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Stochastic Inventory Model
Stochastic Inventory Model
Stochastic Inventory Model
INVENTORY MODELS
INOPER3 Notes
Single Period Model
(Newsboy Problem)
Parameters:
› a = ordering cost
› s = selling price
› c = purchase cost
› v = salvage value
› p = stock-out cost
Decision Variable
› Q = order quantity
Random Variable
› x = demand (per period)
› f(x) = demand density function
Single Period Model
(Newsboy Problem)
Expected profit = E(P)
If x < Q:
P1 s * x v(Q x) cQ a
If x > Q:
P2 s * Q p( x Q) cQ a
Single Period Model
(Newsboy Problem)
Expected Profit
Q
E ( P ) [ sx v(Q x) cQ a ] f ( x )dx [ sQ p ( x Q ) cQ a ] f ( x)dx
Q
Q
[ sx v(Q x)] f ( x)dx [ sQ p ( x Q)] f ( x)dx cQ a
Q
Single Period Model
(Newsboy Problem)
Applying Leibniz Rule:
Q
dE ( P)
1[ sQ 0] f (Q) 0 v( fx )dx 0 1[ sQ 0] f (Q) [ s p] f ( x)dx c 0
dQ Q
v[1 f ( x)dx] (s p)f ( x)dx c 0
Q Q
v ( s p v) f ( x)dx c 0
Q
c v
f ( x)dx s p v
(critical ratio )
Q*
Single Period Model
(Newsboy Problem)
If x is discrete, the critical ratio
becomes: c v
f ( x) s p v
Q*
If B = beginning inventory,
› Q* < B, then order zero (0)
› Q* > B, then order Q* - B
Example 1
A small grocery store has the problem of
determining the number of trays of bread to
stock each day. A tray costs Php125 and sells for
Php150. The leftover trays at the end of the day
can be sold as day-old bread at Php112.50. The
probability distribution of demand is given below.
Find the optimal order quantity.
x 10 11 12 13 14 15
f(x) 0.15 0.20 0.19 0.18 0.17 0.11
Example 2
Given the same problem, find the
optimal order quantity if the demand
has the following density function:
1
f ( x) ; 10 x 15
5
0 ; elsewhere
Example 3
A company is trying to determine the
amount of particular part to manufacture as
replacements before shutting down the
production lines of this model. No future
runs will be considered. The parts sell for
Php10, cost Php6 to manufacture and can
be scrapped at Php2 if not sold. The
demand for the product is exponential with
a mean of 50 units. At present, there are
twenty parts in the inventory. How many
should be produced?
Example 4
A book store orders copies of popular
magazine at a cost of Php7.50 per copy.
The magazine can be sold at Php15.00 per
copy. At the end of the month, when the
next issue is delivered, any leftovers can be
returned to distributor for a credit of
Php2.50. Monthly demand for the
magazine can be regarded as normal with a
mean of 50 and a standard deviation of 15.
How many copies should the store order?
Example 5
A certain vending machine dispenses
sandwiches. Each morning new sandwiches
are put in, and the excess, if any, from the
previous day are removed. Sandwiches cost
the vendor PhP3.50, and are sold for
PhP8.50. Day old sandwiches are sold for
PhP1.20 a piece to a skid-row soup kitchen.
Assuming that daily demand is Poisson
distributed with a mean of 25, determine the
number of sandwiches to put into the
machine each day.
Continuous Review Models: Lot
Size, Reorder Point Models
Back order Case
Stock out Case
Back Order Case
Parameters
› a = fixed ordering cost
› h = holding cost per unit
› p = back-order cost per unit
› d = expected demand per planning horizon
Decision Variable
› Q = order quantity
› r = reorder point
Random Variable
› x = demand during lead time
› f(x) = density function of demand during lead time
› µ = mean demand during lead time
Back Order Case
Inventory
Time
Back Order Case
EAC (Q, r) = Total Expected Annual
Cost
= ordering cost + holding cost +
back order cost
= OC + HC + BC
Ordering cost: d
OC a
Q
Back Order Case
Holding cost:
HC h * I ave
I max I min
I ave
2
› Expected inventory level just before arrival
of Q = r - µ (can be negative)
› Expected inventory level just after arrival
of Q = Q + r - µ
Back Order Case
Holding cost (cont.) :
Qr r Q
I ave r
2 2
Q
HC h r
2
Back order cost:
› Let B(r) = number of back ordered units
› B(r) = 0 ; x < r
› B(r) = x - r ; x > r
Back Order Case
Back order cost (cont.):
r
B( r ) 0 * f ( x) dx ( x r ) f ( x) dx
r
( x r ) f ( x)dx
r
d
BC p * B(r )
Q
Back Order Case
Total Expected Annual Cost (EAC):
ad Q pd
EAC (Q, r ) h[ r ] B(r )
Q 2 Q
* 2d [a pB (r )
Q Equation (1)
h
Back Order Case
Applying partial derivative:
EAC pd
0 h B ' ( r ) 0
r Q
hQ
f ( x)dx
r
pd Equation (2)
Iterative Process:
1. Set B(r) = 0 and solve for Q1 using Equation (1)
2. Solve r1 using Equation (2)
3. Solve B(r1)
4. Solve Q2
5. Solve r2
6. Continue process until vales of Q and r converge.
Back Order Case
Note: When f(x) is complicated, the
evaluation of B(r) may not be trivial.
When x is normal:
r r
B( r ) f r G
Where: r
f is the value of the function at (r- µ)/σ
r
G is the area to the right of z
2
1 r
r 1
2
f e
2
Example 6
Items can be ordered at a cost of Php20.
It costs Php1 per week to store one unit
and Php5 is the cost incurred for every
item back-ordered. Lead time equals
one week. Find the optimal order
quantity and reorder point assuming:
(a) demand has the following distribution
X 10 11 12 13 14
f(x) 0.3 0.25 0.2 0.15 0.1
d
SC p * B (r )
Q
Total Expected
ad Annual
Q Cost
pd
EAC (Q, r ) h[ r B(r )] B(r )
Q 2 Q
Stock-out Case
Applying partial derivative:
Iterative Process:
1. Set B(r) = 0 and solve for Q1 using Equation (1)
2. Solve r1 using Equation (2)
3. Solve B(r1)
4. Solve Q2
5. Solve r2
6. Continue process until vales of Q and r converge.
Stock-out Case
Note: When f(x) is complicated, the
evaluation of B(r) may not be trivial.
When x is normal:
r r
B(r ) f r G
Where: r
f is the value of the function at (r- µ)/σ
r
G is the area to the right of z
2
1 r
r 1
2
f e
2
Example 8
Consider Example 6. Assume Stock out
case.
Consider Example 7. Assume Stock out
case.
Periodic Review Model for
Stochastic Demand
m-μ
tr L
Periodic Review Model for
Stochastic Demand
Let
› tr = elapsed time between reviews
› m = target level to which we want to restore the inventory
› Ir = inventory at the time of review
› f(x) = density function of demand during lead time
› a = combined order cost and cost of reviewing
› h = holding cost per unit per T
› p = back order cost
› μ = mean of density function of demand during lead time
› d = expected value of demand
› Beginning inventory of a cycle = m – μ
› Expected Demand during tr = d * tr
› Ending Inventory = m – μ – d * tr
Periodic Review Model for
Stochastic Demand
a
Total Order and Review Cost =
tr
Total Holding Cost =
m m dt r 1
H H m dt r
2 2
Total time when demand is
present = tr + L
f(D/tr+L) = density function of demand
given a time period of tr + L
Periodic Review Model for
Stochastic Demand
Bm = expected back ordered units
Bm ( D m) f ( D / t r L)dD
m
p
Bm
Expected back ordered cost = tr
Therefore,
a 1 p
E (c ) H m dt r ( D m) f ( D / t r L)dD
tr 2 tr m
Using Leibniz Rule: dE (c) H p f ( D / t
r L)dD 0
dm t r
m
Ht r
m f ( D / t r L)dD p
Example 9
Assume that an item can be ordered at
a cost of Php20. It costs Php1 per week
to store it and Php5 is incurred for every
item back ordered. The lead time is 1
week. A Php10 review cost is also
incurred. Assume that the demand per
week is normal with a mean of 12 and a
variance of 1. Find the target level of
inventory m of the review period is 2
weeks.
Solution to Example 9
Given: tr = 2 weeks
L = 1 week
a = 20 + 10 = 30
h = 1 per unit per week
p = 5 per unit
Normal distribution of demand with μ = 12
and σ2 = 1
tr + L = 3 weeks
Solution to Example 9
P ( D m ) 0 .4
m 36
z 0.6 0.255
3
m 36.44
36.44 36 36.44 36
Bm 3 f G 36 36.44 0.4929
3 3
30 1 5
E (c ) 1 36.44 12 (12)( 2) (0.4929) 28.67
2 2 2
Solution to Example 9
tr E(c)
1 37.98
2 28.67
2.2 28.45
2.3 28.41
2.4 28.43
3.0 29.29