# Economic Order Quantity Model (EOQ)

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As the name suggests, Economic order quantity (EOQ) model is the method that provides the company with an order quantity. This order quantity figure is where the record holding costs and ordering costs are minimized. By using this model, the companies can minimize the costs associated with the ordering and inventory holding. EOQ model was first developed by an American management scientist named F. W. Harris in 1913. He published it in the article "Economic Lot Size in Purchasing" in the journal "Journal of the American Statistical Association". The EOQ model is considered to be one of the earliest and most widely used quantitative models in inventory management. It is still widely used today by businesses and organizations to optimize their inventory management.

## Definition

Economic Order Quantity (EOQ) is a model used to calculate the optimal quantity that can be purchased or produced to minimize the cost of carrying inventory and processing purchase orders or production setups.

EOQ is used in inventory management to determine the optimal order quantity that a company should purchase in order to minimize the total cost of ordering and holding inventory. It is commonly used in manufacturing and retail industries to balance the trade-off between the cost of ordering inventory and the cost of holding inventory. This model is used to determine the optimal order quantity, the optimal reorder point, and the total inventory cost.

## Formula

Following is the formula for the economic order quantity (EOQ) model:

Where Q = optimal order quantity

D = units of annual demand

S = cost incurred to place a single order or setup

H = carrying cost per unit

This formula is derived from the following cost function:

Total cost = purchase cost + ordering cost + holding cost

Limitations of the economic order quantity model:

It is necessary for the application of EOQ order that the demands remain constant throughout the year. It is also necessary that the inventory be delivered in full when the inventory levels reach zero.

## Underlying Assumption of the EOQ Model

The following are the assumptions underlying the EOQ model. Without these assumptions, the EOQ model cannot work to its optimal potential.

• The cost of the order remains constant.

• The demand rate for the year is known and evenly distributed throughout the year.

• Lead time does not vary (lead time is the latency time it takes to initiate and complete a process).

• There are no cash or settlement discounts, and the purchase price is constant for each item.

• The optimal plan is calculated for only one product.

• There is no delay in replenishing inventory, and the order is shipped in the quantity demanded, i.e., in full.

These basic assumptions are the key to the Economic Order Quantity model, and these assumptions help companies understand the shortcomings they incur in applying this model.

Economic Order Quantity (EOQ) is a model used to determine the optimal order quantity for a company to purchase or produce in order to minimize the total cost of inventory. The main benefits of using EOQ include:

1. Minimization of total inventory cost: EOQ helps minimize the total cost of inventory by finding the optimal order quantity that balances the costs of ordering and holding inventory.

2. Efficient use of resources: EOQ helps ensure that resources are used efficiently by minimizing the number of orders placed and the amount of inventory held.

3. Improved forecasting: EOQ can help companies make more accurate forecasts of future demand by taking into account factors such as lead time, carrying costs, and ordering costs.

4. Simplicity: EOQ is a relatively simple model that is easy for companies to understand and implement.

5. Flexibility: EOQ can be easily adapted to consider specific factors such as inflation, changes in demand or cost, and other variables that may affect inventory decisions.

Economic Order Quantity (EOQ) model has some limitations and disadvantages, including:

Assumptions: The EOQ model assumes that demand is constant and known, lead time is constant and known, and there is no stockout or backorder costs. These assumptions are often not met in real-world situations, which can result in inaccurate results.

Ignores price changes: The EOQ model does not consider changes in the price of the item being ordered, which can have a significant impact on the optimal order quantity.

Does not consider quantity discounts: Many suppliers offer quantity discounts for large orders. The EOQ model does not take into account these discounts and may result in the company ordering less than the optimal amount.

Does not consider the impact of inflation: The EOQ model does not take into account the impact of inflation on the cost of ordering and holding inventory, which can result in inaccurate results over time.

Does not consider the impact of the carrying cost of capital: The EOQ model does not take into account the carrying cost of capital when determining the optimal order quantity.

Does not consider the impact of various transportation costs: EOQ model does not consider the impact of various transportation costs.

It is important to keep in mind that EOQ is a model and it should be used as a guide and not a definitive solution, the results should always be compared with the real-world situations.

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Quote Guest, 11 January, 2013
thanks
Quote Guest 2, 20 February, 2013
Brief and ok
Quote Guest, 20 May, 2013
thank u so much. it is really beneficial
Quote Guest, 21 May, 2013
The given explanation is clear and brief kindly tell me for  in EOQ if the discount is given means how to calculate? AS soon as possible
Quote Guest, 20 June, 2013
As clear as mud
Quote Laxst the "handsome", 27 June, 2013
Quote ESTIMATE, 31 July, 2013
how to calculate eoq, if in the question it cannot give a demand? i'm confused.
Quote Guest, 20 August, 2013
Quote
Guest wrote:
The given explanation is clear and brief kindly tell me for in EOQ if the discount is given means how to calculate? AS soon as possible
Quote Guest, 20 August, 2013
in what types of inventories can the EOQ and order level policies be used
Quote Guest, 6 September, 2013
thanks but what if there is quantity discount
Quote Guest, 20 September, 2013
thanks it is understandable
Quote msk king, 31 October, 2013
is there consider , half of order quantity as safety stock ?
Quote Mahendra Joshi, 6 November, 2013
How can i calculate the cost incurred to place a single order ?
Quote Sarath, 26 November, 2013
Thank you for the nice explanation...;)
Quote Guest, 20 January, 2014
good job
Quote Guest, 30 April, 2014
Thanks for the brief explanation.
Quote Guest, 14 May, 2014
A firm consumes annually 12500 small screws at an even rate of 2500 per week. The cost of the screw is N40.00 per 1,000. The cost of placing an order irrespective of the quantity ordered is N50.00. The risk obsolescence is negligible and the cost of storage has been estimated atN10.00 per 1,000 screws per annum. the firm's minimum required rate of return on capital is 20%
ROQ:
(1) Calculate the EOQ and state the optimum ordering policy from supplier who can guarantee immediate delivery
(2) State the change required in the re=ordering policy if there were a lead time of two weeks.
Quote
Guest wrote:
in what types of inventories can the EOQ and order level policies be used
Quote Guest, 2 May, 2015
Very satisfactory explanation...  Thanx

Short and sweet
Quote Guest, 6 January, 2016
Thanks
Quote Guest, 12 January, 2016
Briefly describe situation that led to the use of the EOQ model
Quote Nandan, 12 January, 2016
Briefly describe situation that led to the use of the EOQ model
Quote Guest, 12 January, 2016
Inventory Management at ABC organization

ABC is an organization that procures a product PQ from another organisation. ABC requires 11,000 units of PQ every year. The cost of the product is Rs.5 per unit and its ordering cost is estimated to be Rs.100 per order. The cost of carrying inventory is 25%. The consumption rate of PQ in the organization is uniform. Therefore, ABC needs to spend a huge amount on the procurement of product PQ. The CEO of ABC called the production manager of the organization to discuss whether the manufacturing of the product PQ would be more economical for the organisation.

The production manager conducts a research and identifies equipment that can be used for producing PQ. This equipment can yield 100 units of PQ per day. The cost of producing a single unit of PQ by using the equipment is Rs.3.50 per unit. In addition, the setup cost of equipment and inventory carrying costs are Rs.50 per setup and 25%, respectively. From the preceding data, it is found that the production of product PQ would be more beneficial for ABC. Therefore, ABC has purchased the equipment and has started in - house production of PQ. This has reduced the cost of procuring PQ almost five times.

Question

Calculate the EOQ. Analyse if EOQ has helped ABC in managing inventory.

1) Calculation of EOQ

2) Briefly describe situation that led to the use of the EOQ model.

3) Assess the pre EOQ situation to post EOQ situation

4) Summarise if EOQ has helped ABC
Quote Guest, 2 March, 2016
thank u
Quote Guest, 26 June, 2016
Thanx alot.  U hav just added something special to me.
Quote Guest, 4 March, 2017
what are the limitations of eoq model?
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