LECTURE NOTES ON ECONOMIC ORDER

QUANTITY (E.O.Q.)
Ramun Prasad†*
(Lecture No. -35)

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Recapitulate

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Learning Outcomes
After this session students will be able to:

- Explain the term “Economic Order Quantity.

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- Demonstrate “Economic Order Quantity” with the help of graph.

1 Introduction & Graphical Representation of E.O.Q.

Definition: Economic Order Quantity (EOQ) is a production formula used to determines
the most efficient amount of goods that should be purchased based on ordering and carrying
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costs. In other words, it represents the optimal quantity of inventory, a company should order
each time in order to minimize the costs associated with ordering and holding inventory.

1.1 Introduction to E.O.Q.

This model is known as Economic Order Quantity (EOQ) model, because it established the
most economic size of order to place. It is one of the oldest classical production scheduling
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models. In 1913, Ford W. Harris developed this formula whereas R. H. Wilson is given
credit for the application and in-depth analysis on this model.By using this model, the com-
panies can minimize the costs associated with the ordering and inventory holding.It can be
a valuable tool for small business owners who need to make decisions about how much in-
ventory to keep on hand, how many items to order each time, and how often to reorder to
incur the lowest possible costs.There are two most important categories of inventory costs
are ordering costs and carrying costs.
* Lecturer,Department of Humanity (Economics), Government Polytechnic, Gaya, Bihar
†
E-mail: ramuncup@gmail.com, Homepage: https://ecoramun.wordpress.com/
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©Govt. Polytechnic, Gaya

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1.2 Ordering costs

It is the costs that are incurred on obtaining additional inventories. They include costs in-
curred on communicating the order, traveling allowance and daily allowance to purchase
officers, printing and stationary, salary of purchase department, cost of inspection, cost of
receiving the material, transportation cost etc. all above cost, other than transport costs
remain unchanged per order irrespective of the order size. Therefore, it is assumed that
ordering cost per order remain constant. The more frequently orders are placed, and fewer
the quantities purchased on each order, the grater will be ordering cost and vice versa. This
relation is shown in the figure 1.

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Figure 1: Ordering costs

1.3 Carrying cost:

It is the cost incurred for holding inventory in hand. They include interest on the money
locked up in stocks, storage costs, deterioration spoilage costs, insurance, evaporation,
godown rent, pilferage, shrinkage, obsolescence, other overhead of stores department etc.
They are assumed to be constant per unit of inventory. The large the volume of inventory,
the higher will be the inventory carrying cost and vice versa. This relation is shown in the
figure 2.

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Figure 2: Carrying cost

1.4 Economic Order Quantity (EOQ) Model

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From the above discussion it is clear that ordering costs and carrying costs are quite opposite
to each other. If we need to minimize carrying costs, we have to place small order which
increases the ordering costs. If we want tominimize our ordering costs we have to pla
cefew orders in a year and this requires placing large orders which in turn increases the to
talcarrying costs for the period. We need to minimize the total inventory costs, Thus, E.O.
Q.
is determine by the intersection of ordering cost curve and carrying cost line. At this point
total ordering cost is equal to total carrying cost, and the total of the two costs is the least
which has been demonstrated in the figure 3.

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ay Figure 3: Economic Order Quantity

The Inventory order cycle of Economic Order Quantity (EOQ) Model can also be demon-
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strated with the help of following graph:
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Figure 4: Economic Order Quantity

1.5 Assumptions in EOQ Model:

The model is based on the following assumption:
1. Demand is known with certainty and is constant over time.
2. There is no time gap between placing an order and receiving its supply i.e. lead time
for the receipt of order is constant.

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3. Ordering cost vary directly with the number of orders.

4. Carrying cost vary directly with the average inventory.

5. There is no quantity discount.

1.6 Conclusion
During this session, we have discussed about the Economic Order Quantity (EOQ) which is
very useful tool for inventory control. It may be applied to finished goods inventories, work-
in-progress inventories and raw material inventories. It regulate of purchase and storage
of inventory in such a way so as to maintain an even flow of production at the same time

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avoiding excessive investment in inventories.

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1.7 Questions for Self-Assessment
1. Explain the term “Economic Order Quantity”.

2. Demonstrate “Economic Order Quantity with the help of graph.

3. Write the Assumption Economic Order Quantity.

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4. What is Ordering? Explain it.

5. Explain the term “carrying cost”.

1.8 Glossary
Economic Order Quantity (EOQ) is the order quantity that minimizes total inventory
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costs.
Order Quantity is the number of units added to inventory each time an order is placed.

Total Inventory Costs is the sum of inventory acquisition cost, ordering cost, and hold-
ing cost.
Ordering Cost is the cost incurred in ordering inventory from suppliers excluding the cost
of purchase such as delivery costs and order processing costs.
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Carrying cost, also known as Holding Cost, is the total cost of holding inventory such
as warehousing cost and obsolescence cost.

References
[1] (https://www.ripublication.com/gjfem16/gjfemv5n1_01.pdf)

[2] (https://youtu.be/fFR1nYhF_iw)

[3] (https://images.app.goo.gl/buQLhoBRo1h5XD1j8)

[4] (https://images.app.goo.gl/z2mCLhptrHBMnBuB6)

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APPENDIX:

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Figure 5: AC, AVC & AFC