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Now, to find an expression for inventory carrying cost, think about the average inventory level. In a deterministic situation with constant demand and lead time, one places an order in such a way that when the stock position touches zero, the next lot arrives. At the arrival of a lot, Q units replenish the inventory because Q was the order quantity. Thus inventory level rises to Q + 0 = Q. Since the consumption rate is constant, the inventory level fluctuates between a maximum of Q units to a minimum of 0 units at constant rate. So the average inventory level will be (Q + 0)/2. So, the average inventory level = Q/2. Average inventory value = Qv/2. Here we simply multiplied the average inventory level by unit cost to get the average value of inventory. This is the amount getting blocked in inventory on an average. Since r is the rate of inventory carrying cost in fraction, Inventory carrying cost = Qvr/2 Cost of items for total demand of D units at the rate of v Rs./unit will be Dv. Thus Total cost (C) = AD/Q + Qvr/2 + Dv. .................................. (1) Here A, D, v and r are all estimated or forecasted values known to us. We are trying to find the order quantity Q that will make the total cost C minimum. So, C is a function of Q. We will use the concept of Maxima and Minima of Differential Calculus to find the value of Q for minimum C. This will give the Economic Order Quantity. Rate of change of C with respect to Q is given by dC/dQ which is differential coefficient of C with respect to Q. Differentiating the expression (1) for C with respect to Q we get dC/dQ = -AD/Q^2 + vr/2 For maxima or minima dC/dQ = 0, hence -AD/Q^2 + vr/2 = 0 or, AD/Q^2 = vr/2 or, Q^2 = 2AD/vr which gives Q = Sqrt (2AD/vr) .............................(2) This Q can give maxima as well as minima. To check for maxima or minima we will have to differentiate dC/dQ again. So d^2C/d^2Q = 2AD/Q^3
If we analyse 2AD/Q^3 we find that this expression will always give a positive value for positive A, D and Q. Hence the value of Q obtained above in (2) is for a minima. Thus Economic Order Quantity = Sqrt (2AD/vr)
Now you give a thought on the values of ordering cost and inventory carrying cost when we order for EOQ in every order and see if there is any relationship between the two.