What do you understand by Economic Order Quantity (EOQ) ? Explain EOQ using suitable diagram.

Economic Order Quantity (EOQ) is a mathematical formula used in inventory management to determine the optimal order quantity that minimizes total inventory costs. The EOQ model seeks to balance two types of inventory costs: ordering costs and carrying costs.

The EOQ formula is calculated as follows:

[EOQ = \sqrt{\frac{{2DS}}{{H}}}]

Where:

• (D) = Annual demand or usage rate (in units)
• (S) = Ordering cost per order
• (H) = Holding cost per unit per year

The EOQ model assumes a constant demand rate and ordering cost, as well as instant replenishment of inventory upon depletion. It aims to find the order quantity that minimizes the total cost of inventory management, including ordering costs and holding costs.

The EOQ model is illustrated graphically with the Total Cost Curve. This curve depicts the relationship between the order quantity (Q) and the total cost of inventory management. The total cost consists of ordering costs and holding costs.

In the EOQ model, the total cost curve has a U-shape, as shown below:

• Ordering Cost Curve (OC): This curve represents the ordering costs, which decrease as the order quantity increases. Ordering costs include expenses associated with placing and processing orders, such as order processing fees, procurement staff salaries, and paperwork.

• Holding Cost Curve (HC): This curve represents the holding costs, which increase as the order quantity increases. Holding costs include expenses associated with holding inventory, such as storage, insurance, obsolescence, and capital tied up in inventory.

• Total Cost Curve (TC): This curve represents the total cost of inventory management, which is the sum of ordering costs and holding costs. The total cost curve is U-shaped, with a minimum point indicating the optimal order quantity (EOQ). At the EOQ, the ordering costs and holding costs are balanced, resulting in the lowest total inventory cost.

The EOQ model helps organizations determine the most cost-effective order quantity to minimize inventory costs while ensuring adequate stock levels to meet customer demand. By optimizing the order quantity, businesses can reduce expenses associated with ordering and holding inventory, leading to improved profitability and efficiency in inventory management.