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Correct Answer: economic order quantity
the economic order quantity (eoq) refers to the ideal order size a company should purchase for its inventory with the objective of minimizing its total costs related to ordering, receiving, and holding inventory. eoq is a fundamental principle of inventory management and supply chain management, ensuring that the right amount of inventory is ordered without overburdening the storage with excess stock or risking stockouts.
to understand eoq, it's crucial to grasp the balance it seeks to achieve between various costs. there are primarily two types of costs associated with inventory: the ordering costs and the holding costs. ordering costs are expenses incurred every time an order is placed. these can include costs related to paperwork, communication, or transportation, among others. on the other hand, holding costs are the costs to store unsold goods. these can include expenses such as warehousing, spoilage, insurance, and opportunity costs of capital tied up in inventory.
the eoq model finds the quantity that minimizes the total of these costs. at the heart of the eoq formula is a trade-off between ordering costs and holding costs. ordering large quantities less frequently can decrease ordering costs because fewer orders need to be placed over time. however, this approach increases holding costs due to higher average inventory levels. conversely, ordering small quantities frequently can lower holding costs but increase ordering costs. the eoq formula calculates the most economical point where the combined ordering and holding costs are minimized.
the eoq formula is expressed as:
\[ eoq = \sqrt{\frac{2ds}{h}} \]
where:
- \( d \) is the annual demand for the product,
- \( s \) is the ordering cost per order, and
- \( h \) is the holding or carrying cost per unit per year.
it's important to note that the assumptions of the eoq model include constant demand, constant lead time, and constant prices, which may not hold in all business scenarios. therefore, while eoq provides a good baseline or starting point for order quantity decisions, businesses may need to adjust their calculations based on practical considerations such as fluctuating demand, bulk discounts, or changes in supply chain dynamics.
in summary, eoq helps in maintaining sufficient inventory levels that a business requires to meet customer demand while minimizing the costs associated with ordering and holding the inventory. it is a valuable tool for inventory management, especially in helping businesses to optimize their inventory control and reduce unnecessary costs.
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