ECONOMIC ORDER QUANTITY (EOQ)

ECONOMIC ORDER QUANTITY (EOQ) MODEL

The economic order quantity (EOQ) is the order quantity that minimizes total holding and ordering costs for the year. Even if all the assumptions don’t hold exactly, the EOQ gives us a good indication of whether or not current order quantities are reasonable.

What is the EOQ Model?

• Cost Minimizing “Q”
• Assumptions:
  • Relatively uniform & known demand rate
  • Fixed item cost
  • Fixed ordering and holding cost
  • Constant lead time

(Of course, these assumptions don’t always hold, but the model is pretty robust in practice.)

What Would Holding and Ordering Costs Look Like for the Years?

A = Demand for the year
Cp = Cost to place a single order
Ch = Cost to hold one unit inventory for a year

Total Relevant* Cost (TRC)

Yearly Holding Cost + Yearly Ordering Cost

* “Relevant” because they are affected by the order quantity Q

Economic Order Quantity (EOQ)

EOQ Formula:

A = Demand for the year
Cp = Cost to place a single order
Ch = Cost to hold one unit inventory for a year

Example:

Pam runs a mail-order business for gym equipment. Annual demand for the TricoFlexers is 16,000. The annual holding cost per unit is $2.50 and the cost to place an order is $50. What is the economic order quantity?