Economic Order Quantity

Economic order quantity is used in inventory control. We shall discuss the economic order quantity formula below as well as show examples of calculating economic order quantity.

Economic order quantity explained

Inventory control is a science in itself. The concept of economic order quantity comes from the fact that if a firm holds excessively high levels of stocks then it incurs additional costs such as:

• warehousing costs
• insurance costs
• deterioration of stocks costs
• cost of capital tied up in acquiring stocks (opportunity cost)

However, if the firm holds too low level of stock then it may run out of stock. This leads to loss of production and sales to customers which is also a bad problem. The firm may need to order emergency stock and put in extra money to fulfill orders.

Assumptions in the Economic Order Quantity (E.O.Q) model

• lead time is zero (lead time is the delay between order being placed and delivery)
• demand is constant

The assumptions of the Economic Order Quantity (E.O.Q) model means that the stock level falls at a constant rate and when the last unit of stock is used, the stock level is immediately restored by the order and delivery. The saw tooth model below illustrates the Economic Order Quantity (E.O.Q) model.

Economic Order Quantity Formula

Calculating Economic Order Quantity