The EOQ Model

JYOTHISHMATHI INSTITUTE OF TECHNOLOGY & SCIENCE
Nustulapur, Karimnagar - 505481

(Approved by AICTE, New Delhi & Affiliated to JNTUH)
DEPARTMENT OF MECHANICAL ENGINEERING
The EOQ Model
To a pessimist, the glass is half empty.

to an optimist, it is half full.
– U SAIPRASANRAJ
ASST.PROF.
MECH
IV B.TECH
PRODUCTION PLANNING & CONTROL
2018-19
EOQ History
– Introduced in 1913 by Ford W. Harris, “How Many Parts to Make at Once”
– Interest on capital tied up in wages, material and overhead sets a

maximum limit to the quantity of parts which can be profitably
manufactured at one time; “set-up” costs on the job fix the minimum.
Experience has shown one manager a way to determine the economical
size of lots.
– Early application of mathematical modeling to Scientific Management

MedEquip Example
• Small manufacturer of medical diagnostic equipment.
• Purchases standard steel “racks” into which electronic components are
mounted.
• Metal working shop can produce (and sell) racks more cheaply if they are
produced in batches due to wasted time setting up shop.
• MedEquip doesn’t want to tie up too much precious capital in inventory.
• Question: how many racks should MedEquip order at once?

EOQ Modeling Assumptions
1. Production is instantaneous – there is no capacity constraint and the
entire lot is produced simultaneously.
2. Delivery is immediate – there is no time lag between production and
availability to satisfy demand.
3. Demand is deterministic – there is no uncertainty about the quantity or
timing of demand.
4. Demand is constant over time – in fact, it can be represented as a
straight line, so that if annual demand is 365 units this translates into a
daily demand of one unit.
5. A production run incurs a fixed setup cost – regardless of the size of the
lot or the status of the factory, the setup cost is constant.
6. Products can be analyzed singly – either there is only a single product or
conditions exist that ensure separability of products.
Notation
D demand rate (units per year)
c unit production cost, not counting setup or inventory costs (dollars per
unit)
A fixed or setup cost to place an order (dollars)
h holding cost (dollars per year); if the holding cost consists entirely of
interest on money tied up in inventory, then h = ic where i is an annual
interest rate.
Q the unknown size of the order or lot size

Costs
Q
Holding Cost: average inventory =
2
hQ
annual holding cost =
2
hQ
unit holding cost =
2D
Setup Costs: A per lot, so
Production Cost: unit setup cost =

A
Q
Cost Function: Y (Q) =

hQ A
+ +c
2D Q
MedEquip Example Costs
D = 1000 racks per year
c = $250
A = $500 (estimated from supplier’s pricing)
h = (0.1)($250) + $10 = $35 per unit per year
i = 10%
Costs in EOQ Model
20.00
18.00
16.00
14.00
Cost ($/unit)
12.00
10.00 Y(Q)
Q* =169
8.00
6.00 hQ/2D
4.00
2.00 c A/Q
0.00
0 100 200 300 400 500
Order Quantity (Q)

Inventory vs Time in EPL Model
Production run of Q takes Q/P time units
(P-D)(Q/P)
Inventory
(P-D)(Q/P)/2
Time
Economic Order Quantity
dY (Q) h A
= − 2 =0
dQ 2D Q
2 AD
Q* = EOQ Square Root Formula
h
2(500)(1000)
Q =
*
= 169 MedEquip Solution
35
EOQ Modeling Assumptions
1. Production is instantaneous – there is no capacity constraint
and the entire lot is produced simultaneously.
2. Delivery is immediate – there is no time lag between production and
availability to satisfy demand.
3. Demand is deterministic – there is no uncertainty about the quantity or
timing of demand.
4. Demand is constant over time – in fact, it can be represented as a
straight line, so that if annual demand is 365 units this translates into a
daily demand of one unit.
5. A production run incurs a fixed setup cost – regardless of the size of the
lot or the status of the factory, the setup cost is constant.
6. Products can be analyzed singly – either there is only a single product or
conditions exist that ensure separability of products.
Notation – EPL Model
D demand rate (units per year)
P production rate (units per year), where P>D
c unit production cost, not counting setup or inventory costs (dollars per
unit)
A fixed or setup cost to place an order (dollars)
h holding cost (dollars per year); if the holding cost consists entirely of
interest on money tied up in inventory, then h = ic where i is an annual
interest rate.
Q the unknown size of the production lot size

Solution to EPL Model
Annual Cost Function: AD h(1 − D / P)Q

Y (Q) = + + Dc
Q 2
setup holding production
Solution (by taking derivative and setting equal to zero):
• tends to EOQ as P →
2 AD
Q* =
h(1 − D / P ) • otherwise larger than EOQ
because replenishment takes
longer

The EOQ Model

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JYOTHISHMATHI INSTITUTE OF TECHNOLOGY & SCIENCE

Nustulapur, Karimnagar - 505481

The EOQ Model

To a pessimist, the glass is half empty.

– Introduced in 1913 by Ford W. Harris, “How Many Parts to Make at Once”

– Interest on capital tied up in wages, material and overhead sets a

– Early application of mathematical modeling to Scientific Management

• Question: how many racks should MedEquip order at once?

A fixed or setup cost to place an order (dollars)

Q the unknown size of the order or lot size

Production Cost: unit setup cost =

Cost Function: Y (Q) =

D = 1000 racks per year

A = $500 (estimated from supplier’s pricing)

h = (0.1)($250) + $10 = $35 per unit per year

Order Quantity (Q)

P production rate (units per year), where P>D

A fixed or setup cost to place an order (dollars)

Q the unknown size of the production lot size

Annual Cost Function: AD h(1 − D / P)Q

setup holding production

Solution (by taking derivative and setting equal to zero):

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