Inventory

Definition:

“Inventory “is essential to produce flexibility in operating a system (or) organization.

Classification of inventory:

An inventory can be classified into ‘3’ classifications.

 Raw-material inventory
 Work-in-process inventory
 Finished goods inventory

1. Raw-material inventory:

The raw material inventory removes dependency between suppliers and plants.

2. work-in-process inventory:

The process inventory removes dependency between various machines of a product line.

3. Finished good inventory:

The finished- good- inventory removes dependency between plants and its customers or market.

Functions of inventory: the main functions of an inventory are.

 Smoothing-out irregularities in supply

 Minimising the production coast
 Allowing organizations to cope-up with perishable materials.

Inventory decisions: the following ‘2’ basis ‘decisions’ are generally taken as managers

 When to replenish the inventory of an item?

 How much of an item to order when the inventory of that item is to be replenished? (to
make full again by replacing what has been used)

Costs of inventory system:

The following coasts are associated with the inventory system

 Purchase price/unit
 Ordering cost/order
 Carrying cost/unit/period
 Shortage cost/unit/period

Economic order quantity (E.O.Q):

 If we place the frequent order & the cost of ordering will be more but the inventory carrying cost
will be less.
On the other hand, if we place less frequent order & ordering cost will be less, but the carrying cost
will be more.
Trade –off between coasts

Total cost curve

Carrying cost
Total cost ACC=AOC

Ordering cost

Order
Order quantity
In the above diagram for an increase in order size (Q) the carrying cost increases and the ordering
cost decreases. The cost curve represents the sum of ordering cost and carrying cost for each order
size.

The order size of which the total cost minimum then it is called “Economic Order Quantity”
(E.O.Q) or optimal order size (Q)”.

Models of inventory

There are different models of inventory. The inventory models can be classified into deterministic
inventory models & probabilistic models

 Deterministic inventory models

 Probabilistic inventory models

Model-I

Purchase model with instantaneous replenishment and without shortages.

The objective this model is to find the economic lot size for the optimum production quantity (Q*)
per cycle of a single product so as to minimize the total average cost per unit time where.

 Demand is uniform at a rate of R quantity units per unit time.

 Lead time is zero(o known exactly)
 Production rate is infinite i.e. production is instantaneous
 Shortage are not allowed
 Holding cost is Ch per quantity/time
  Set up coat is CO per/setup.

In this inventory model orders of equal size are placed at periodical intervals the items against
an order replenished instantaneously and the items are consumed at a constant rate. The
purchase price per unit is same irrespective of order size.

Let us suppose that

D or R = Annual demand in units

CO = Ordering cost/order or set up coast/order

Cc or Ch = carrying cost/ unit /year

P or C = Purchase price /unit

Q = order size (quantity).

Inventory level

Max. Inventory
level
Q Q Q
Order quantity

Q = R (t)

0 Time

t t t t t

maximum level+ minimum level Q+ 0 Q

Avg .inventory =
2
= 2
= 2

Q
Avg .inventory =
2
[Link] 1

the no orders D
year
=
Q
[Link] 2

cost of ordering D
year
=
Q
Co [Link] 3
 cost of carrying Q
year
=
2
Cc [Link] 4

purchace of price
year
= D.P [Link] 5

Total inventory cost/year

= (cost of ordering / year) + (cost of carrying / year) + (Purchase price / year)

D Q
T.C =
Q
Co + 2
Cc + D.P [Link] 6

Differencing “6” [Link] Q then

d
dQ (T.C) =
d D
dQ Q [ Q
Co+ Cc + D . P
2 ]
=
d D
dQ Q ( )
Co + d Q
dQ 2 ( )
Cc + d
dQ
(D.P)

= D Co ( dQd Q1 ) + ( Cc2 ) ( dQd (Q)) + 0

= D Co ( −1Q ) + Cc2 (1)
2

d
dQ (T.C) = -
DCo
Q
2 ( ) + ( Cc2 ) [Link] 7

Again differentiating [Link] “Q”

{[ ] [ ]} = - [ ]+ [ ]
2
d d −DCo Cc d 1 d Cc
( T . C )= + DCo.
dQ
2
dQ Q
2
2 dQ Q2 dQ 2

DCo 2 DCo
= 3
2 ( 1 ) +0 = 3
Q Q
2
d ( 2 DCo
2
T .C )= 3 [Link] 8
dq Q

Since the 2nd derivative is +ve the optimal value of Q obtained by equating the 1st derivative to “o”

−DCo CC DCo Cc
O= 2 + 2 2 =
Q Q 2

Q C c = 2 DCo
2
 2 2 DCo
Q =
Cc

Q=
√ 2 DCo
Cc

I.

II.
The optimal order size Q* =
√
2 CoD
Cc
Total no. Of orders pr year (N)* optimum no. Of orders = D/Q*
III. Time b/w orders or optimum ordering interval (t*) = Q*/D
IV. Optimum inventory cost = √ 2× D× Co× Cc
D Q∗¿
V. Total cost is given by TC* = (
Q∗¿ ¿
) Co + ( 2
¿) Cc + D.P

Problems on model -I

Problem-I Find the EOQ for the following data

Annual usage =1,000 expenditure cost = R.s 4/order

Cost per price = RS.250/- inventory holding cost =20% of average inventory

Ordering coast = Rs.6/order material holding coast = Rs.1/ Piece.

Solution: Given that

D = annual demand in units =1,000/-

Co = ordering coast/ order = ordering cost + expenditure cost = Rs.6+Rs4 = Rs10/order

Cc= carrying cost /unit/year = (cost per piece) × (inventory holding cost)× (material holding cost)

2
= Rs 250×0.20×1 = 250× × 1 = 50×1 = Rs.50/-
10

Economic ordering quantity (or) Q* =

√ 2 CoD
Cc

Optimum order quantity =

√ 2 ×10 × 1000
50
=
√
20000
50
= √ 400 = 20

EOQ = Q* = 20
 Problem -2 A textile will buys its raw material from a vendor. The annual demand of the raw-
material is 9000 units. The ordering cost is R.s100/- per order and the carrying cost is 20% of the
purchase price per unit per month, where the purchase price per unit is Rs.1 find the following

i. Economic order quantity (EOQ)

ii. Total cost W.R.T EOQ
iii. Number of orders per year
iv. Time between consecutive 2 orders.

Solution:

D = annual demand in units = 9000 units/year

Co = ordering cost/order = Rs100/year

P = purchase cost/ unit = Rs 1/ unit

20 2
Cc = carrying cost /unit/year = 20% purchase rice = × Rs 1= × Rs 1
100 10

= 0.2×Rs1 = Rs0.2 Cc = Rs 0.2/month

= 0.2×12 2.4/units/year (∴ 1 year = 12 months)

Cc = Rs 2.4/units/year

i. The economic order quantity (EOQ) = Q* =

= 866.3 = Q* = 866 units

√ 2 CoD
Cc
=
√ 2 ×100 × 9000
2.4
=
√
1800000
2.4
= √ 7500000

( )
¿
D Q
ii. Total cost (TC)* = ¿ Co + ( )Co+D.P
Q 2

= (( ) ) [( )( ) ]
9000
866
×100 +
866
2
2.4 + (2000×1)

= ( 9000
866 )
+ 433(2.4) +9000 = 1039.26+1039.2+9000

(TC)* = Rs11078.46/year

D 9000
Number of orders /year (N)* = ¿ = = 10.39 orders / year
Q 866
¿
Q 866
Time between ‘2’ consecutive orders = = = 0.0962 year
D 9000

= 0.0962×12 = 1.15 month (∴ 1 year = 12 months)

= 1.15 ×30 = 34.5 days (∴ 1 month = 30 days.)

 ¿
Q
=34.5 days.
D

Model-2
Manufacturing model without shortages

Lets us suppose that

I. R or r = annual demand in units

II. K = Production rate of the item (or) total no. Of units produced/year
III. Co = ordering cost/order or set-up cost/order
IV. Cc = carrying cost/unit/year(or) holding cost/unit/year
V. P = production cost/unit
VI. t 1 = period of production as well as consumption of the item
VII. t 2= period of consumption only
VIII. t = cycle time i.e. t = t 1+ t 2

If a company “manufacturers” an item which is required for its main product then the corresponding
model of inventory is called “manufacturing model”.
In this model shortage are not required the rate of consumption of the item is assumed to be
uniform throughout the year. The item is produced and consumed simultaneously for a portion of the
cycle time. During the remaining cycle time, only the consumption of the item taxes place and the cost of
production per unit are same irrespective of production lot size.
The operation of the manufacturing model without shortage is shown in the following figure.

Units

Rate of production &

consumption

(K-R) (K-R)
r Q r
Stock Q
level

Q/(K-R) Q/r Q/(K-R) Q/r

Time
B
M
 t1 t2 t1 t1

t t Manufacturing model without shortages

During the period t 1 the item is produced at the rate of “K” units per period and simultaneously it
is consumed at the rate of “r” units per period during this period, the inventory is built at the rate of (k-r) units
period during the period t 2 the production of the items is discontinued but the consumption of the same item is
continued. Hence the inventory is decreased at the rate of ‘r’ units per period during this time ‘ t 2’.

From the graph we have

Q Q
t1 = t 1=¿ [Link].1
k−r r

Since the total quantity produces during the production period t 1 is q and the quantity which is
consumed during the period t 1 is Rt 1

i.e. q= total quantity produced during the period t 1

Rt 1= total quantity which consumed during the period t 1

Then the remaining quantity which is stored during the period “t 1 is

Q=q-R (t 1)

Q Q
Q = q-R ( ) {from [Link] 1 t 1 = }
k−r k−r

Q ( k−R ) Q+ RQ
Q = Q+R ( k−r ) = q = = (K-R) q = (KQ – RQ) + RQ
(K−R)

( k−R )
(K-R) q = KQ = Q = q [Link].2
K 1
∆ ABC= × base × height
2
Holding cost for the time period‘t’ is
MN = Q OB =t from diagrom
Carrying cost (or) holding coast = ( ∆ ONB ) × C c

= ( 12 MN × OB) ×C c

= ( 12 × (Q ) × t )× C c

Qt
Holding cost = ×C c [Link].3
2
Ordering per the period‘t’ = C o [Link].4

The total average cost = (carrying cost /period )+ (ordering cost/eriod)

[ ]
Qt
= 2
×C c
t
+ ( C2 )
o
{from 3 & 4}

[{ ( ) ] } [ ]
Since Q or q =Rt
1 K−R
q × C c ×t
= 2 K Co t = q/R
+
t t

=[ ( ) ] [ ] [ ( ) ] [ ]
1 K−R C
q ×C c + o 1 K−R Co R
2 K q = q ×C c +
2 K q
r

C (q) =
[( ) ][ ]
1 K−R
2 K
q ×C c +
Co R
q
[Link].5

For the optimum value of q, first we derivate the ‘5’ W.R.T to ‘q’ on B.S

d
dq
C ( q )=
d
dq {[ (2 ] [ ]}
1 K −R
K )
q × Cc +
Co R
q d 1 d −2
= x
dx x 2 dx
1
=2 ( ) [ ] [ ]
K−R
K
Cc
d
dq
(q ) +
d Co R
dq q = (-2). x−2−1 = -2 x−3 =
−2
x
3

=
[ ( [ ]) ]
1
2
1−
R
k
−1
×C c + ( C o R ) 2
q ( )
dc
dq
==
1
2
1−
[ ( [ ]) ]
R
k
Co R
Cc - 2
q
[Link].6

Again dervating’6’ W.R.T to ‘q’ on b.s

{[ [ ] ] [ ]}
2
d c d 1 R C R
2
= 1− C − o2
d q dq 2 k c q

¿
d
dq {[ [ ] ] [ ]}
1
2
1−
R
C −
d Co R
k c dq q2

2
d c Co R 2
d c
2
=¿ 2+ 3 = 3 >0 [Link].7
dq q dq
the optimum value of q is obtained by equating 1st derivating to ‘o’

dc
dq
1
=0=¿ 1−
2
R
[ [] ]
C R
C − o2 = 0
k c q

Co R 1 R Co R (k−R)Cc
¿
q
2 = 2 ×1− k C
c
= q
2
=
2K

2 2 c o (RK)
¿ q ( K −R ) C c =2 K (C o R) = q 2 =
Cc ¿ ¿

¿ q=
√ (
2 c o RK
Cc K−r )
Or
√
2 co R K
C c K −r ( )
FORMULAS∈ MODEL:−¿

1. Economic batch quantity (EBQ) or Q* or Q* =

√
2 co R K
C c K −r
Q∗¿
( )
2. Period of production as well as consumption t 1* = ¿
K

[ ]
R
3. period of consumption only t 2* = Q*
1−( )
R
K =
( K−R ) t 1 Q∗¿ K−R
R
+
R K ( ¿ )
Q∗¿ Q∗¿
4. cycle time t = t 1*+t 2* or t* = ¿ or ¿
R D
R D
5. number of orders/ year (or) optimum number of production cycles/year = or
Q∗¿ ¿ Q∗¿ ¿

√
6. total minimum production inventory cost is C min= 2 R C c C o
(K −R)
K

Note 1:

1. if K= R then C min= 0 i.e. there will be no holding cost & carrying cost
2. if K= ∞ i.e production is finite this model reduces to model –I

Problems on model –II

Problem-1: an automobile factory manufactures a particular type of gear within the factory. This
gear is used in the final assembly. The particular of this

Demand rate R = 14,000 units / year

Production rate K=35000 units/year

Ordering cost C o= Rs500 / setup

Carrying cost C c = Rs 15/ unit layer

Find ‘i” the economic batch quantity (EBQ) and “ii” no. of orders per year.

Solution:

The economic batch quantity (EBQ) =Q* =

√ 2 R Co K
C c K −R

=
√ 2 ×14000 × 500
15
35000
35000−14000
=
√
14000000 35000
15 21000
= √ 9 , 33,333.33 (1.67 )

= √ 15 ,55,555.55 = 1247.22 units

Q* = 1247

Q∗¿
The period of production as well as consumption t 1* = ¿
K

= 1247/35,0000 = 0.0356/year = 0.0356×12 /mkonths

=0.4275/month = 0.4275×30/ (day)

t 1* = 13 approximately

the prtiod of consumption is

Q∗¿ K−R
t 2* = ¿( ¿
R K

¿ 1247/14,000 × 35000-14000/35000 = (0.0891) (21000/35000)

¿ 0.0191 ×(0.6) = 0.0535/year

¿ 0.0535 ×12 /month = 0.642/month

¿ 0.642 ×30 /days = 19.26/days

t 2*= 20 days

the cycle time t=t 1*+t 2* = 13+20 =33 days t=33days

R
The number of setups orders per year = = 14,000/1247 = 11.23
Q∗¿ ¿

Problem – 2: company manufacturers a low cost bearing which is used in its main production the
demand of the bearing is 19000 units per month and the production rate of the bearing is 25000 units
per month. The carrying cost as the bearing is Rs0.02 per bearing per year and the Setu cost is Rs.18
per setup find the economic batch quantity (EBQ) and cycle time (t*)

Solution: given that

Annual demand = D or R = 10,000 bearing / month = 10,000×12 /year = 1,20,000/year

Production rate = K = 25,000 bearing / month = 25000×12/year = 3,00,000/year

Ordering cost = C o = Rs 18/order

Carrying cost =C c = Rs 0.02/bearing / year

The economic batch quantity (EBQ) or Q* =

√ (
2 co R K
C c K −r )
=
√ 2 ×1 , 20,000 ×18
0.02 (
×
300000
300000−120000 ) =
√ (
4320000 300000
0.02
×
180000 )
= √ 216000000 ×1.67 = √ 360000000 = 18973.67

Q* = 18974 units

Q∗¿
The cycle time is t* = ¿
R

= 18974/120000 = 0.1581/ year = 0.1581× 12/month

= 1.90/month =1.90×60 /day =56.922/ days

t* = 57 days

The period of production & consumption the period of consumption

Q∗¿ 1 Q∗¿
t∗¿ 1 ¿= ¿ 18974/300000 = 0.0632 = 2 t∗¿ 2 ¿= ¿ (K-R/K)
K R

¿ 0.0632 ×365=22.77=23 days =18974/120000 × 180000/300000

= (0.1581)×0.6 = 0.09486 year

= 0.09486×365 days=34 days

t=t∗¿ 1+t∗¿2 ¿ ¿ = 23+34 = 57 days

Model [Link]

Purchase model with instantaneous replenishment with and shortages

Notations in model-II

D or R = demand / period C o = ordering cost/order

C c = carrying cost/unit/period C s = shortage cost/unit/period

 Q=order ¿ ¿ Q1 = maximum inventory

Q2 = maximum stock-out t 1 = period of positive stock or period of inventory

t 2 = period of shortage t=cycle time(t 1 +t 2)

In this model, an item on order will be received instantaneously and it is consumed at a

constant rate. The purchase price per unit is same irrespective of order size.

Back ordering: If there is no stock at the time of receiving a request for the item, it is assumed that it
will be satisfied at a later date with a penalty. This is called “back ground”.

This model can be shown in the following figure

Purchase model with shortage.

units

Q1

Q2
Q Time

t1

t2

t3

Formulas in model –III

1. economic order quantity (EOQ) or Q* =

√( 2 DC o
Cc )(
×
Cc +C s
Cs )
2. maximum inventory Q∗¿1 ¿ =
√( 2 DC o
Cc )(
×
CS
Cc +C s )
 3. maximum stock-out Q∗¿2 ¿ = Q∗−¿ Q∗¿1 ¿
Q∗¿
4. cycle time t* = ¿
D
Q∗¿ 1
5. period of positive stock or inventory = t∗¿ 1 ¿ = ¿
D
Q∗¿ 2
6. period of shortage = t∗¿ 2 ¿ = ¿
D
D
7. number of orders/period (N*) =
Q∗¿ ¿
D
8. total cost W.R.T to T.C* = ( C +¿
Q∗¿ ¿ o

Problem-I: The annual demand for a component is 7200 units. The carrying cost is
Rs.1500/unit/year. The ordering cost is Rs.1500/order and the shortage cost is Rs.2000/unit/year. Find
the optional values of economic order quantity maximum inventory, maximum shortage quantity, cycle
time (t), inventory period(60) and shortage period(t 2).

Solution:
D = 72000 units/year C c = Rs.500/unit/year
C o = Rs.1500/order C s = Rs.2000/unit/year

economic order quantity (EOQ) Q* =

√( 2 DC o
Cc )(
×
Cc +C s
Cs )
= (√ 2 ×7200500×1500 )× ( 500+2000
2000 )

2600 ) √ ( 4 )
= √ ( 43200 ) × (
2500 21600
=

= 232.38 = Q* 232 units

Maximum inventory Q1∗¿ =

√( 2 × D ×C o
Cc
×)( CS
C c +C s )
=(√ 2 ×7200500×1500 )× ( 2000+500
2000
)
√ 2500 )
= 43200 × (
42000

√ 5 ) = √34560 = 185.90
= (
172800

= Q1∗¿ = 186
 Maximum stock out Q2∗¿ = Q* - Q1∗¿
= 232 – 186 = 46 units
Q∗¿ 232
Cycle time t* = ¿= = 0.0322 year = 0.0322×365 days
D 7200
t* = 12 days
1∗¿ 186
Period of positive stock t 1 * = Q ¿= = 0.0258 year = 0.0258 ×365days
D 7200
= 9.45 = 10 days
Period of shortage 2 * = t* - t 1 *
t
= 12-10
= 2 days
D∗¿ 7200
Number of orders per year = ¿= = 31.03 = N* = 31.03
Q 232

Problem – 2: The demand of a bought out item in a store is 12000 units per year the carrying cost is
Rs.2 per unit per year and the ordering cost is Rs.600 per order. The shortage cosat is Rs.10 per unit per
year. Find the 70Q and the corresponding number of orders per year, the maximum inventory and
maximum shortage quantity.
Solution: Given that

D = 12000 units/year C c = Rs.2/unit/year

C o = Rs.600/order C s = Rs.10/unit/year

The economic order quantity(EOQ) Q* =

√( )(
2 DC o
Cc
C +C
× c s
Cs )
=(√ 2 ×12002 ×600 )× ( 10+2
10 )

√
= ( 7200000 ) ×( ) = √ ( 8 , 64,000 )
12
10
= 2939.39 = Q* 2940 units

Maximum inventory Q1∗¿ =

√( 2 × D ×C o
Cc
×)( CS
C c +C s )
=(√ 2 ×12002 ×600 )× ( 10+2
10
)
√ 12
= 600000 ×( )
10

= √ ( 600000 ×10 ) = √ 600000 = 2449.49

= Q1∗¿ = 2458 units

Maximum stock out Q2∗¿ = Q* - Q1∗¿

 = 2940 – 2450 = 490 units
= 490 units

D∗¿ 1200
Number of orders per year = ¿= = 4.0816 orders/ year
Q 2940
= N* =4.0816 orders/year
Maximum shortage quantity/year = (maximum stock-out)× (No. Of orders/year)
= 490× 4.0816 = 1999.98
Shortage quantity/year = 200 units.

Model – IV:
Manufacturing model with shortage
Notations in model –IV:
The variables which are used in this model are given below.

R or r = demand / period C o = ordering cost/order (or) setup cost/setup

C c = carrying cost/unit/period k = production rate of the item

p∨c= purchase cost /unit∨ pr oduct t = total cycle time

t 1 = period of production as well as consumption t 2 = period of consumption only

t 3 = period of shortage

t 4 = period of production as well as consumption item statistically back order.

In this model, an item is Produced and consumed simultaneously for a portion of the cycle time.
During the remaining cycle time, only the consumption of the item takes place. The cost of production
per unit is same irrespective of the production lot size.

Back ordering:

Stock out is permitted in this model and it is assumed that the stock out units will be satisfied from the
units which will be produced at a late date with”penalty”. This is called “back ordering”.

The operation of this model is shown in the following figure.

Manufacturing model with shortage

Inventory

A
 (K-R)
Q1 R

C D
Q
E
B
t3 T4
O Time

t1 t2

Q2

F
Production cycle time

Formulas in model –IV t

I. economic batch quantity (EBQ) = Q* =

√( 2 RC o
Cc () K K−R )(
C c +C s
Cs )
II. maximum inventory = Q1* =
√(2 RC ) K )( CC+C )
(
2 RC o
K −R
Cc
Cs
c s

III. maximum stock-out = Q2* =

(√ C ) ( K −R
K )( C +C )
c
o

c
c

Q1* = (
K )
K−R
Q*- Q2*
Q∗¿
IV. cycle time t* = ¿
R
Q∗¿
V. period of production & consumption t1* = ¿
( K −R)
1∗¿
VI. period of consumption t2* = Q ¿
R
2∗¿
VII. period of shortage t3* = Q ¿
R
 2∗¿
VIII. period of back-order t4* = Q ¿
(K−R)

IX. total minimum inventory cost C min= 2 D Co C c ×

Problems on model – IV
√ ( K−R
R
× )(
C c +C s
Cs )
Problem-I the demand for an item is 600 units per year. Its production rate is 1000 units per month.
The carrying cost is Rs.50/unit/year and the setup cost is Rs.200 per setup. The shortage cost is Rs.
1000 per unit per year. Find various parameters of the inverters system.
SOLUTION:
Given that

R = 600 units/year
K = production rate/year = 1000 units/month
= 1000 × 12 /year = 12,000 units/month
C o = ordering cost/order = Rs.2000/order
C c = ordering cost/unit/year = Rs.50/unit/year
C s = shortage cost/unit/year = Rs.1000/unit/year

economic batch quantity ( EBQ ) Q∗¿ =

√( 2 RC o
Cc )( K
K −R )(
C c +C s
Cs )
(√ 2 ×60050×200 )( 12000−6000
12000
)( 50+1000
1000 )

√ ( 180000 ) × ( 12000
6000 ) ( 1000 )
×
1050 =
√ ( 8 ) × ( 120 ) × ( 150 ) = √ ( 1008000 ) = 1003.99
Q∗¿ 1004 units

Maximum stock-out = Q2* =

√( 2 RC o
Cc () K −R
K )( C +C )
Cc
c s

(√ 2 ×6001000×2000 )( 12000−6000
12000 )( 50+ 1000 )
50

√ ( 24000000/1000 ) × ( 12000
6000
)× ( 1050
50 =
) √ 24000 × ( 0.5 ) × ( 0.0476 ) = √ 571.4286 = 23.90
24 units .

Q1* = ( K−R
K )
Q*- Q2* = (
12000−6000
12000 ) (1004) – 24 = ( 12000
6000
) (1004 )- (24)
=(
2 )
1004
- (24) = 502-24 = 478 units.
t* =
Q∗¿
R
׿ 365 =
1004
6000( )
× 365 = 0.1674×35 = 61.0 = 61 days

t1* =
Q∗¿
( K −R)
¿ × 365 =
478
(
12000−6000
× 365 =
478
6000 )
×365 = 0.07967 ×365 = 29.07 = 29 days.

t2* = Q
1∗¿
R ( )
× ¿ 365 =
478
6000
×365 = 0.07967×365 = 29.07 = 29days

× ¿ 365 = (
6000 )
2∗¿ 24
t3* = Q ×365 = 0.004×365 = 1.46 = 1.5 days
R

× ¿ 365 = ( ) × 365 = (
6000 )
2∗¿ 24 24
t4* = Q ×365 = 0.004×365 = 1.46 = 1.5 days.
(K−R) 12000−6000

Problem-2 in a ‘2’ wheeler manufacturing company pistons are being fed into main assembly line
from a product line situated. In the next day, the annual demand fro the pistons are 8000 units and the
annual production capacity of the product line manufacturing the piston is 12,000 units. The set up cost
is Rs.125 per setup and the carrying cost is Rs.4 per piston per year. The shortage cost is Rs.8 per
pistons. Find Q*,Q1*,Q2*,t*,t1*,t2*,t3* & t4*

Solution: given that

R = 8000 pistons/year K = 12000 pistons /year

C o = Rs.125 per setup C c = Rs.4/Pistons/year C s = Rs.8/pistons/year

economic batch quantity ( EBQ ) Q∗¿ =

√( 2 RC o
Cc )( K
K −R )(
C c +C s
Cs )
(√ 2 ×125
4 )( 12000−800
12000−8/000 )( 8 )
4+ 8

√ ( 250/4 ) × ( 96000000 ) × ( 128 ) = √ ( 3) × ( 250) × ( 12000000 ) = √ ( 9000000000 )

= 15000pistons

Maximum inventory = Q1* =

√( 2 RC o
Cc )( K −R
K )(
Cs
C c +C s )
= (√ 2 ×80004 ×125 )( 12000−8000
12000 )( 4+8 8 ) = 333.33 units = 333 pistons
 Maximum stock-out = Q2* =
√( 2 RC o
Cc )( K −R
K )(
Cc
C c +C s )
(√ 2 ×80008 ×125 )( 12000−8000
12000 )( 4+ 8 )
4

= 166.67 = 167 pistons

t* =
Q∗¿
R
¿=
1500
8000(=
1500
8000 )( )
× 365 = 0.1875×365 = 68.4 = 68.4 days

t1* =
Q∗¿
( K −R)
¿= (
333
12000−8000
×365 = )
333
12000−8000
×365 = 0.0832 ×365 = 30.4= 30.4 days.

t2* = Q
1∗¿
R
¿=( )( )
333
8000
=
333
8000
×365 = 0.0416×365 = 15.2 = 15.2days

¿= (
8000 )
2∗¿ 167
t3* = Q = 0.0209×365 = 7.6 = 7.6 days
R

¿= ( )=(
4000 )
2∗¿ 167 167
t4* = Q × 365 = 0.0417×365 = 15.2= 15.2 days.
(K−R) 12000−8000

Quantity discount (Price breaks) models

I. Purchase inventory model with one price break.
II. Purchase inventory model with two price break.
III. Purchase inventory model with multiple price breaks.

Introduction: For the ‘deterministic inventory’ models, it was assumed that the unit ‘production
cost’ or ‘purchase cost’ was ‘constant’ over the range of possible order sizes. So there was no need to
consider this cost directly.

But in this model we shall consider a class of inventory problem in which each cost is a
variable cost.

However, to obtain a higher sales volume, many companies (industries) offer reduced
purchasing costs for large purchases such discounts are typical referred to ‘ quantity discounts ‘ or ‘ rice
breaks’.

To purchase large questions on reduce price, the organization must decide between the EOQ
qe and quality discount (QD*). The overall approaches is to decide which option qe* or qd* minimizes the
total costs.

Total cost = ordering costs holding cost+ purchasing cost.

Cc= C×P = C×I

( QD ) C +( Q2 ) c + D . P
√ √
T.C = o c 2 RCo 2 RCo
Q*D = or
Cc C× p
T.C = ( QD ) C +( Q2 ) c .( p)+ D . P
o

Here purchasing cost = D×P

= (annual demand)×(purchase cost per unit)

I. Purchase inventory model with one price break suppose the following price discount schedule
is quoted ‘bo’ a supplier in which a price break(quality discount) occurs at quality ‘b1’ this means

Quality price / unit(Rs)

Q≤Q1 <b1 C1

b1≤Q2 C2(<C1)

Algorithm for one-price break

Step-1: consider the lowest C2 and determine Q2* by using the EOQ formula.

Q2* =
√ 2 DCo
C 1× C 2
or Q2* =
√ 2 DCo
Cc √
or Q2* =
2 DCo
C ×P2

Case -1:

If Q2* ≥b1 then Q2* is the EOQ

Q* = Q2*

The optimum cost (TC)* associated with Q2* is calculated as followed as

(TC)* = ( bD1 )Co + ( b21 )(C×P2)+(D)C2

Case -II

If Q2* ¸b1 then go next ste.

Then calculate the Q1 with the price C1 and the corresponding total coast(TC) at Q1* compare TC (b1)
& TC(Q1*)

Q1* =
√ 2 RCo
Cc
or Q1* =
√ 2 RCo
C ×C 1

Sub case –I: if TC (b1)>T.C(Q1*) then Q8=Q1* = TC(Q1*) <TC(b1)

Sub case-II: otherwise Q*=b1 is the required EOQ = TC(b1) < tc (Q1*)

Problems:
Problem- no 1: find the optimum order quantity for a product for which the price breaks are given
below.

Quality O≤q1≤500 q2≥500

Unit cost Rs.15.00 RS.14.50

Monthly demand for the product is 250 units cost of carrying is 2% of the unit cost and cost of ordering
is Rs.300

Solution:

Given that D=250 Co= ordering cost/order =300

Cc= carrying cost/unit/year = Rs.2% of unit of ordering

Q
= = 0.02
100

C2 = 14.50

Optimum order quantity (Q2*) =

√ 2 DCo
C ×C 2
=
√ 2 ×250 × 300
0.02× 14.5
= 719

Q2* = 719

Since Q2* = 719 ≥500 = Q2* ≥b1

The optimum purchase quantity will be Q2* =719

Problem-2:

The annual demand of a product is 10,000 units. Unit cost is Rs100 if the orders placed in
quantities below 200 units but for orders of 200 or above the price is Rs.95 the annual inventory holding
cost is 10% of the value of the item and the ordering cost is Rs.5 per order. Find the economic lot size.

Solution : annual demand D or R = 10,000 units

Ordering cost / order = Co =Rs.5/order

10
Holding cost or carrying cost/unit/year = 10% item = = R.s 0.10/unit/year.
100

Cost price quality Cc = C×P2 or C×C2 = C×1

Rs.100 0≤q1≥200

Rs.95 q2 ≥ 200

The EOQ is givne by EOQ (Q2*) =

√ 2 × R × Co
C×C2
=
√
2 ×10000 × 5
0.10 × 95
=
√ 100000
9.5
= √ 10526.3158 = 102.60 = Q2* =103 units

Since Q2* < b1 i.e. 103<200

Thus the coordination Q2* ≥ b1 is not satisfied , so calculate Q1* value

Q1* =
√ 2 × R × Co
C×C2 √
=
2 ×10000 × 5
0.10 × 100
=
√
100000
100
= √ 10000 = Q1* = 100 units

Since Q1* ≤b1 i.e 100<200. So the condition is satisfied.

The economic lot size EOQ = 100 units

Problem-3: Find the EOQ for the following financial demand =400 units ordering cost is R.s20,
inventory cost carrying changes =20% cost per unit. The unit cost is Rs.50 if q<100 and Rs.49 if q≥100.

Solution:

Given that

D or R = annual demand = 400 units carrying cost/unit/year =C= Rs.200/100

Ordering cost/order = Co= R.s20/order

Unit cost quality

R.s 50 O<q1<100

Rs. 49 q2 ≥ 100

The EOQ is given by Q2*=

units
√ 2 × R × Co
C×C2
=
√ 2 × 400 ×200
0.20× 49
=
√ 1600
9.8
= √ 1632.6531 = 40.40 =Q2* = 40

Since Q2*<b1 i.e 40<100

But the condition Q2*Q2* ≥b1 is not satisfied so find Q1*

Q1* =
√ 2 × R × Co
C×C1 √
=
2 × 400 ×20
0.20 ×50
=
√
1600
10
= √ 1600 = 40 = Q1* = 40 units

Now Q1* <b1 = 40<100

Since the consideration is satisfied so the economic lot size is 40 units.

EOQ = 40 units.
 Purchase inventory model with-two price breaks

Suppose that the following price discount schedule is quated by a supplier, in which a rice break occur at
quantity b1 & b2.

Quality price /unit (Rs)

O<q1<b1 C1

b1≤q2<d2 C2

b2≤q3 C3

Note: C3<C2<C1

The optimum purchase quantity can be determined by the procedure given below

Algorithm

Step-1: compute Q3* and compare with b2

Case -1: if Q3*≥b2 then the optimum purchase quantity is Q3*

Case-2: if Q3*<b2 then go to Step-2

Step-2: compute Q2* since Q3*<b2 and q2

Thus, there are only 2 possible when Q2*≤b2. i.e either Q2*≥b1 or Q2*<b1

CASE-1:

If Q2*<b2 but Q2*≥b1

Then proceed as in the case of the area price break only i.e, compare the costs C(Q2*) and C(b2) to
obtain the optimum purchase quantity .the quantity with lower cost will naturally be the optimum.

Case -2:

If Q2*<b2 but Q2*< b1 then go to step-3

Then Q1* which will satisfy the irregularity Q1*<b1. In this case compare the cost C(Q1*) with
C(b1)&C(b2) both to determine the optimum Purchase quantity.

Problem-1:

Find the optimum order quantity for a product for which the price breaks are as follows.

Quantity 0≤q1≤50 50≤q2≤100 100≤q3

Unit cost Rs.10 Rs.9 Rs.8

 The monthly demand for the Product is 200 units the cost of the storage is 25% of the unit cost and
the ordering cost is 20 per order.

Solution:

The optimum order quantity corresponding to unit cost C3 is

Q3* =
√ 2 × R × Co
C ×C 3
=
√
2 ×200 × 20
8 × 0.25
=
8000
2 √
= √ 4000 = 63.24

Q3* = 63 units

But Q3*< b2 i.e 63<100 the condition Q3*≥b2 is not satisfied C3=8 so Q3* is not correct optimum lot
size.

Q2* =
√ 2 × R × Co
C ×C 3
=
√
2 ×20 × 200
9 × 0.25
=
8000
225 √
= √ 3555.55 = 59.62

Q2*=60

Since Q2*< b2 = 60<100 Q2*>61

Thus the condition is satisfied we have to compare the total cost of 60 and 100 to find the lot size.

TC (Q2*) = (R/Q2*)Co+(Q2*/2)(Cc×C2)+R(C2)

T.C(b0) = ( 200
60 ) ×20+
60 × 0.25× 9
2
+ ( 200 ×9 )

4000 135
= + + 1800 = 1934.17
60 2

T.C (b2) = ( bR2 ) ×Co+( b22 )× ( C × R 2) + R ( C 3 )

= ( 200100×20 )+ (100× 0.25
2
×8)
+ ( 200 ×8 ) = 40+
200
2
+1600 = 40+100+1600 = Rs.1740

= TC (b2) = Rs.1740 T(b2)<T(Q2*) EOQ is b2 = 100

C(100)<C(60) = R.s1740<R.s 1934

So the optimum lot size is 100 units.

Probnlem-2: A sub contractor has been found who can supply machines to a power plant
manufacturer who require 83 machines per day in his assembly operations. No shortages are to be
allowed procurement cost will be Rs.90 per chase order. The cost per unit is a function of the purchase
quantity as following.
Purchase quality 1-199 200-499 500 or more

Price per bushing 115 110 100

The holding cost is R.s 0.45 per bushing per day. Calculate the least purchase quantity for
Purchasing from the sub-contractor.

Solution: given that

R or D = Annual demand = 83 bushing per day.

Co = ordering cost/order = R.s90/order

Cc=carrying cost/unit/year = Rs.0.45 = C×P

Quantity 1≤q1≤199 200≤q2≤499 q3≥500

Price Rs.115 Rs.110 Rs.100

Q3* =
√ 2 × R × Co
C× P
=
√
2 × 83× 90
0.45
=
14940
0.45√= √ 32200 = 182.00

Q3* = 182 units

Since Q3*<b1 , Q3*<b2,Q3*<b3 i.e 182<199<499<500..

So find the optimum lot size we have to calculate total costs fro 199,499,500, and 182 i.e
TC(182),Tc(199)TC(499)Tc(500).

TC (Q3*) = (R/Q3*)Co+(Q3*/2)(Cc×C2)+R(C2)

Problem-3: Annual demand for an item is 6000 units, ordering cost is Rs. 600 per order. Inventory
carrying cost is 18% of the purchase price/unit/year. The price break-ups are as shown below.

Quantity Price (in Rs.) per unit

0≤Q1<2000 20

2000≤Q2<4000 15
4000≤Q3 9

Find the optimal order size

Solution: Given that

D = 6000/year C O = Rs. 600/order C C = 18% of purchase price/unit/year = 18/100 = 0.18/unit/year

b1 = 2000 b2 = 4000 C1 = 20 C2 = 15 C3 = 9
¿
Step-1: Calculate Q3

⟹Q3 = 2108.18
¿
Q3 =
√ 2 × R × Co
C ×C 3
=
√
2 ×6000 × 600
0.18 X 9
=
1.62√
7200000
= √ 4444444.44 = 2108.18
¿

⟹ 2018> 2000 then go to step-2

¿ ¿
Since Q3 < b2 i.e. 2018< 4000 And Q3> b1
¿
Step-2: Calculate Q2

⟹Q3 = 1633
¿
Q2 =
√ 2 × R × Co
C×C2
=
√
2 ×6000 × 600
0.18 X 15
=
2.7 √
7200000
= √ 2666666.67 = 1632.99
¿

¿
Since Q2 < b1 i.e. 1633< 2000 then go to step-3
¿
Step-3: Calculate Q1

= √ 2000000 = 1414.21 ⟹Q1 = 1414.21

¿
Q1 =
√ 2 × R × Co
C×C1
=
√
2 ×6000 × 600
0.18 X 20
=
3.6 √
7200000 ¿

¿
Since Q1 < b1 i.e. 1414< 2000

Then find the following costs and select the order size with respect to the least cost as the optimum
order size
¿
T.C. (Q1), T.C.( b1 ), T.C.( b2 ) i.e. T.C.(1414), T.C.(2000), T.C. (4000)
¿ ¿ ¿
TC (Q1) = (R/Q1) Co+ (Q1/2) (Cc×C1) +R (C1)

6000 1414 360000 5094

= (600) + (20) (0.18) + 6000 (20) = + + 120000
1414 2 1414 2

= 125091.17 ⟹ T.C. (Q1) = 125091.17

¿
= 2544.17 + 2547 + 120000

TC (b1) = (R/ b1) Co+ (b1 /2) (Cc×C2) +R (C2)

6000 2000 360000 5000

= (600) + (15) (0.18) + 6000 (15) = + + 90000
2000 2 2000 2

⟹ T.C. (Q1) = 94500

¿
= 1800 + 2700 + 90000 = 94500
TC (b2) = (R/ b2) Co+ (b2 /2) (Cc×C3) +R (C3)

6000 4000 360000 6480

= (600) + (9) (0.18) + 6000 (9) = + + 54000
4000 2 4000 2

⟹ T.C. (Q2) = 58140

¿
= 900 + 3240 + 54000 = 58140
¿
T.C. (Q1) < T.C. (b1) < T.C. (b2) i.e (125091) < 94500 < 58140

So the optimum order size is b2 i.e b2 = 4000 units

3) PURCHASE INVENTORY MODEL WITH – MULTIPLE PRICE BREKS (n PRICE BREK):

The situation may be represented as below.

Range of quantity Purchase price per unit

O < q1 <b1 C1

b1 ≤ q2 <b2 C2

. .

. .

bn-2 ≤ qn-1 < bn-1 Cn-1

bn-1 ≤ qn Cn

ALGORITHM:

The procedure to compute the optimum order size for this situation is given in the following steps

STEP -1:

Find the EOQ for the nth (last) price break

Qn =
¿

√ 2 × R × Co
C ×C n
¿
or Qn =
√ 2 × R × Co
CC
¿ ¿
Case - i) If Qn ≥ bn-1 then the optimum order size Q¿ is equal to Qn
¿
Case - ii) If Qn < bn-1 Otherwise go to step -2

STEP -2: Find the EOQ for the (n-1) price break

Q¿(n −1 ) =
√ 2 × R × Co
C ×C (n−1)
¿
or Q(n −1 ) =
√ 2 × R × Co
CC
¿
Case - i) If Q(n −1 ) ≥ bn-2
 Then compute the following total costs and select the lest cost purchase quantity as the optimum
order size
¿ ¿
i) Total cost for Q(n −1 ) i.e. T.C. (Q(n −1 ))

ii) Total cost for b (n-1) i.e. T.C. (bn-1)

¿
Case - ii) If Q(n −1 ) < bn-2 then go step – 3

STEP -3: Find the EOQ for the (n-2) price break

¿
Q(n −2 ) =
√ 2 × R × Co
C ×C(n−2)
¿
or Q(n −2 ) =
√ 2 × R × Co
CC
¿
Case - i) If Q(n −2 ) ≥ b (n-3)

Then compute the following total costs and select the lest cost purchase quantity as the optimum
order size
¿ ¿
i) Total cost for Q(n −2 ) i.e. T.C. (Q(n −2 ))

ii) Total cost for b (n-2) i.e. T.C. (bn-2)

iii) Total cost for b (n-1) i.e. T.C. (bn-1)

¿
Case - ii) If Q(n −2 ) < b (n-3) then go step – 4
¿
STEP -4: continue in this manner until Q(n −i ) ≥ b (n-i-1)
¿
Then compute the total costs T.C. (Q(n −i ) ), T.C. (b (n-i)), T.C. (b )... T.C. (bn-1) corresponding to
(n-i-1)
¿
purchasing quantities (Q(n −i ) ), (b (n-i)), (b (n-i-1))... (b n-1) respectively.

Finally, select the purchase quantity with respect to the minimum total cost as the optimum order
size.

Problem-1: Annual demand for an item is 550 units; the cost of shortage per unit per year is 10% of the
unit cost. The ordering cost is Rs. 150 for each order. The unit cost depends on the amount ordered. The
range amount ordered and the unit cost price are as follows.

Quantity Price (in Rs.) per unit

0 ≤Q1<550 25

550 ≤ Q2<1600 24

1600 ≤ Q3< 3000 23

3000 ≤ Q4 23
Find the optimal order size

Solution: Given that

D = 550/year C O = Rs. 150/order C C = 10% = 10/100 = 0.10/unit/year

b1 = 550 b2 = 1600 b2 = 3000 C1 = 25 C2 = 24 C3 = 23 C4 = 22

¿
Step-1: This is 3 price break problem. First calculate Q4

= √ 75000 = 273.86 ⟹Q4 = 274

¿
Q4 =
√ 2 × R × Co
C ×C 4
=
√
2 ×550 × 150
0.12 X 22
=
16500
2.2 √ ¿

Since Q4 < b3 i.e. 274< 3000 thus the condition Q4 > b3 is not satisfied. Then go to step-2.
¿ ¿

¿
Step-2: Calculate Q3

⟹Q3 = 268
¿
Q3 =
√ 2 × R × Co
C ×C 3
=
√
2 ×550 × 6150
0.10 X 23
=
165000
2.3 √
= √ 71739.13 = 267.84
¿

¿
Since Q3 < b2 i.e. 268< 1600then go to step-3
¿
Step-3: Calculate Q2

= √ 68750 = 262.20 ⟹Q2 = 262

¿
Q2 =
√ 2 × R × Co
C×C2
=
√
2 ×550 × 150
0.10 X 24
=
165000
2.4 √ ¿

¿
Since Q2 < b1 i.e. 262< 550 then go to step-4
¿
Step-4: Calculate Q1 and calculate the total cost and the least cost of purchase quality as the optimum
order size
¿
T.C. (Q1), T.C.( b1), T.C.( b2).

= √ 66000 = 256.90 ⟹Q2 = 257

¿
Q1 =
√ 2 × R × Co
C×C1
=
√
2 ×550 × 150
0.10 X 25
=
165000
2.5 √ ¿

And it must satisfy the inequality Q1 < b1 ⟹257< 550

¿

¿ ¿ ¿
TC (Q1) = (R/Q1) Co+ (Q1/2) (Cc×C1) +R (C1)

550 257 82500 642.5

= (150) + (25) (0.10) + 550 (25) = + + 13750
257 2 257 2

⟹ T.C. (Q1) = 14392

¿
= 321.01 + 321.25 + 13750 = 14392.26

TC (b1) = (R/ b1) Co+ (b1 /2) (Cc×C2) +R (C2)

 550 550 82500 1320
= (150) + (24) (0.10) + 550 (24) = + + 13200
550 2 550 2

= 150 + 660 + 13200 = 14010 ⟹ T.C. (b1) = 14010

TC (b2) = (R/ b2) Co+ (b2 /2) (Cc×C3) +R (C3)

550 1600 82500 3680

= (150) + (23) (0.10) + 550 (23) = + + 12650
1600 2 1600 2

= 51.56 + 1840 + 12650 = 14541.56 ⟹ T.C. (b2) = 14541

Since T.C. (b2) > TC (Q1) > TC (b1) ⟹ TC (b1) < TC (Q1) < T.C. (b2)
¿ ¿

⟹14010 < 14392 < 14541

∴ The optimum order quantity b1 = 550 ⟹E.O.Q. = 550 units

2) PROBABILISTIC INVENTORY MODELS (OR) STOCHASTIC MODELS:

For the deterministic inventory models, it was assumed that ‘demand’ and the ‘lead time’ are
known and constant.

However if the values of the demand and the lead time are not known exactly, then we use
probability distributions (discrete & continuous) to find the values. Then the models are called
“probabilistic Inventory” models. That means the demand can be known with certain probability.

In this case we cannot minimize actual cost. But the optimum quantity of inventory is determined
on minimising the “Total Expected Cost” (T.E.C.) instead minimising the actual cost.

TYPES OF MODELS:

1) MODEL – I: Discrete Demand, Discrete stock level, set up cost zero, Lead time zero.
2) MODEL – II: Discrete Demand, Continuous stock level, No set up cost, Lead time zero.
3) MODEL – III: Continuous Demand, Discrete stock level, set up cost zero, Lead time zero.
4) MODEL – IV: Continuous Demand, Continuous stock level, No set up cost, Lead time zero.
1) MODEL –I : DISCRETE DEMAND, DISCRETE STOCK LEVEL, SET UP COST
ZERO, LEAD TIME ZERO

The objective of this model is to find an “optimum stock level” rather than to find the “optimum order
quantity (EOQ). The advantage of this model is to achieve the long term expected profit from selling
a unit with the potential loss of having to scrap it.

Let D = Instantaneous (Discrete) demand

Q = Order size

Ch = C C = Carrying cost / unit or holding cost / unit/ period

CS = Shortage cost / unit / period

 ¿
We have to find the optimal level of inventory ( Q ) at the beginning of the period and minimizes the
Total Expected Cost (TEC) which is associated with the “surplus” and “shortage”.

Depending upon the relationship between D & Q, 2 situations may arises

i) D≤Q ii) D≥Q

Inventory level
Demand < Supply

D<Q

Q D

D-Q

Surplus Stock (Or)

Over Stock

Time

Demand > Supply

Inventory Level
D>Q

D Q

D-Q

Time
Shortage Stock (or)

Under Stock

t
FORMULA:
¿
The optimum inventory level ( Q ) is determined when the value of Cumulative Probability

Distribution (C.P.D.) exceeds the ratio

CS
CC +C S ( )
P [D≤ (Q¿-1)] ≤ ( CS
CC +C S )
≤ P [D≤ (Q¿)]

PROBLEM -1:

The probability distribution of monthly sales of certain item is as follows

Monthly sales 0 1 2 3 4 5 6
Probability 0.01 0.06 0.25 0.35 0.20 0.03 0.10
The cost of carrying inventory is Rs. 30 per unit per month and the cost of unit shortage Rs. 70 per
month. Determine the optimum stock level that minimizes the total expected cost.

SOLUTION: Given that CC = Holding cost or Carrying cost / unit / month = Rs. 30 / unit / month

CS = Shortage cost = Rs. 70 / month

Then the critical ratio is = ( CS

CC +C S
=
)( 70
30+70
=
70
100 ) ( )
= 0.7

The optimum solution is obtained by developing the cumulative probability distribution of monthly sales
as follows.

Monthly 0 1 2 3 4 5 6
sales
Probability 0.01 0.06 0.25 0.35 0.20 0.03 0.10
Cumulative 0.01 0.07 0.32 0.67 0.87 0.90 1.00
probability
¿
P[D≤ (Q )]
¿
This suggests that Q = 0.70 lies between 0.67 & 0.87

⟹0.67 ≤ 0.70 ≤ 0.87 ⟹P [D≤ (4-1)] ≤ 0.70 ≤ P (D≤4) ⟹ P [D≤ (3)] ≤ 0.70 ≤ P (D≤4)
¿
Thus the condition for optimality suggests that Q = 4

∴Optimum Inventory Level Q = 4

¿

2) MODEL –II: DISCRETE DEMAND, CONTINUOUS STOCK LEVEL, NO SET UP COST,

LEAD TIME ZERO

This model is similar to Model –I except that the stock level is continuous.
If f (D) = Probability density function of the demand (D) of an item.

Q = Order size

Ch = C C = Carrying cost / unit or holding cost / unit/ period

CS = Shortage cost / unit / period

FORMULA:

The optimum order quantity (Q¿) is determined when the cumulative probability distribution is equal to

the critical ration (C.R.) =

CS
CC +C S ( )
( )
Q
CS
P [D≤ (Q )] ≤ ∫ f ( D ) dD =
¿

0
CC +C S

PROBLEM -1:

A baking company sells cake by its weight in kilograms. It makes a profit of Rs. 5.00 on
every kilogram sold on the day it is baked. It disposes of all cakes not sold on the date they are baked, at a
loss of Rs. 1.20 per kg. If the demand is known to be rectangular distribution lies between 2,000 and
3,000 kgs. Determine the optimum daily amount baked.

SOLUTION: Given that

C S = Profit = Rs. 5.00 per kg C C = Loss = Rs. 1.20 kg

The demand is a rectangular distribution lies between 2,000 and 3,000 kgs. We know that p.d.f. of
rectangular distribution is given by

1 1 1
f (D) = = = ; 2000 ≤ D ≤ 3000 →1
b−a 3000−2000 1000

Then the critical ratio is ( CS

=
5
= )5
CC +C S 5+1.20 6.20
= 0.80645 →2

The cumulative probability distribution is given by

[ ] [ ]
Q Q Q
1 1 D Q−2000
P [D ≤ Q] = P [2000 ≤ D ≤ Q] = ∫ 1000
f ( D ) dD =
1000 ∫ f ( D ) dD =
1000
=
1000
→3
2000 2000 2000

The optimum value of inventory level is obtained by equating C.p.d.f. to the ratio ( CS
CC +C S)i.e.

⟹∫ f ( D ) dD = ( ) ⟹ [ = 0.80645 ⟹ [Q-2000] = 0.80645 (1000)

]
Q
CS Q−2000
0
CC +C S 1000
⟹ [Q-2000] = 806.45 ⟹ Q = 806.45 + 20000 ⟹ Q = 2806.45

∴ The optimum daily amount baked is Q = 2806.45

¿

2) MODEL –I : CONTINUOUS DEMAND, DISCRETE STOCK LEVEL, SET UP COST

ZERO, LEAD TIME ZERO

This model is similar to Model –I except the cost equation is continunous and discrete stock
level will be different

D = Demand

Q = Order size

C h= C C = Carrying cost / unit or holding cost / unit/ period

C S = Shortage cost / unit / period

The n there may be 2 possibilities when D & Q are compared

i) D≤Q ii) D≥Q

FORMULA:
¿
The optimum order level (Q ) is determined when the value of Cumulative Probability Distribution

(C.P.D.) exceeds the ratio

CC
CC +C S ( )
P [L≤ (Q¿-1)] ≤ ( CC
CC +C S)≤ P [L≤ (Q¿)]

[ ∑ P ( D )+(Q− 12 ) ∑ ](
CC
) [ ∑ P ( D )+(Q+ 12 ) ∑ ]
Q−1 ∞ Q ∞
P(D) P( D)
≤ ≤
D =0 D=Q D CC +C S D =0 D =Q +1 D

PROBLEM -1:

The probability distribution of monthly sales of a certain item is follows

Monthly 0 1 2 3 4 5 6
sales (D)
Probability 0.02 0.05 0.30 0.27 0.20 0.10 0.06
The cost of carrying inventory is Rs. 10 per unit per month. The current policy is to maintain a stock
of 4 items at the beginning of each month. Assuming that the cost of shortage is proportional to both
time and quantity, Obtain the inputted cost of shortage.

SOLUTION: Given that

Q = Stock level = 4 units

 C C = Carrying cost = Rs. 10 / unit / month

D = Range of the month of sales lies between 0 to 6.i.e. 0 ≤ D ≤ 6

Now applying the optimum order (Q¿) formula to find the shortage cost.

P [L≤ (Q -1)] ≤
¿
( CC
CC +C S ) ¿
≤ P [L≤ (Q )]

[ ( )∑ ]( CS
) [ ( )∑ ]
Q+ 1 ∞ Q ∞
P(D) P( D)
∑ P ( D )+ Q− 12 D
≤
CC +C S
≤ ∑ P ( D )+ Q+ 12 D
D =0 D=Q D =0 D =Q +1

[∑ ( )∑ ]( CS
) [ D ]
( ) ∑ P(D)
3 6 4 6
1 P(D)
P ( D )+ 4−
2 D
≤
CC +C S
≤ ∑ P ( D )+ 4+ 12
D =0 D=4 D =0 D =5

Now calculate the value L.H.S

[ ∑ P ( D )+( 4− 12 ) ∑ ][ ∑ P ( D )+( 8−1

2 ) ]
3 6 3 6
P(D) P( D)
D
= ∑ D
D =0 D=4 D =0 D=4

[ ∑ P ( D )+( 72 ) ∑ ]
3 6
P(D)
=
D =0 D =4 D

= [ P ( 0 ) + P ( 1 )+ P ( 2 )+ P ( 3 ) ] + ( 72 ) {[ P (4)
4 ] +[
P(5)
5 ] +[
6 ]}
P (6)

= [0.02 + 0.05 + 0.30 + 0.27] + ( 72 ) [ 0.204 + 0.105 + 0.066 ]

= 0.92

We can find C S value from L.H.S or R.H.S

( ) ⟹ ( ) ⟹ C S = 0.92 (10+C S) ⟹ C S = 0.92 (10)

CS CS
Since = 0.92 = 0.92
CC +C S 10+C S
+0.92 (C S)

⟹ C S = 9.2 +0.92 (C S) ⟹ (C S - 0.92 C S ) = 9.2 ⟹

C S (1-0.92) = 9.2

⟹ CS = ( 0.08 ) ⟹ C S = 115 →1
9.2

Similarly from the R.H.S. value we have

[ ∑ P ( D )+( 4+ 12 ) ∑ ][ ∑ P ( D )+( 8+1
2 ) ]
4 6 4 6
P(D) P( D)
D
= ∑ D
D =0 D =5 D =0 D =5

= [ P ( 0 ) + P ( 1 )+ P ( 2 )+ P ( 3 ) + P ( 4 ) ] + ( 92 ) {[ P 5(5) ]+[ P(6)

6 ]}

= [0.02 + 0.05 + 0.30 + 0.27 + 0.20] + ( 92 )

[ 0.10 0.06
5
+
6 ]
= 0.975

( ) ⟹ ( ) ⟹ C S = 0.975 (10+C S)
CS CS
Since = 0.975 = 0.975
CC +C S 10+C S

⟹ C S = 0.975 (10) +0.975 (C S)

⟹ C S = 9.75 +0.975 (C S) ⟹ (C S -0.975 (C S ) ) = 9.75

⟹ C S (1-0.92) = 9.75

⟹ CS = ( 0.025 ) ⟹ C S = 390 →2
9.75

From equations 1& 2 we have

Hence the inputted cost of shortage is given by

Rs. 115 ≤ C S≤ Rs. 390