p. 135

3.

opportunities an historical overview". International Journal of

Production Economics 41: 114. doi:10.1016/0925-5273(95)00109-3.

4.

McGraw Hill Higher Education. edit

5.

Jump up^ Altintas, N.; Erhun, F.; Tayur, S. (2008). "Quantity Discounts

Under Demand Uncertainty". Management Science 54 (4): 777

792. doi:10.1287/mnsc.1070.0829. edit

6.

Jump up^ Andrew Caplin and John Leahy, "Economic Theory and the

World of Practice: A Celebration of the (S,s) Model", Journal of Economic

Perspectives, Winter 2010, V 24, N 1

7.

Multiple Objectives. John Wiley & Sons. ISBN 978-1-118-58537-5.

Further reading[edit]

Chicago: Shaw (1915).

Business Review, 13, 116-128 (1934).

External links[edit]

http://www.inventoryops.com/economic_order_quantity.htm

http://www.scmfocus.com/supplyplanning/2014/04/10/economic-orderquantity-calculator/

Edition. McGraw Hill. 1984. (first edition 1975)

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