Inventory Control & EOQ Models — revision notes (GATE ME)
Inventory control (EOQ) is a high-yield GATE ME topic (~2 marks). The economic-order-quantity formula and its total-cost/reorder logic are heavily and predictably tested.
Basic EOQ model
Balances ordering cost (per order) against holding/carrying cost (per unit per year):
- EOQ: Q* = √(2·D·S/H), where D = annual demand, S = ordering cost per order, H = holding cost per unit per year.
- At the EOQ, ordering cost = holding cost (they are equal at the optimum). Minimum total cost (excluding purchase) = √(2·D·S·H).
- Number of orders = D/Q*; cycle time = Q*/D. Reorder point ROP = d·L (demand rate × lead time); with variability add safety stock.
Extensions
- EOQ is robust: total cost is flat near Q*, so small errors in Q barely raise cost.
- Production/EPQ model (finite replenishment rate p): Q* = √(2DS/H) × √(p/(p − d)) — larger than EOQ because stock builds while producing.
- Quantity-discount model: compare total cost (including purchase price) at the EOQ and at each price-break quantity.
- ABC analysis: classify items by annual value (A = few, high value → tight control).
Exam Tricks & Tips
- 🎯 EOQ = √(2DS/H) — the single most-tested IE formula; watch units (S per order, H per unit per year).
- 🎯 At EOQ, ordering cost = holding cost — a fast check and a common conceptual MCQ.
- 🎯 Minimum total (inventory) cost = √(2DSH) — derived by substituting EOQ back.
- 🎯 EPQ > EOQ because stock accumulates during production (factor √(p/(p−d))).
- 🎯 Reorder point ROP = demand × lead time (+ safety stock) — don't forget the safety stock under demand variability.
- ❌ Common mistake: mixing per-order and per-unit costs, or annual vs per-period demand — EOQ needs D annual, S per order, H per unit per year, all consistent.
Expected exam pattern
A 1-mark EOQ, number-of-orders, or ROP NAT, and a 2-mark total-cost, EPQ, or quantity-discount problem. The "ordering = holding at EOQ" fact and the √(2DSH) minimum cost are frequent points.
Quick recap
EOQ Q* = √(2DS/H); at optimum ordering cost = holding cost; min total cost = √(2DSH). Orders = D/Q*, cycle = Q*/D, ROP = d·L (+ safety stock). EPQ = EOQ·√(p/(p−d)) (finite production). Quantity discount: compare total cost at breaks. ABC by annual value.
Inventory Control & EOQ — Flashcards
Cover the answer, recall, then check. 11 cards on inventory control for GATE ME.
Q1. State the basic EOQ formula.
A1. Q* = √(2·D·S/H), where D = annual demand, S = ordering cost/order, H = holding cost/unit/year.
Q2. What is true about the two cost components at the EOQ?
A2. Annual ordering cost equals annual holding cost — they are balanced at the optimum quantity.
Q3. Minimum total inventory cost (excluding purchase)?
A3. √(2·D·S·H), obtained by substituting the EOQ back into the total-cost expression.
Q4. Number of orders per year and cycle time at EOQ?
A4. Number of orders = D/Q*; cycle time = Q*/D.
Q5. Define the reorder point.
A5. ROP = demand rate × lead time (d·L), plus safety stock when demand/lead time varies.
Q6. How does the EPQ (production) model differ from EOQ?
A6. Q* = √(2DS/H)·√(p/(p − d)) — larger than EOQ, because inventory builds up during finite-rate production.
Q7. Why is EOQ described as robust?
A7. The total-cost curve is flat near the optimum, so moderate errors in Q raise cost only slightly.
Q8. How is a quantity-discount decision made?
A8. Compare total annual cost (ordering + holding + purchase) at the EOQ and at each price-break quantity; pick the lowest.
Q9. What is ABC analysis?
A9. Classifying inventory by annual value: A (few items, high value, tight control), B (moderate), C (many, low value, loose control).
Q10. What is safety stock for?
A10. A buffer against demand and lead-time variability, preventing stockouts between reorder and receipt.
Q11. Effect of doubling annual demand on EOQ?
A11. EOQ rises by √2 (≈ 41%), since Q* ∝ √D.
Inventory Control & EOQ Models
Holding too much inventory ties up cash; too little risks stockouts. Inventory models find the sweet spot. GATE reliably tests the Economic Order Quantity (EOQ) and its variants — among the most formula-clean, high-scoring Industrial Engineering topics.
Core concept: the EOQ balances ordering cost (favours large, infrequent orders) against holding cost (favours small, frequent orders) to minimise total inventory cost.
Deep explanation
Beginner — the basic EOQ
With annual demand D, ordering cost per order C_o, and holding cost per unit per year C_h:
EOQ Q* = √(2 D C_o/C_h).
At the EOQ, ordering cost = holding cost (the two curves cross at the minimum). Total minimum cost (excluding purchase) = √(2 D C_o C_h). Number of orders = D/Q*; cycle time = Q*/D.
Intermediate — reorder point and safety stock
- Reorder point (ROP) = demand during lead time = d × L (d = demand rate, L = lead time). Order when stock hits ROP.
- Safety stock buffers demand/lead-time variability: ROP = d̄L + z·σ_L, where z is the service-level factor. Higher service level → more safety stock.
- EOQ is robust: being off the optimum order size by ±20% raises total cost only slightly (a flat minimum).
Advanced — EOQ variants
- Production/EPQ model (finite replenishment rate p): Q* = √(2 D C_o/C_h) × √(p/(p − d)) — larger than EOQ because stock builds gradually.
- Quantity discounts: compute EOQ, then check discount price breaks; the optimum may be a break quantity even if it exceeds EOQ (compare total costs including purchase).
- Backorder model: allowing planned shortages (with shortage cost) increases the optimal order quantity.
- ABC analysis prioritises control: A-items (high value, tight control), B, C (low value, loose control).
Worked example
Annual demand D = 10,000 units, ordering cost C_o = 50 per order, holding cost C_h = 4 per unit per year. Find the EOQ and the number of orders per year.
Q* = √(2 D C_o/C_h) = √(2 × 10,000 × 50/4) = √(1,000,000/4) = √250,000 = 500 units.
Number of orders = D/Q* = 10,000/500 = 20 orders per year. (Check: ordering cost = 20×50 = 1000; holding = (500/2)×4 = 1000 — equal, confirming the EOQ.)
GATE relevance
EOQ (√(2DC_o/C_h)), the ordering = holding cost condition, reorder point/safety stock, and the EPQ and quantity-discount variants are staple Industrial Engineering questions. The EOQ formula and its properties (flat minimum, equal costs) are must-knows.
Exam tricks & shortcuts
- EOQ = √(2DC_o/C_h); at the optimum, annual ordering cost = annual holding cost — a quick check.
- Total minimum cost (excl. purchase) = √(2 D C_o C_h).
- EPQ > EOQ by the factor √(p/(p−d)) (finite production rate).
- Mnemonic: "Root of two-D-C-o over C-h."
Using demand during lead time as the order quantity, or confusing EOQ (how much to order) with ROP (when to order). EOQ = √(2DC_o/C_h) sets the size; ROP = d×L sets the trigger. Also, holding cost is per unit per year — annualise if given per period.
- ✓- EOQ Q* = √(2DC_o/C_h); at optimum ordering cost = holding cost.
- ✓- Min total cost = √(2DC_oC_h); orders/year = D/Q*.
- ✓- Reorder point = d×L; safety stock = z·σ for variability.
- ✓- EPQ = EOQ × √(p/(p−d)) (finite replenishment).
- ✓- ABC analysis prioritises inventory control effort.
- ✓EOQ = √(2DC_o/C_h) minimises total cost by balancing ordering against holding cost (equal at the optimum). Set the order size with EOQ and the timing with the reorder point, and adjust with EPQ, discount and safety-stock variants for real conditions.
Inventory Control & EOQ Models — Formula Sheet
Key formulas
- Economic order quantity: EOQ = √(2DS/H) (D = annual demand, S = ordering cost, H = holding cost/unit/yr).
- Total cost: TC = (D/Q)S + (Q/2)H + DC.
- Number of orders: D/EOQ; cycle time = EOQ/D.
- Reorder point: ROP = d·L (+ safety stock).
- EOQ with shortages / quantity discounts adjust the base model.
- ✓- EOQ = √(2DS/H).
- ✓- At EOQ, ordering cost = holding cost.
- ✓- ROP = demand rate × lead time (+ safety stock).
EOQ minimises total inventory cost by balancing ordering and holding costs; reorder point covers lead-time demand.
Inventory Control & EOQ Models — Worked Example
Worked Example
Problem: A product has an annual demand of 10000 units. Each order costs ₹100 to place, and the holding cost is ₹2 per unit per year. Find the economic order quantity (EOQ), the number of orders placed per year, and the total annual inventory cost (ordering + holding).
Solution:
Economic order quantity (Wilson formula):
EOQ = √(2·D·C_o/C_h) = √(2 × 10000 × 100/2) = √(2000000/2) = √1000000 = 1000 units.
Number of orders per year:
N = D/EOQ = 10000/1000 = 10 orders/year.
Total inventory cost = ordering cost + holding cost:
Ordering = (D/Q)·C_o = 10 × 100 = ₹1000.
Holding = (Q/2)·C_h = (1000/2) × 2 = ₹1000.
Total = 1000 + 1000 = ₹2000 per year.
Note that at the EOQ the ordering and holding costs are equal — a defining property of the optimum.
Answer: EOQ = 1000 units, 10 orders/year, total inventory cost = ₹2000/year.
- ✓- EOQ = √(2DC_o/C_h) balances ordering cost against holding cost to minimise total inventory cost.
- ✓- At the optimum, annual ordering cost equals annual holding cost — a quick check of an EOQ answer.
- ✓- The total-cost curve is flat near the EOQ, so moderate deviations from the exact quantity barely raise cost.