Question

Distinguish between basic Economic Order Quantity (EOQ) and Quantity Discount Models. Your answer should be supported with relevant examples and calculations

Answer 1

Economic Order Quantity (EOQ) refers to the number of units of a particular product that a company should purchase from outside so as to minimize the total costs of inventory (holding costs, order costs etc.)

Formula to calculate EOQ: Square root of [(2 x D x S)/ H], where

D = Annual demand in units

S = Cost per order

C = Cost per unit

I = Holding cost (%)

H = Holding cost (I x C)

Quantity discount model is a form of EOQ model which includes a reduction in the price of a product if the buyer chooses to purchase the product in a large quantity.If such discount is offered, the buyer would consider the benefits of "lower price and fewer orders" against the "increase in carrying costs caused by higher average inventories."

For example, A business proposes to purchase 12,000 units @$10 each, per quarter throughout the year so as to maintain sufficient production levels to meet the demand, and reduce the total inventory handling cost. This is considered EOQ model.

Now, the supplier decides to provide a 10% discount if 20,000 units are ordered by the business each quarter. Thus, the business would need to consider the benefit due to such discount, along with additional cost of inventory handling. This is known as a Quantity discount model.