Chapter 10

Managing Economies of Scale in the Supply Chain: Cycle

Inventory
True/False

1. Cycle inventory exists because producing or purchasing in large lots allows a

stage of the supply chain to exploit economies of scale and increase cost.
Answer: False

2. A lot or batch size is the quantity that a stage of the supply chain either
produces or purchases at a given time.
Answer: True

3. Cycle inventory is the physical inventory in the supply chain due to either
production or purchases demanded by the customer.
Answer: True

4. The inventory profile is a plot depicting the level of inventory over time.
Answer: True

5. When demand is steady, cycle inventory and lot size are related as follows:
Cycle Inventory = Lot Size x 2 = Q*2.
Answer: False

6. Lot sizes and cycle inventory do not affect the flow time of material within the
supply chain.
Answer: False

7. Average flow time resulting from cycle inventory = Cycle Inventory/Demand =

Q/2D.
Answer: True

8. Cycle inventory is primarily held to take advantage of economies of scale and

reduce profit within the supply chain.
Answer: False

9. Increasing the lot size or cycle inventory often decreases the cost incurred by
different stages of a supply chain.
Answer: True

10. Cycle inventory exists in a supply chain because different stages exploit
economies of scale to lower total cost.
Answer: True

11. The costs considered in lot sizing decisions include material cost, fixed
ordering cost, and manufacturing cost.
Answer: False

12. The total annual cost is the sum of annual material cost, annual order cost,
and annual holding cost, and is given as TC = CD + (D/Q)S + (Q/2)hC.
Answer: True

13. The optimal lot size is referred to as the economic order quantity (EOQ). It is
denoted by Q * and is given by the equation: Q* = √2DS/hC.
 Answer: True

14. Total ordering and holding costs are unstable around the economic order
quantity.
Answer: False

15. A firm is often better served by ordering a convenient lot size close to the
economic order quantity rather than the precise EOQ.
Answer: True

16. If demand increases by a factor of k, the optimal lot size decreases by a

factor of k.
Answer: False

17. To reduce the optimal lot size by a factor of k, the fixed order cost S must be
reduced by a factor of k.
Answer: False

18. Aggregating across products, retailers, or suppliers in a single order allows for
a reduction in lot size for individual products because fixed ordering and
transportation costs are now spread across multiple products, retailers, or
suppliers.
Answer: True

19. A key to reducing cycle inventory is the reduction of lot size.

Answer: True

20. A key to reducing lot size without increasing costs is to reduce the holding
cost associated with each lot.
Answer: False

21. Reduction of fixed cost may be achieved by aggregating lots across multiple
products, customers, or suppliers.
Answer: True

22. A discount is volume-based if the pricing schedule offers discounts based on

the quantity ordered in a single lot.
Answer: False

23. A discount is volume-based if the discount is based on the total quantity

purchased over a given period, regardless of the number of lots purchased
over that period.
Answer: True

24. Pricing schedules with all unit quantity discounts encourage retailers to
increase the size of their lots, which reduces the average inventory and flow
time in a supply chain.
Answer: False

25. Marginal unit quantity discounts have also been referred to as multi-block
tariffs.
Answer: True

26. Quantity discounts lead to a minor buildup of cycle inventory in the supply
chain.
Answer: False
27. For commodity products where price is set by the market, manufacturers can
use lot size based quantity discounts to achieve coordination in the supply
chain and decrease supply chain cost.
Answer: True

28. The supply chain profit is higher if each stage of the supply chain
independently makes its pricing decisions with the objective of maximizing its
own profit.
Answer: False

29. For products where the firm has market power, two-part tariffs can be used to
achieve coordination in the supply chain and maximize supply chain profits.
Answer: True

30. Discounts related to price discrimination will be lot size based.

Answer: False

31. Price discrimination is the practice where a firm charges differential prices to
maximize profits.
Answer: True
32. The goal of trade promotions is to influence retailers to act in a way that helps
the retailer achieve its objectives.
Answer: False
33. Although a forward buy is often the retailer’s appropriate response and
increases their own profits, it usually increases demand variability with a
resulting increase in inventory and flow times within the supply chain.
Answer: True
34. Trade promotions lead to a significant increase in lot size and cycle inventory
because of forward buying by the retailer.
Answer: True

Multiple Choice

1. Cycle inventory exists because producing or purchasing in large lots allows a

stage of the supply chain to
a. exploit economies of scale and raise cost.
b. exploit economies of scale and lower cost.
c. exploit customers and lower cost.
d. exploit customers and raise cost.
e. none of the above
Answer: b

2. The quantity of inventory that a stage of the supply chain either produces or
purchases at a given time is
a. an order.
b. a job.
c. a shipment.
d. a lot or batch.
e. none of the above
Answer: d

3. The average inventory in the supply chain due to either production or

purchases in lot sizes that are larger than those demanded by the customer is
a. annual inventory.
 b. distribution inventory.
c. cycle inventory.
d. physical inventory.
e. b and c only
Answer: c

4. A graphical plot depicting the level of inventory over time is

a. an inventory graph.
b. a distribution inventory.
c. an inventory drawing.
d. an inventory profile.
e. an inventory picture.
Answer: d

5. When demand is steady, cycle inventory and lot size are related as
a. Cycle Inventory = Lot Size x 2.
b. Cycle Inventory = Q*2.
c. Cycle Inventory = Q/2.
d. Cycle Inventory = Lot Size = Q.
e. none of the above
Answer: c

6. Average flow time resulting from cycle inventory is equal to

a. Cycle Inventory/Demand = Q/2.
b. Cycle Inventory/Demand = Q/2D.
c. Cycle Inventory = Q/2.
d. Cycle Inventory = Lot Size = Q.
e. none of the above
Answer: b

7. Cycle inventory is primarily held to

a. take advantage of diseconomies of scale and increase cost within the
supply chain.
b. take advantage of diseconomies of scale and reduce cost within the
supply chain.
c. take advantage of economies of scale and increase cost within the supply
chain.
d. take advantage of economies of scale and reduce cost within the supply
chain.
e. None of the above are true.
Answer: d

8. Which of the following is not a cost that must be considered in any lot sizing
decision?
a. Average price per unit purchased, $C/unit
b. Fixed ordering cost incurred per lot, $S/lot
c. Holding cost incurred per unit per year, $H/unit/year = hC
d. Manufacturing cost per unit, $M/unit
e. All of the above are costs to be considered.
Answer: d

9. The primary role of cycle inventory is to allow different stages in the supply
chain to
a. purchase product in lot sizes that maximize the sum of the material,
ordering, and holding cost.
 b. purchase product in lot sizes that minimize the sum of the material,
ordering, and holding cost.
c. sell product in lot sizes that maximize the sum of the material, ordering,
and holding cost.
d. sell product in lot sizes that minimize the sum of the material, ordering,
and holding cost.
e. none of the above
Answer: b

10. Economies of scale in purchasing and ordering motivate a manager to

a. increase the lot size and cycle inventory.
b. decrease the lot size and cycle inventory.
c. eliminate inventory.
d. increase the lot size and reduce cycle inventory.
e. none of the above
Answer: a

11. Which of the following is not a situation in which any stage of the supply
chain exploits economies of scale in its replenishment decisions?
a. A fixed cost is incurred each time an order is placed or produced.
b. A holding cost is incurred each period for each unit of inventory.
c. The supplier offers price discounts based on the quantity purchased per
lot.
d. The supplier offers short-term discounts or holds trade promotions.
e. all of the above
Answer: b

12. The price paid per unit is referred to as

a. the material cost and is denoted by C.
b. the fixed ordering cost and is denoted by S.
c. the holding cost and is denoted by H.
d. the purchase price and is denoted by P.
e. none of the above
Answer: a

13. All costs that do not vary with the size of the order but are incurred each time
an order is placed are referred to as
a. the material cost and is denoted by C.
b. the fixed ordering cost and is denoted by S.
c. the holding cost and is denoted by H.
d. the purchase price and is denoted by P.
e. none of the above
Answer: b

14. The cost of carrying one unit in inventory for a specified period of time,
usually one year, is referred to as
a. the material cost and is denoted by C.
b. the fixed ordering cost and is denoted by S.
c. the holding cost and is denoted by H.
d. the purchase price and is denoted by P.
e. none of the above
 Answer: c

15. Which of the following would not be an example of a fixed ordering cost?
a. administrative cost incurred to place an order
b. trucking cost incurred to transport an order
c. labor cost incurred to receive an order
d. labor cost incurred to manufacture a part
e. none of the above
Answer: d

16. Which of the following would not be included in holding cost?

a. cost of capital
b. cost of physically storing the inventory
c. cost of manufacturing
d. cost that results from the product becoming obsolete
e. none of the above
Answer: c

17. The total annual cost is the sum of annual material cost, annual order cost,
and annual holding cost, and is given as
a. TC = CD + (D/Q)S + (Q/2)hC.
b. TC = CD + (Q/2)S + (D/Q)hC.
c. TC = CDS + D/Q + (Q/2)hC.
d. TC = Q/2 + (D/Q)S + (CD)hC.
e. none of the above
Answer: a

18. Total ordering and holding costs

a. are relatively stable.
b. are relatively stable around the economic order quantity.
c. are relatively unstable around the economic order quantity.
d. are unstable.
e. none of the above
Answer: b

19. If demand increases by a factor of k, the optimal lot size increases by a factor
of
a. k.
b. k/2.
c. k + 2.
d. k-squared.
e. the square root of k.
Answer: e

20. If demand increases by a factor of k, the number of orders placed per year
should increase by a factor of
a. k.
b. k/2.
c. k + 2.
d. k-squared.
e. the square root of k.
Answer: e
21. To reduce the optimal lot size by a factor of k, the fixed order cost S must be
a. increased by a factor of k.
b. increased by a factor of k-squared.
c. reduced by a factor of k-squared.
d. reduced by a factor of the square root of k.
e. reduced by a factor of k.
Answer: c

22. Aggregating across products, retailers, or suppliers in a single order allows for
a. an increase in lot size for individual products.
b. an increase in customer demand.
c. a reduction in holding cost per unit.
d. a reduction in lot size for individual products.
e. a reduction in purchase price per unit.
Answer: d

23. Aggregating across products, retailers, or suppliers in a single order allows for
a reduction in lot size for individual products because
a. fixed ordering and transportation costs are now charged to retailers.
b. fixed ordering and transportation costs are now charged to suppliers.
c. fixed ordering and transportation costs are now spread across multiple
products, retailers, or suppliers.
d. holding costs are now charged to retailers or suppliers.
e. holding costs are now spread across multiple products, retailers, or
suppliers.
Answer: c

24. A key to reducing cycle inventory is

a. the reduction of holding cost.
b. the reduction of manufacturing cost.
c. the reduction of lot size.
d. the reduction of warehouse space.
e. all of the above
Answer: c

25. A key to reducing lot size without increasing costs is to

a. reduce the holding cost associated with each lot.
b. reduce the fixed cost associated with each lot.
c. reduce the material cost associated with each lot.
d. reduce the manufacturing cost associated with each lot.
e. increase the holding cost associated with each lot.
Answer: b

26. A price discount where the pricing schedule offers discounts based on the
quantity ordered in a single lot is
a. customer based.
b. lot size based.
c. supplier based.
d. volume based.
e. none of the above
Answer: b
27. A price discount where the discount is based on the total quantity purchased
over a given period, regardless of the number of lots purchased over that
period is
a. customer based.
b. lot size based.
c. supplier based.
d. volume based.
e. none of the above
Answer: d

28. Pricing schedules with all unit quantity discounts encourage retailers to
a. decrease the size of their lots.
b. increase the size of their lots.
c. decrease the size of their inventory.
d. increase the price of their products.
e. none of the above
Answer: a

29. In the pricing schedule for marginal unit quantity discounts

a. the average cost of a unit decreases at a breakpoint.
b. the average cost of a unit increases at a breakpoint.
c. the marginal cost of a unit decreases at a breakpoint.
d. the marginal cost of a unit increases at a breakpoint.
e. the average cost and the marginal cost of a unit decrease at a breakpoint.
Answer: c

30. Quantity discounts lead to

a. a significant buildup of cycle inventory in the supply chain.
b. a slight buildup of cycle inventory in the supply chain.
c. a decrease in cycle inventory in the supply chain.
d. minor fluctuations of cycle inventory in the supply chain.
e. a major drop in cycle inventory in the supply chain.
Answer: a

31. For commodity products where price is set by the market, manufacturers can
use lot size based quantity discounts to
a. achieve coordination in the supply chain and decrease supply chain cost.
b. relax coordination in the supply chain and increase supply chain cost.
c. relax coordination in the supply chain and decrease supply chain cost.
d. achieve coordination in the supply chain and decrease supply chain cost.
e. None of the above are accurate.
Answer: d

32. In a supply chain where each stage of the supply chain independently makes
its pricing decisions with the objective of maximizing its own profit,
a. supply chain profit is lower than a coordinated solution.
b. supply chain profit is higher than a coordinated solution.
c. supply chain profit is about the same as a coordinated solution.
d. supply chain profit will be maximized.
e. None of the above are accurate.
Answer: a

33. For products where the firm has market power, coordination in the supply
chain can be achieved and supply chain profits maximized through the use of
a. two-part tariffs or volume based quantity discounts.
b. marginal unit quantity discounts.
 c. all unit quantity discounts.
d. basic quantity discounts.
e. none of the above
Answer: a

34. The practice where a firm charges differential prices to maximize profits is
a. lot pricing.
b. marginal pricing.
c. price incrimination.
d. price discrimination.
e. all of the above
Answer: d

35. Discounts related to price discrimination will be

a. volume based.
b. unit based.
c. marginally based.
d. lot size based.
e. none of the above
Answer: a

36. The goal of trade promotions is to

a. influence retailers to act in a way that helps the retailer achieve its
objectives.
b. influence retailers to act in a way that helps the manufacturer achieve its
objectives.
c. influence retailers to act in a way that will maximize supply chain profit.
d. influence retailers to act in a way minimize supply chain cost.
e. none of the above
Answer: b

37. Which of the following is not a key goal (from the manufacturer’s perspective)
of a trade promotion?
a. Induce retailers to use price discounts, displays, or advertising to spur
sales.
b. Shift inventory from the manufacturer to the retailer and the customer.
c. Shift inventory from the retailer to the customer.
d. Defend a brand against competition.
e. none of the above
Answer: c

38. Which of the following is a possible response that a retailer could make to a
trade promotion?
a. Pass through some or all of the promotion to customers to spur sales.
b. Pass through very little of the promotion to customers but purchase in
greater quantity during the promotion period to exploit the temporary
reduction in price.
c. Shift inventory from the retailer to the customer.
d. a and b only
e. b and c only
Answer: d

39. When the retailer decides to pass through some or all of the promotion to
customers to spur sales, the result is
a. a lowering of the price of the product for the end customer.
 b. increased purchases and thus increased sales for the entire supply chain.
c. an increase in the amount of inventory held at the retailer.
d. all of the above
e. a and b only
Answer: e

40. When the retailer decides to pass through very little of the promotion to
customers but purchase in greater quantity during the promotion period to
exploit the temporary reduction in price, the result is
a. a lowering of the price of the product for the end customer.
b. increased purchases and thus increased sales for the entire supply chain.
c. an increase in the amount of inventory held at the retailer.
d. all of the above
e. a and b only
Answer: c

41. The manufacturer can justify offering trade promotions resulting in forward
buying by retailers when
a. they have inadvertently built up a lot of excess inventory.
b. the forward buy allows the manufacturer to smooth demand by shifting it
from peak to low-demand periods.
c. the retailer decreases his total cost.
d. all of the above
e. a and b only
Answer: e

42. The retailer can justify the forward buying when

a. they have inadvertently built up a lot of excess inventory.
b. the forward buy allows the manufacturer to smooth demand by shifting it
from peak to low-demand periods.
c. it decreases his total cost.
d. all of the above
e. a and c only
Answer: c

43. Replenishment orders in multi-echelon supply chains should be

a. synchronized to increase cycle inventory and order costs.
b. synchronized to facilitate supplier evaluation and selection.
c. synchronized to keep cycle inventory and order costs low.
d. separated to increase cycle inventory and order costs.
e. separated to keep cycle inventory and order costs low.
Answer: c

44. When developing estimates for holding and ordering costs, it is important to
a. estimate these costs to a high level of precision.
b. get a good approximation quickly.
c. develop estimates that will not be changed.
d. both a and c
e. none of the above
Answer: b

45. Which cost takes into account the return demanded on the firm’s equity and
the amount the firm must pay on its debt?
a. cost of capital
b. obsolescence (spoilage) cost
c. handling cost
 d. occupancy cost
e. none of the above
Answer: a

46. Which cost estimates the rate at which the value of the product being stored
drops either because the market value of that product drops or because the
product quality deteriorates?
a. cost of capital
b. obsolescence (spoilage) cost
c. handling cost
d. occupancy cost
e. none of the above
Answer: b

47. Which cost should only include receiving and storage costs that vary with the
quantity of product received?
a. cost of capital
b. obsolescence (spoilage) cost
c. handling cost
d. occupancy cost
e. none of the above
Answer: c

48. Which cost should reflect the incremental change in space cost due to
changing cycle inventory?
a. cost of capital
b. obsolescence (spoilage) cost
c. handling cost
d. occupancy cost
e. none of the above
Answer: d

49. Which of the following would not be a component of order cost?

a. buyer time
b. transportation cost
c. handling cost
d. receiving cost
e. All of the above are components of order cost.
Answer: c