In inventory management, which technique is used to determine the optimal order quantity?

• A. Just-In-Time (JIT)
• B. Safety stock
• C. Economic Order Quantity (EOQ)
• D. Material Requirements Planning

Answer: (C)

Determining how much to order each time to minimize total inventory costs is what the Economic Order Quantity concept is all about. The idea is to balance two kinds of costs that change opposite as you adjust order size.

• Ordering costs: Each time you place an order, there’s a fixed cost for processing, receiving, and handling. If you order in small lots, these costs add up quickly.

• Holding (carrying) costs: Keeping inventory on hand costs money—storage, insurance, depreciation, and the opportunity cost of tied-up capital. If you order in large quantities, you hold more units for longer, increasing these costs.

The optimal order quantity is found where the total cost is minimized, which happens when the savings from ordering less offset the higher holding costs from carrying more inventory. The Economic Order Quantity model provides a formula to calculate this balance: Q* = sqrt(2DS/H), where D is annual demand, S is the cost per order, and H is the annual holding cost per unit.

For example, if annual demand is 10,000 units, the cost to place an order is $50, and the holding cost per unit per year is $2, the calculation suggests ordering around 707 units each time. This quantity keeps the sum of ordering and holding costs as low as possible, given the assumptions of the model (steady demand, fixed lead time, no stockouts, etc.).

Other concepts mentioned aim at different aspects of inventory. Just-In-Time focuses on minimizing inventory levels by coordinating deliveries with production and demand, not on calculating an exact optimal order size. Safety stock is buffer inventory to guard against variability, not the quantity that minimizes total costs. Material Requirements Planning schedules material purchases based on production plans and bill of materials, rather than optimizing order quantity.