What is the primary purpose of the basic economic order quantity model shown below?

 Options:

A. to calculate the reorder point, so that replenishments take place at the proper time B. to minimize the sum of carrying cost and holding cost C. to maximize the customer service level D. to minimize the sum of setup cost and holding cost E. to calculate the optimum safety stock

The Correct Answer Is:

D. to minimize the sum of setup cost and holding cost

Correct Answer Explanation: D. to minimize the sum of setup cost and holding cost

The basic Economic Order Quantity (EOQ) model is a fundamental tool in inventory management, aiming to strike a balance between inventory holding costs and ordering costs. The correct answer, D, highlights the core objective of this model: to minimize the sum of setup (or ordering) costs and holding costs.

The EOQ model computes the optimal order quantity that minimizes the total inventory costs, which consist of two primary components: setup/ordering costs and holding (or carrying) costs.

Firstly, let’s delve into why answer D is the correct choice. The EOQ model minimizes the sum of setup cost and holding cost by finding the order quantity that achieves an equilibrium point. The setup cost refers to the expenses incurred each time an order is placed, encompassing activities like processing orders, paperwork, and logistics expenses.

This cost tends to decrease as the order quantity increases because larger orders mean fewer orders need to be placed, reducing the frequency of setup costs. On the other hand, holding costs entail expenses related to storing inventory, such as warehousing, insurance, depreciation, and obsolescence.

These costs generally increase as the order quantity rises due to higher inventory levels.

The EOQ model seeks to find the sweet spot—the order quantity where the sum of these costs is minimized. At this optimal quantity, the total cost curve reaches its minimum, ensuring that the combined expenses of setup and holding costs are at their most efficient level.

Now, let’s break down why the other options are not the primary purpose of the EOQ model:

A. To calculate the reorder point, so that replenishments take place at the proper time:

The EOQ model does not explicitly calculate the reorder point. While the reorder point is a crucial aspect of inventory management, it focuses on determining when to place an order based on inventory levels and lead times.

The EOQ model primarily deals with the order quantity, not the timing of orders.

B. To minimize the sum of carrying cost and holding cost:

This answer inaccurately combines “carrying cost” and “holding cost,” which are essentially the same thing.

Additionally, the EOQ model aims to minimize the sum of setup (or ordering) cost and holding (or carrying) cost, as explained earlier, rather than a combination of carrying and holding costs.

C. To maximize the customer service level:

While maintaining a high customer service level is a priority in inventory management, the EOQ model is specifically designed to optimize costs associated with inventory.

While it indirectly impacts customer service by ensuring the right inventory levels, its primary focus is not maximizing customer service.

E. To calculate the optimum safety stock:

Safety stock is a buffer of inventory kept to mitigate uncertainties in demand or supply variability. The EOQ model does not directly calculate safety stock.

Instead, it concentrates on determining the optimal order quantity to minimize costs, which can indirectly influence the need for safety stock but is not its primary purpose.

In summary, the EOQ model’s primary objective is to find the order quantity that minimizes the total inventory costs by balancing setup/ordering costs and holding/carrying costs. This model aids in making informed decisions about inventory management, ensuring efficiency and cost-effectiveness in maintaining optimal inventory levels.

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