The Economic Order-Quantity (EOQ) Model

The economic order-quantity model considers the tradeoff between ordering cost and storage cost in choosing the quantity to use in replenishing item inventories. A larger order-quantity reduces ordering frequency, and, hence ordering cost/ month, but requires holding a larger average inventory, which increases storage (holding) cost/month. On the other hand, a smaller order-quantity reduces average inventory but requires more frequent ordering and higher ordering cost/month. The cost- minimizing order-quantity is called the Economic Order Quantity (EOQ). This chapter builds intuition about the robustness of EOQ, which makes the model useful for management decision-making even if its inputs (parameters) are only known to be within a range of possible values. This chapter also provides intuition about choosing an inventory-management system, not just an EOQ.