Posts Tagged ‘economic order quantity formula explained’
Economic Order Quantity Formula Explained
June 18th, 2009
< H3 align=center>Economic Order Quantity Formula
In this section, we are going to derive the Economic Order Quantity formula which you can use as a template for other Economic Order Quantity calculation.
Deriving the economic order formula
From the diagram in the Economic Order Quantity section, let’s:
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C = cost of carrying a unit of stock for one year
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O = cost of placing an order for stock
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D = annual demand in units
In calculating the Economic Order Quantity and deriving the Economic Order Quantity formula, we observe that the level of stock falls from Q to zero at a steady rate. The average level of stock held over a period of time is therefore: Q/2.
If D units are required over the year and Q units are ordered each time then the firm will need to replace D/Q orders each year. Therefore:
The total inventory cost (holding cost and ordering cost) per year, T is then:
Now we can find the order size, Q, which minimized the total inventory cost (the Economic Order Quantity).
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