What is Economic Order Quantity (EOQ)? What are the different assumptions made while deriving EOQ for a simple deterministic model?

Economic Order Quantity (EOQ) is a classic inventory management model used to determine the optimal order quantity that minimizes total inventory costs, including holding costs and ordering costs. EOQ seeks to strike a balance between the costs of holding excess inventory (holding costs) and the costs of placing frequent orders (ordering costs).

The EOQ formula is calculated as follows:

EOQ = √((2 D S) / H)

Where:

• D represents the annual demand for the product (in units).
• S represents the ordering cost per order.
• H represents the holding cost per unit per year.

The assumptions made while deriving EOQ for a simple deterministic model include:

1. Constant Demand: The EOQ model assumes that demand for the product is constant and known with certainty over the planning horizon. This implies that demand does not vary over time and remains stable throughout the year.

2. Constant Lead Time: The model assumes that lead time, which is the time between placing an order and receiving the inventory, is constant and consistent for each order. This implies that there are no variations or delays in lead time.

3. Instantaneous Replenishment: The model assumes that inventory is replenished instantaneously upon placing an order. This means that there are no delays or shortages in receiving the ordered inventory once an order is placed.

4. Fixed Ordering Costs: The model assumes that ordering costs, such as setup costs, transportation costs, and administrative costs, remain fixed and do not change with order quantity or frequency. This assumption simplifies the calculation of total ordering costs.

5. Fixed Holding Costs: The model assumes that holding costs, which include storage costs, insurance costs, and obsolescence costs, remain constant and do not vary with order quantity or inventory levels. This assumption simplifies the calculation of total holding costs.

By making these assumptions, the EOQ model provides a straightforward and practical approach to determining the optimal order quantity for inventory management, helping businesses minimize total inventory costs and optimize inventory levels. However, it is essential to recognize that these assumptions may not always hold true in real-world inventory management scenarios, and adjustments may be necessary to accommodate variations and uncertainties in demand, lead time, and costs.