Economic Order Quantity

Model 3 : EOQ Model for

Production Runs Model 4 :
Inventory Model with Planned Shortages

Submitted to:
Submitted by:
Dr. Devendra Kumar
 Economic Order Quantity
EOQ is the size of the lot to be purchased
which is economically viable. This is the
quantity materials which can be purchased at
minimum costs.
The cost of a managing inventory is solely
made of two parts:
a) Ordering cost ( it includes costs associated
with the processing and chasing of the
purchase order, transportation, inspection
for quality, & so on.)
 Model 3: EOQ Model for
Production Runs

In this EOQ model an order is

received gradually, as inventory is
simultaneously being depleted it
means non-instantaneous receipt
model.
When the production begins, a
constant number of units are
Inventory profile

Q
Maximum inventory
Inventory Level

p
d
P-d

tp
Time
T
To calculate the Total Inventory cost:- Ordering cost
+ Holding cost
 Set up Cost : DA/Q { O(Q) = N x A }
D = total demand, Q = order size, A = set up cost, N = No. of
times an order is placed
 Holding Cost = h x average inventory
tp= Q avg. inventory= tp(p-d)
p 2
 Holding Cost : hQ 1 - d
2 2 p
Here, h = holding cost per unit per year
d = consumption (demand)
p = production rate
 total cost: T(Q) = DA /Q + hQ 1 - d
2 p

From this, the optimal order quantity (Q*),

determined,
Q* = 2AD
1-d
h p

= 2AD p
h p- d
 Total cost (of holding & ordering) corresponding
to Q*
T(Q*) = 2ADh 1 – d
p

Q.The brown sugar corporation sells baking supplies to

foodies over the internet. The company mixes a special blend
to multigrain flour with the trade name of wild horses. The
annual demand for wild horses is 5000 one pound bags. The
cost to set-up a production run to mix the flour is Rs 50 per
set-up. The cost to hold one bag of flour for 1 year is Rs 2/
bag. The production rate is 50 pounds per day. determine the
EOQ & total cost?
D = 5000 ; A= 50 ; h = Rs 2 ; p = 50 d = ?
To calculate d,
d = D = 5000 = 13.70
365 365
Q* = 2x50x5000 50
2 50 – 13.70
= 586.81units

T(Q*) = 2x 50x 5000x2 1 – 13.70

50 =Rs 852.05
Model 4: Inventory Model with Planned
Shortages
 This model allows the Back Ordering situation.
Back order is an order for a good or service that
cannot be filled at the current time due to lack of
available supply.
 Here we are allowing the shortages in the
inventory & for fulfilling these shortages we have
to build back order.
 Inventory profile

I
Inventory level

t2
t1
S
Q
T
To calculate the Total Inventory cost:- Order cost + Holding cost +
Shortage cost
Ordering cost:
Item cost = D x A
If D = Annual demand, Q = order size, So cost of no. of orders per
year will be
Ordering cost = DA
Q
Holding cost = Average inventory x holding cost (t1)
= I ht1
2
Q-S =I, Which last a period t1, Q-S = t1d, where d is usage rate.
Similarly Q is adequate to last cycle T, &, therefore, Q = Td. On
dividing the first of these equations by the second, we get
 Q – S = t1d
Q Td
t1 = T(Q – S )
Q
Holding cost = Q – S h T (Q – S )
2 Q
2
=( Q – S ) hT
2Q
Shortage cost : S bt2 ( b = back order cost , S= Max. level of shortages )
2
As before, we note that d = Q, Similarly S = dt2 So, t2 = TS
T Q
shortage cost = S b TS = bTS2
2 Q 2Q
 2 2
T(Q) = DA + ( Q – S ) h + bS
Q 2Q 2Q
From this, the optimal order quantity (Q*), determined,
Q* = 2AD h+b S* = Q* h
h b h+b

T(Q*) = 2ADh h+b

b

Q. We have, D=10,000/Year, A=Rs 300/Order, per Unit cost

of item is Rs20 and h= Rs 4/unit per year and b= Rs 25/unit
per year. Calculate EOQ and total cost?
Q*= 2x1oooox3oo (4+25)
4x25
= 1319.09 units

T(Q*) = 2x300x10000x4 4+25

25

= Rs 5276.36
THANK YOU!