Question

1. Give an explanation of what Economic Order Quantity(EOQ) is.

2. EOQ and TAIC: Give an explanation of how the EOQ and the TAIC are interconnected;

3. Real-world example: pick a real-world firm of your interest, and explain how they would manage their inventory and whether an adaptation of the EOQ model would be useful for them;

Answer 1

1) Economic Order quantity (EOQ) is an important concept in inventory management which helps to minimize the holding and ordering cost. It gives the right quantity to be ordered each time so as to optimize the cost. EOQ equation is:

EOQ = sqrt(2*D*S/H)

D = Annual Demand of an item

S = Ordering cost or cost incurred for each order

H = Annual holding cost per unit

For H, it may also be linked to Price. In that case H = Price*Holding % per unit per annum

Total ordering cost = D/EOQ*S

Total holding cost = EOQ/2*H

If price discount concept is taken in to account, the total cost = Total ordering cost + Total holding cost + Total material cost

Total material cost = Price per unit*D

Accordingly, Total cost is computed by factoring in all the above three costs

Ex: If D = 100, S = 4$ per order , H = 2$ per unit

EOQ = sqrt(2*100*4/2) = 20 units

Total ordering cost = 100/20*4 = 20$

Total holding cost = 20/2*2 = 20$