ECONOMIC ORDER QUANTITY (EOQ) MODEL
The economic order quantity (EOQ) is the order quantity that minimizes total holding and ordering costs for the year. Even if all the assumptions don’t hold exactly, the EOQ gives us a good indication of whether or not current order quantities are reasonable.
- Cost Minimizing “Q”
- Relatively uniform & known demand rate
- Fixed item cost
- Fixed ordering and holding cost
- Constant lead time
(Of course, these assumptions don’t always hold, but the model is pretty robust in practice.)
A = Demand for the year
Cp = Cost to place a single order
Ch = Cost to hold one unit inventory for a year
Yearly Holding Cost + Yearly Ordering Cost
* “Relevant” because they are affected by the order quantity Q
Pam runs a mail-order business for gym equipment. Annual demand for the TricoFlexers is 16,000. The annual holding cost per unit is $2.50 and the cost to place an order is $50. What is the economic order quantity?