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Physical stock of
items held in any
business for the
production or sales
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Finished Product
Raw Material
In-Process
Finished Goods !
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Determination of the type
and the quantity of
inventory items that
would be required at
future points for
maintaining schedules
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Primarily concerned
with the inventory
cost control
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How much to stock or
how much to buy?

How often to buy or

when to buy?
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Economic Order
Quantity Model

Economic Batch/ Lot

Size Mode
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Item Cost, Rs C1/item
Ordering Cost, Rs C2 /order
Holding Cost Rs C3
/item/unit time
Shortage Cost Rs C4
/item/unit time 8
This is the cost of the item whether it is
manufactured or purchased. If it is
manufactured, it includes such items as
direct material and labor, indirect materials
and labor and overhead expenses. When
the item is purchased, the item cost is the
purchase price of 1 unit. Let it be denoted
by Rs. C1 per item.

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Administrative and clerical costs are
involved in processing a purchase order,
expediting, follow up etc., It includes
transportation costs also. When a unit is
manufactured, the unit set up cost includes
the cost of labor and materials used in the
set up and set up testing and training costs.
This is denoted by Rs. C2 per set up or per
order.
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If the item is held in stock, the cost involved
is the item carrying or holding cost. Some
of the costs included in the unit holding
cost are
 
•Locked up capital in inventory
•Storage-space costs,
•Items handling costs,
•Taxes on inventories,
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 Insurance costs for inflammable and
explosive items,
•Obsolescence,
•Deterioration of quality, theft, spillage
and damage to times,
•Cost of maintaining inventory records.
 
This cost is denoted by Rs. C3 item/unit
time. The unit of time may be days, months,
weeks or years.
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The shortage cost is due to the delay in
satisfying demand (due to wrong
planning); but the demand is
eventually satisfied after a period of
time. Shortage cost is not considered
as the opportunity cost or cost of lost
sales. The unit shortage cost includes
such items as
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Overtime requirements due to shortage,
•Clerical and administrative expenses.
•Cost of expediting.
•Loss of goodwill of customers due to
delay.
•Special handling or packaging costs.
•Lost production time.
 
This cost is denoted by Rs. C4 per item
per unit time of shortage. 14
The inventory control model can be
broadly classified into two
categories:
1.Deterministic inventory problems.
2.Probabilistic or stochastic inventory
problems.

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In the deterministic type of
inventory control, the parameters
like demand, ordering quantity
cost, etc are already known or
have been ascertained and there
is no uncertainty. In the stochastic
inventory control, the uncertain
aspects are taken into account.

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First let us consider the
inventory control of the
deterministic type, EOQ (economic order
quantity model also known as Wilson inventory model)

We will discuss four EOQ

models, the first one is the
well known Wilson’s inventory
model.
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The following assumptions are
made in deriving the formula for
economic order quantity.
 
Demand (D) is at a constant rate.
Replacement of items is instantaneous
(lead time is zero i.e time takes to receive item).

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The cost coefficients C1, C2,
and C3 are constant.

There is no shortage cost

or C4 = 0.

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Quantity

Time
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