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Module 3: Deterministic Inventory Models

Lecture 3.3: EOQ Extensions

IEE 534: Supply Chain Modeling & Analysis

Prof. Esma S. Gel

Objectives
• By the end of this lecture, you will be prepared to:
• Calculate the EOQ inventory ordering policy for cases with
incremental and all units discounts

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Recall…
• In the last lecture, we covered positive lead times and
economic production lotsize (EPL) model
• Note that in the basic EOQ model, the total cost
function is
KD Q
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C(Q) = + cD + h
Q 2
• The purchasing component is “independent” of the
ordering quantity, Q
• But what if the unit cost was a function of the ordering
quantity?

Extension: Quantity Discounts

• The basic EOQ model can be extended to the case of

quantity discounts given as part of contractual
agreements.
• There are one or more breakpoints defining changes in
the unit cost of purchasing, c.
• Hence, the unit cost of purchasing is a function of Q,
meaning that the term cD is no longer irrelevant in the
total cost per unit time function.

Extension: Quantity Discounts

Two common types:
• All units discount: the discount is applied to all of the units in
an order.
• Incremental discount: the discount is applied only to the
additional units beyond the breakpoint

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Example – Quantity Discounts

The Weighty Trash Bag company has the following
price schedule for its large trash can liners. For orders
of less than 500 bags, the company charges 30 cents
per bag; for orders of 500 or more but fewer than 1000
bags it charges 29 cents per bag; and for orders of
1000 or more, it charges 28 cents per bag.
Suppose that you would like to order trash can liners for
your restaurant. Assuming that the holding cost is
based on a 20% annual interest rate, and the setup
cost is $8 per order. The annual demand is 600 units.
• What is the optimal ordering quantity?
• What happens when the discount is “incremental,” rather
than for “all-units” purchased?

All Units Quantity Discounts

• The discount applies to all of the units purchased.
• The purchasing cost of ordering Q units (denoted by
PC(Q) here) is:

Source: Nahmias

All Units Discount Case

The total cost function for the example:

The EOQ values corresponding to the cost functions are

not the same!!!

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All Units Quantity Discounts

Algorithm for calculating the optimal ordering quantity
for all-units discount case
• Determine the largest realizable EOQ value
• Compare the value of the average annual cost at the largest
realizable EOQ and at all the price breakpoints that are
greater than the largest realizable EOQ.
• The optimal Q is the point at which the average annual cost
is a minimum.

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All Units Discount Case

To calculate the optimal ordering quantity, we need to
compare

MINIMUM COST IS ACHIEVED

BY AN ORDER QUANTITY OF
500 UNITS!!!

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Incremental Quantity Discounts

• The discount applies only to the incremental units
above the break point.
• The purchasing cost of ordering Q units in this case is

=0.30(500)+0.29(500)

Source: Nahmias

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Incremental Discounts
Average unit cost can be calculated by finding PC(Q)/Q:

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Incremental Quantity Discounts

• Determine an algebraic expression for PC(Q)
corresponding to each price interval.

• Use that to determine an algebraic expression for the

“average unit cost”, PC (Q)/Q.

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Incremental Quantity Discounts

Substitute the expression derived for PC(Q)/Q into the
defining equation for each C i(Q). Compute the minimum
value of Q corresponding to each price interval separately.

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Incremental Discount Case

BOTH REALIZABLE,
WHICH ONE TO
PICK?

NOT REALIZABLE,
SINCE <1000!

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Incremental Quantity Discounts

Algorithm for calculating the optimal ordering quantity
for incremental discount case
• Determine which minima computed are realizable.

• Compare the values of the average annual costs at the

realizable EOQ values and pick the lowest.

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Incremental Quantity Discounts

• Determine which minima computed are realizable.
à Q0 and Q1 are realizable as they fall within allowable purchase
ranges…Q2 is not.
• Compare the values of the average annual costs at the realizable
EOQ values and pick the lowest.
à Need to compare the costs for those two options:

à Optimal order size is 400 units.

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Time to reflect…

This Photo by Unknown Author is licensed under CC BY-SA-NC

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