EOQ

Inventory Models for Independent Demand

address two important questions:
(1) when to order and  ROP
(2) how much to order  EOQ

These independent demand models are:

1. Basic economic order quantity (EOQ) model

2. Production order quantity model
3. Quantity discount model

Economic order quantity (EOQ) model

An inventory-control technique that minimizes the total of ordering and holding costs.

The Basic Economic Order Quantity (EOQ) Model

commonly used inventory-control techniques and is easy to use.

based on several assumptions:

1. Demand for an item is known, reasonably constant, and independent of decisions for other
items.
2. Lead time—that is, the time between placement and receipt of the order—is known and
consistent.
3. Receipt of inventory is instantaneous and complete. In other words, the inventory from an order
arrives in one batch at one time.
4. Quantity discounts are not possible.
5. The only variable costs are the cost of setting up or placing an order (setup or ordering cost) and
the cost of holding or storing inventory over time (holding or carrying cost). These costs were
discussed in the previous section.
6. Stockouts (shortages) can be completely avoided if orders are placed at the right time.

With these assumptions, the graph of inventory usage over time has a sawtooth shape, as in Figure 12.3.
In Figure 12.3, Q represents the amount that is ordered. If this amount is 500 dresses, all 500 dresses
arrive at one time (when an order is received). Thus, the inventory level jumps from 0 to 500 dresses. In
general, an inventory level increases from 0 to Q units when an order arrives.

Because demand is constant over time, inventory drops at a uniform rate over time. (Refer to the sloped
lines in Figure 12.3.) Each time the inventory is received, the inventory level again jumps to Q units
(represented by the vertical lines). This process continues indefinitely over time.
Minimizing Costs
objective: minimize total costs.

With the assumptions just given,

significant costs are:

(1) setup (or ordering) cost and
(2) holding (or carrying) cost.

All other costs, such as the cost of the inventory itself, are constant.

Thus, if we minimize the sum of setup and holding costs, we will also be
minimizing total costs.
Robust Model – Benefit of EOQ:
it gives satisfactory answers even with substantial variation in its parameters
As we have observed, determining accurate ordering costs and holding costs for inventory is often
difficult.

Consequently, a robust model is advantageous:

(1) The total cost of the EOQ changes little in the neighbourhood of the minimum.
(2) The curve is very shallow.
This means that variations in setup costs, holding costs, demand, or even EOQ make relatively modest
differences in total cost.

Conclusion
 We may conclude that the EOQ is indeed robust and that significant errors do not cost us
very much.
 This attribute of the EOQ model is most convenient because our ability to accurately determine
demand, holding cost, and ordering cost is limited.