Dynamic Lot Sizing

• The demand per period (daily, weekly, monthly or annual), though deterministic, is
dynamic, in that it varies from one period to the next, thus we violate the
assumption of constant demand.
• The Wagner-Whitin model considers the problem of determining production lot
sizes when demand is deterministic but time-varying.
• All the other assumptions for the EOQ model are valid for the Wagner-Whitin
model.
• We will work with discrete time corresponding to days, weeks, or months.
• A daily production schedule might make more sense for a high-volume system with
rapidly changing demand.
• A monthly schedule may be more adequate for a low-volume system with demand
that changes more slowly.
• For simplicity, assume that setup costs 𝑨𝒕 , production costs 𝒄𝒕 , and holding costs 𝒉𝒕 are
all constant over time.
• Problem is to satisfy all demands by minimizing total cost, i.e., production plus setup plus
holding cost.
• The only available controls available to solve this problem are the production quantities 𝑄𝑡 .
• But all demands must be filled.
• So, only the timing of production is open to choose, not the total production quantity.
• Hence if unit production cost is constant (that is, 𝑐𝑡 does not vary with 𝑡), then production cost will be
the same for all possible timings of production.
• So, we will only minimize setup plus holding cost.
• Wagner–Whitin Property: Under an optimal policy either
✓ the inventory carried to week 𝑡 + 1 from a previous week will be zero
✓ or the production quantity in week 𝑡 + 1 will be zero
• Why? Because either
✓ it is cheaper to produce all of week 𝑡 + 1’s demand in week 𝑡
✓ or all of it in week 𝑡 + 1
• It is never cheaper to produce some in each because if we produce items in week 𝑡 then we incur a
setup cost to satisfy demand in week 𝑡 + 1.
• But then if we also produce in week 𝑡 + 1 then we incur an extra setup cost.
• The Wagner-Whitin property implies that either 𝑄𝑡 = 0 or 𝑄𝑡 will be exactly enough
to satisfy demand in the current week plus some integer number of future weeks.
• By the Wagner–Whitin property, we produce in a week only if the inventory carried
to that week is zero.
• For instance, in a 6-week problem, there are six possibilities for the amount we can
produce in week 1, namely, 𝐷1 , 𝐷1 + 𝐷2 , 𝐷1 + 𝐷2 + 𝐷3 , … , 𝐷1 + 𝐷2 + 𝐷3 + 𝐷4 +
𝐷5 + 𝐷6 .
• If we choose to produce 𝐷1 + 𝐷2 , then inventory will run out in week 3 and so we
will have to produce again in week 3.
Wagner–Whitin Algorithm
• We could similarly solve the whole problem in a mechanical fashion.
• But notice the blank spaces in the upper right-hand corner of this table.
• This is due to the planning horizon property.
 Planning Horizon Property
• Is it cheaper to produce for week 5 in week 3 than in week 4?
• If we produce in week 3 or 4, then the produced items in weeks 3 and 4 must be held in inventory
up to week 5.
• In both cases, the carrying cost from week 4 to week 5 will be same.
• So we only need to ask: is it cheaper to set up in week 3 and carry inventory from week 3 to week
4 than it is to set up in week 4?
• But we already know the answer to this question from step 4: It is cheaper to set up in week 4.
• Therefore, it is unnecessary to consider producing in weeks 1, 2, and 3 for the demand in week 5.
• We need to consider only weeks 4 and 5.
How to interpret the above table to solve the original dynamic lot sizing problem?
• The minimum total setup plus inventory carrying cost is read from last column of the penultimate
row 𝑍10 = 580.
• The optimal lot sizes are determined from the 𝑗𝑡∗ values.
• Since 𝑗𝑡∗ represents the last week of production in a 𝑡-week problem, it is optimal to produce
enough to cover the demand from week 𝑗𝑡∗ through week 𝑡.
∗
• Therefore, since 𝑗10 = 8, it is optimal to produce for weeks 8, 9, and 10 in week 8.
• Doing this leaves us with a 7-week problem.
• Since 𝑗7∗ = 4, it is optimal to produce for weeks 4, 5, 6, and 7 in week 4.
• This leaves us with a 3-week problem.
• Since 𝑗3∗ = 1, we should produce for weeks 1, 2, and 3 in week 1.
 EOQ with Price breaks
• This is also a type of Static EOQ model.
• The inventory item can be purchased at a discount if the size of the order 𝑦 exceeds a given limit 𝑞.
• Let 𝑐 denote the unit purchasing price.
<

• Note that in the classical EOQ model, we did not consider purchasing cost.

<

• Verify that without discounting, above formula does not depend on 𝑦.

• This is because just like the classical EOQ model, every 𝑡0 units of time we order 𝑦 units which costs us 𝑐𝑦.
 <

• Because the two functions differ only by a constant amount, their minima will still coincide at 𝑦𝑚 just
like in the classical case.
• However, there is a clever trick to obtain the correct answer.
• To see this, we must first determine the value of 𝑄 > 𝑦𝑚 as follows (whose significance will be
explained later)
• There will be three possible cases depending on the actual value of 𝑞.
• If 𝑞 < 𝑦𝑚 , then we see that the dashed curves will be ignored.
• Considering only the solid curves, the minimum point is obvious.
• All the three possible cases are summarized below.
Multi-Item EOQ with Storage Limitation
• This is also a type of Static EOQ model.
• This model deals with multiple items whose individual inventory fluctuations are exactly the same as the
classical EOQ model.
• The only difference is that the items compete for a limited storage space.
 Continuous Review Probabilistic Inventory
Models
“Probabilitized” EOQ Model
• The critical period during inventory cycle occurs between placing and receiving orders because shortage can occur then.
• Probabilitized EOQ Model seeks to maintain a constant buffer stock that will put a cap on the probability of shortage.
• Larger buffer stock results in lower shortage probability and vice versa.
• Let 𝑥𝐿 denote the demand during lead time L.
• Assume that 𝑥𝐿 is a normally distributed RV with mean 𝜇𝐿 and standard deviation 𝜎𝐿 .
• The size of buffer B is determined by demanding the probability of shortage during lead time L is at most 𝛼.
𝑥𝐿 −𝜇𝐿
• We can define a new random variable Z = which is clearly normally distributed with mean 0 and
𝜎𝐿
standard deviation 1.

• We ask a simple question

based on the left plot: For
what value of z, the
probability of 𝑧 being
greater than that value is
exactly equal to 𝛼?
• Answer is 𝐾𝛼 .
• There are standard tables
that compute 𝐾𝛼 .
• For values of 𝑧 greater than
𝐾𝛼 , the area under the
curve only shrinks further.