Single period model

• P-retail price per unit

• C-cost of the unit (Production or buying cost
or wholesale price)
• S-Salvage value
Terms used • Co-cost of overstocking by one unit
• Cu-cost of understocking by one unit
• Co= c-s
• Cu= p-c
• CSL*=optimal service level or critical ratio
 • CSL*-probability that demand during the
season will be at or below Optimum order
quantity O*
• O*-optimal order quantity
• At the optimal service level CSL*, the
marginal contribution of purchasing an
Terms used additional unit is zero.
• If the order quantity is raised from O* to
O*+1, the additional unit sells, if demand is
larger than O*
• This occurs with probability of (1-CSL*) and
results in a contribution of (p-c)
Derivation
• Expected profit of purchasing one extra unit =(1-CSL*)(p-c)
• Expected cost of purchasing one extra unit= CSL*(c-s)
• So, the expected marginal contribution of raising the order size from O* to
O*+1 is
• (1-CSL*)(p-c)-CSL*(c-s)=0
• So, CSL*=(p-c)/(p-s)= Probability (demand is <=O*)
• CSL*= Cu/(Cu+Co)
• O*=Mean demand +Z value for CSL*(SD of demand)
• O*=μ+Zβ (Ϭ)