The economic order quantity approach

2002 Q2
a) Outline the economic order quantity inventory model and explain its merits and limitations.
The economic order quantity approach is used to find the best balance between the advantages and disadvantages of holding stock.


Plan A involves ordering 400 items each time.
Plan B involves ordering 100 items each time but 4 times as often.
The average inventory for Plan B is one-quarter that of A.

To calculate which plan minimises the total cost of holding stock we need ;
The total cost of holding one unit in stock for a period of time CH
The total cost of placing an order CO

Holding costs include: working capital costs, storage costs, Obsolescence risk costs.
Order costs include: cost of placing the order (including placing the order), price discount costs.

Holding cost = holding cost/unit x average inventory
= .5Q x CH

Order cost = ordering cost x number of orders per period
= D/Q x CO

Total Cost CT = CH x Q/2 + CO x D/Q

The following table illus...