Economic Order Quantity
Economic order quantity (EOQ) is the ideal quantity of units a company should purchase to meet demand while minimizing inventory costs such as holding costs, shortage costs, and order costs. This production-scheduling model was developed in 1913 by Ford W. Harris and has been refined over time. The economic order quantity formula assumes that demand, ordering, and holding costs all remain constant.
Definition: Economic Order Quantity (EOQ) refers to the ideal number of units a company should purchase to meet demand while minimizing inventory costs, including holding costs, shortage costs, and ordering costs. The EOQ model helps businesses determine the optimal order quantity to achieve the best inventory management.
Origin: The EOQ model was first proposed by Ford W. Harris in 1913. Although the initial model was relatively simple, it has been refined over time by researchers and practitioners to better suit the needs of modern businesses.
Categories and Characteristics: The EOQ model has several key characteristics:
- Fixed Demand: Assumes that the demand rate is known and constant.
- Fixed Ordering Cost: The cost per order is fixed and does not vary with the order quantity.
- Fixed Holding Cost: The cost of holding inventory is fixed and typically proportional to the inventory level.
Specific Cases:
- Case 1: A retail company needs to sell 12,000 products annually. The fixed cost per order is $100, and the annual holding cost per product is $2. Using the EOQ formula, the optimal order quantity is:
EOQ = √(2DS/H) = √(2*12000*100/2) = √1200000 = 1095 units.
This minimizes the total inventory cost. - Case 2: A manufacturing company needs 5,000 parts annually. The fixed cost per order is $50, and the annual holding cost per part is $1. Using the EOQ formula, the optimal order quantity is:
EOQ = √(2DS/H) = √(2*5000*50/1) = √500000 = 707 units.
This effectively reduces both holding and ordering costs.
Common Questions:
- Question 1: Is the EOQ model still applicable if the demand is not constant?
Answer: The EOQ model assumes constant demand. If demand fluctuates significantly, other inventory management models, such as dynamic ordering models, may be more appropriate. - Question 2: How to handle bulk discounts?
Answer: In the presence of bulk discounts, the EOQ formula can be adjusted by considering the total cost for different order quantities and selecting the quantity that minimizes the total cost.
