MATHEMATICAL MODELS FOR DETERMINING ORDER QUANTITY
Now let's look at some mathematical models that determine order quantity and minimize inventory costs, beginning with the economic order quantity (EOQ) model.
Economic order quantity model (EOQ)
An optimizing method used for determining order quantity and reorder points.
Economic Order Quantity (EOQ)
The economic order quantity model (EOQ) has been around since the early 1900s and remains useful for determining order quantities. EOQ is a continuous review system, used to keep track of the inventory on hand each time stock is added or withdrawn. If the withdrawal reduces the inventory level to the reorder point or below, you make a replenishment order.
Thus, EOQ tells you when to place a replenishment order and determines the order quantity that minimizes annual inventory cost. Suppose you decide that your kayaking equipment company needs to place a replenishment order whenever the inventory level of item K310 reaches 100 units. Right now you have 105 units of item K310 in inventory. You withdraw 5 K310s to satisfy a customer order, resulting in an updated inventory level of 100 units. Since the inventory level has reached the reorder point, it is time to place a replenishment order for K310. A key characteristic of the continuous review system is that it keeps track of inventory as it is withdrawn.
In the following section we look ...