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ECONOMIC ORDER QUANTITY MODEL : A REVIEW

Article · December 2014

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Sachin Agarwal
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VSRD International Journal of Mechanical, Civil, Automobile and Production Engineering, Vol. IV Issue XII December 2014 / 233
e-ISSN : 2249-8303, p-ISSN : 2319-2208 © VSRD International Journals : www.vsrdjournals.com

REVIEW PAPER

ECONOMIC ORDER QUANTITY MODEL : A REVIEW

Sachin Agarwal
Assistant Professor, Department of Mechanical Engineering,
SAIT, Indore, Madhya Pradesh, INDIA.
Corresponding Email ID: sachin.agrawal@sait.ac.in

ABSTRACT
Inventory constitutes the most important part of industries. It is very essential to manage inventories efficiently so as to avoid the costs
of changing production rates, overtime, sub-contracting, unnecessary cost of sales and back order penalties during periods of peak and
dynamic demand. Economic Order Quantity (EOQ) models have been effectively employed in marketing, automotive, pharmaceutical,
and retail sectors of the economy for many years. The model gives the optimal solution in closed form which helps to know about the
behavior of the inventory system. The closed-form solution is also easy to compute. The objective is to find the economic order
quantities for both the retailer and the warehouse which minimize the total cost.

Keywords: Economic Order Quantity (EOQ).

1. INTRODUCTION owner. The manufacturer has the expense of materials

Inventory management is important in effective
organization. It is vital in the control of materials and
goods that have use in the production or exchange
activities in case of services. The primary goal of
inventory management is to avoid holding too much
stock. Inventory problems of too great or too small
quantities on hand can cause business failures. If a
manufacturer experiences stock-out of a critical inventory
item, production stop. Moreover, customer demand the
product. If an item is not stocked when the customer
thinks it should be, the retailer loses a customer not only
on that item but also on many other items in the future.
The conclusion one might draw is that effective inventory
management can make a significant contribution to a
company’s profit as well as increase its return on total
assets.
The planning involves:
 What quantity of items to order;
 When do we order.
 How do we order for them to maintain the overall
stock
Effort must be made by the management of any
organization to strike an optimum investment in
inventory since it costs much money to tie down capital
in excess inventory. Economic order quantity model
(EOQ) has proved useful in optimizing resources and
thus, minimizing associated cost.
According to Kotler (2000), inventory management refers
to all the activities involved in developing and managing
the inventory levels of raw materials, semi-finished
materials (working progress) and finished good so that
adequate supplies are available and the costs of over or
under stocks are low.
Rosenblatt (1977) says: “The cost of maintaining
inventory is included in the final price paid by the
consumer. Good in inventory represents a cost to their
and labour. The wholesaler also has funds tied up”.
Therefore, the basic goal of the researchers is to maintain
a level of inventory that will provide optimum stock at
lowest cost.
Morris (1995) stressed that inventory management in its
broadest perspective is to keep the most economical
amount of one kind of asset in order to facilitate an
increase in the total value of all assets of the organization
– human and material resources.
Keth et al. (1994) in their text also stated that the major
objective of inventory management and control is to
inform managers how much of a good to re-order, when
to re-order the good, how frequently orders should be
placed and what the appropriate safety stock is, for
minimizing stockouts. Thus, the overall goal of inventory
is to have what is needed, and to minimize the number of
times one is out of stock.
2. ECONOMIC ORDER QUANTITY MODEL
The EOQ has been previously defined by Dervitsiotis
(1981), Monks (1996), Lucey (1992), and Schroeder
(2000) as the ordering quantity which minimizes the
balance of cost between inventory holding cost and re-
order costs. Lucey (1992) stressed further that to be able
to calculate a basic EOQ, certain assumptions are
necessary:
The basic model makes the following assumptions:
 Demand is uniform, constant and continuous over
time;
 The lead time is constant;
 There is no limit on order size due either to stores
capacity;
 The cost of placing an order is independent of size of
order;
 The cost of holding a unit of stock does not depend
on the quantity in stock;
Sachin Agarwal VSRDIJMCAPE, Vol. IV (XII) December 2014 / 234

The EOQ formula is given below; it’s derivation and In the above formula, Q is defined as the result of the
graphical presentation. calculated EOQ.

EOQ = 2CoD/ Cc … (1) The order quantity, which makes the total cost (TC) at a
minimum, is obtained by differentiating with respect to Q
Where Co, Cc and D denote the ordering costs, carrying and equating the derivative to zero the above total cost
cost and annual demand respectively. equation 2. Thus,

Annual Stock = Q/2, dTc/dQ = Cc/2 – CoD/Q2 and when dTc/dQ = 0 cost
Total annual carrying cost = CcQ/2,
Number of orders per annum = D/Q, is at minimum.
Annual Ordering Costs = CoD/Q
And DCo/Q2 = Cc/2
Total Cost = CcQ/2 + CoD/Q … (2)
Q2 = 2DCo / Cc and Q which represent the EOQ formula

is continuously (perpetually) monitored, and when the

3. INVENTORY MONITORING
APPROACHES
Fixed Quantity, or Q System: This approach maintains
a constant order size, but allows the time between the
placement of orders to vary. This method of monitoring
inventory is sometimes referred to as a perpetual review
method, a continuous review system. The inventory level
inventory drops to the reorder point level, a
replenishment order is placed. The size of the order is
constant (fixed quantity, typically the calculated
economic order quantity for the item). This type of
system provides closer control over inventory items since
the inventory levels are under perpetual scrutiny.

4. FIXED PERIOD SYSTEM This method of monitoring inventory is sometimes

This approach maintains a constant time between the referred to as a fixed interval system. It only requires that
placement of orders, but allows the order size to vary. inventory levels be checked at fixed periods of time. The
Sachin Agarwal
amount that is ordered at a particular time point is the
difference between the current inventory level and a
predetermined maximum inventory level (also called an
order up to level, or a target level). If demand has been
high during the prior time interval, inventory levels will
have been depleted to low levels when the review time
5. HYBRID SYSTEM
It allows both the order size and the time between the
placement of orders to vary. This method of monitoring
inventory is sometimes referred to as an optional
replenishment system, or a min-max system. Hybrid
system combines elements of both the fixed quantity
system and the fixed period system. It is similar to the
periodic review system in that it only checks inventory
levels at fixed intervals of time, and it has a maximum
6. CONCLUSION
Inventory management helps to meet the rising
challenges in most corporate companies. Through a well-
built policy organization is able to handle its idle stock
without incurring unnecessary costs. A basis for
inventory planning and control was also provided in this
study. The study suggests to rectify certain defects in the
VSRDIJMCAPE, Vol. IV (XII) December 2014 / 235
occurs, and the amount to be ordered will be higher.
Since demand continues to occur during the lead time,
inventory levels will increase when the replenishment
order arrives, but not all the way up to the maximum (i.e.,
target) level.
inventory level (or “order up to” or “target” level). An
order is only placed if the size of the order would be
sufficient to warrant placing the order. This determination
is made by incorporating the reorder point concept from
the continuous review system. When demand continues to
occur during the lead time, inventory levels will increase
when the replenishment order arrives, but not all the way
up to the maximum (i.e., target) level.
company inventory policy and if these suggestion are
implemented, the company's inventory management
situation will attain a greater height. Economic order
quantity model useful to maintain an optimal level of
materials in store, the level that minimizes total cost of
investment in inventory. Inventory levels can be a useful
indication of what level of sales to expect.
 Sachin Agarwal VSRDIJMCAPE, Vol. IV (XII) December 2014 / 236

7. ACKNOWLEDGE
Author thanks to the Director, SAIT for their support and
guidance to complete the present paper.

8. REFERENCES
[1] Erlenkotter, D. (1989) “An Early Classic Misplaced: Ford
W. Harris’s Economic Order Quantity Model of 1915,”
Management Science 35:7, pp. 898–900.
[2] R.J. Tersine, Principle of Inventory and Materials
Management, 4th ed., PTR Prentice Hall, Englewood Cliff,
NJ, Ch.4, pp.177-203, 1994.
[3] Federgruen, A. and Y. S. Zheng. (1992) “An Efficient
Algorithm for Computing an Optimal (r,Q) Policy in
Continuous Review Stochastic Inventory Systems,”
Operations Research 40:4, pp. 808–813.
[4] Gallego, G. (1998) “New Bounds and Heuristics for (Q,r)
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[5] R.J. Tersine, Principle of Inventory and Materials
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[7] Schwarz, L. B. (1972) “Economic Order Quantities for
Products with Finite Demand Horizons,” AIIE
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[8] M. Omar, and S.S. Supadi, “A Lot-for-Lot Model with
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[9] Process,” Journal Matematika, 2003, Jilid 19, Bil. 2, pp.
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Zipkin, P. (2000) Foundations of Inventory Management,
McGraw-Hill Higher Education, New York, New York.
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