Economic Order Quantity (EOQ)

The determination of the appropriate quantity to be purchased in each lot to replenish stock as a solution to the order quantity problem necessitates a resolution of conflicting goals. Buying in large quantities implies higher average inventory level which will assure smooth production/sale operations and lower ordering or set up costs. But it will involve higher carrying costs. On the other hand, small orders would reduce the carrying costs of inventory by reducing the average inventory level but the ordering costs would increase as also there is a likely interruption in operations due to stock outs. A firm should place neither too large nor too small orders. On the basis of a trade-off between benefits derived from the availability of inventory and the cost of carrying that level of inventory, the appropriate or optimum level of the order to be placed should be determined. The optimum level of inventory is referred to as the economic order quantity (EOQ).It is also known as the economic lot size.

The economic order quantity may be defined as that level of inventory order that minimises the total cost associated with inventory management. EOQ refers to the level of inventory at which the total cost of inventory comprising acquisition/ordering/set-up costs and carrying costs is the minimum.