Which one of the following is correct about EOQ inventory models?
A. Annual ordering cost is inversely related to order size.
B. The average inventory level is inversely related to order size.
C. When the cost per each order increases, then EOQ level decreases.
D. When the holding cost per unit increases, then EOQ level increases.
The Correct Answer and Explanation is :
The correct answer is:
A. Annual ordering cost is inversely related to order size.
Explanation:
The Economic Order Quantity (EOQ) inventory model is a widely used approach in inventory management that helps determine the optimal order quantity to minimize the total inventory cost, which includes ordering and holding costs.
Why A is Correct:
- Annual Ordering Cost: This cost is calculated as the number of orders placed per year multiplied by the cost per order.
- As the order size increases, fewer orders are needed to meet the annual demand, leading to a reduction in the annual ordering cost.
- Hence, the ordering cost is inversely related to the order size.
Why Other Options are Incorrect:
- Option B: The average inventory level is directly related to order size, not inversely. It is calculated as half of the order quantity (EOQ/2). A larger order size increases the average inventory level.
- Option C: If the cost per order increases, the EOQ will increase, not decrease. This happens because placing fewer, larger orders reduces the number of orders, thus minimizing the higher ordering costs.
- Option D: If the holding cost per unit increases, the EOQ will decrease. Higher holding costs discourage maintaining large inventories, leading to smaller optimal order quantities.
EOQ Formula and Insight:
The EOQ formula is:
[
EOQ = \sqrt{\frac{2DS}{H}}
]
Where:
- (D) = Annual demand
- (S) = Ordering cost per order
- (H) = Holding cost per unit per year
From the formula:
- EOQ increases with higher demand or ordering cost.
- EOQ decreases with higher holding costs.
By balancing ordering and holding costs, EOQ minimizes the total inventory cost, leading to more efficient inventory management.