An Optimal Inventory Model: Income and Loan Availability Elasticity

International Journal of Research in Engineering and Science (IJRES)
ISSN (Online): 2320-9364, ISSN (Print): 2320-9356

www.ijres.org Volume 1 Issue 3 July 2013 PP.39-49
An Optimal Inventory Model : Income and Loan Availability Elasticity

Dr.J.K.Mantri
Deptt of Comp.Application
North Orissa University

jkmantri@gmail.com
ABSTRACT:
The pre sent pape r cons iders the effect of inc ome a nd loan
elastic it y on deman d and determ ines the bu yers opt ional specia l order ,
quant it y as w ell as the optima l time . When the supplier reduce s h is sale
price , the buyer ca n offer a disc ount to push his sa le, so as to incre ase
the profit margin. The pa per introd uces incom e and loan availabilit y
elastic it y effect in inv entory management. Th e g ain equation has been
derived to f ind out the opt imal specia l order quantity and pr ofit
associated w ith it under tw o different condit ions i.e . w hen the remna nt
inv entory is z ero a nd w hen the r emna nt inv entory is f init e.
Keywords: Elasticity,Inventory model,Profit,Loan
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39 | Page

INTR ODUCTION
The elas tic ity of dem and is an ec onom ic term s whic h ref ers to the
res pons ivenes s of dem and to the c hange in pric e. W hen th e dem and is not
elastic, the dras tic change in pr ic e m ay not af f ec t the dem and, f or exam ple a
f all in pric e or ris e in price d oes no t c hange the dem and of ess enti al
c omm odities . In c ase of a fall in pric e tends to reduce dem and and ris e in
price tends to exten d dem and. But in c a se of the artic les , which are s ensitiv e
to the c han ge in pr ic e, the dem and inc reases or dec reas es , s uc h goods or
produc t are pr ic e res ponsive. T he present pa per is devoted to introduce a
new concept i .e. in c om e and loa n availab ili ty e las tic it y v is --vis in ventor y
m odels . Incom e an d loa n availab ili ty el as tic ity m a y be def ined as:
E1 = Proportionate change in demand / Proportionate change in (income + loan availability).
The optional po lic ie s f or no buyers discoun t and c ons tan t d em and are
deriv ed in [1]. O ptional ord ering p olic ies in respons e to perm anent pric e
inc rease
when
de m and
is
as s um ed
to
be
c ons tant
have
be en
well
doc um ented by [2 ], [3], [4] and [5 ]. A m odel to determ ine the o ptional
ordering polic ies f or a f in ite h orizon consis ting of two d is tinc t tim e interv als
c harac teri zed b y dif feren t i nventory param eters is presented by [6]. Mod els
which determ ine the optim al s pec ial order qua nti ty wh en s uppl ier re duces his
price tem poraril y, as s um e tha t th e r educ ed price is in ef fec t buyers
replenishm ent tim e and the dem and rate rem ains cons tant [1 ], [7] and [8]. In
m ost cas es a price dis c ount res ults in an increas e in dem and . Ardalan [9 ]
relax es dem and as s um ption m ade in m os t inv en tor y s ys tem with pr ic e
c hange . Ardalan [9] p res ents a proc edure to inc lude an y re lations hip b etween
price and dem and to determ ine th e c om bined to o ptim al pric e and optim al
order qua nti ty.
The pres ent p aper cons iders th e eff ec t of inc om e and loa n a vailabilit y
elastici ty on dem and and determ ines the bu yer s optim al s pecial order
quanti ty and optim al tim e. W hen s uppl ier reduc es the pr ic e tem porarily, the
buyer m ay of f er a dis c ount to his c us tom ers to push his s ale an d increas e
his prof it m argin. Th is paper brings in to pic ture inc om e and loa n ava ilab ili ty
dem and
rela tions hip,
whic h
dea ls
with
c lass if ic ation
of
products
into
ess ential a nd n on-es sential goods . For n on-es s ential goods lik e Luxuries the
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40 | Page

inc om e
and
loan
ava ilability dem and relati ons hip
is
c ons iderab le. W e
in trod uc e the inc om e and loan ava ilability el as tici ty ef f ec t in to invent or y

ana lys is and obta in the ga in equation to f ind optim al s pec ial order qua nti t y
under two c onditio ns i.e . wh en ther e is f inite rem nant inventor y and when i t
is zero. W e als o determ ine optim al tim e f or plac ing order quantity when th ere
is f inite rem nant i nv entory and extend i t to f ind the op tim al tim e f or plac ing
s uc h an order. W e furth er m odif y our m ode l to f ind c os t of s aving of spec ial
purc has e whe n s upplier announc es to increas e h is s ale pric e b y som e
am ount
f rom
specif ied
date .
Finally
an
op tim al
ordering
polic y
is
determ ined to get prof it m axim iza tion.
MODEL ASSUMPTIONS
The pres ent paper consider the ef f ec t of incom e and lo an a vailabilit y
elastici ty bec aus e of the f ac t th at in the c urren t l iberal ized m ark et and
c ons um erism , the f inanc ia l ins titutions are very m uc h liber al in f ina nc ing
c ons um er loans at ver y low percentage of interes t, the lo w rate loan
ava il ab ili ty c an be considered as an a id to bu ying c apac ity s o we f ind a
heavy dem and on non ess ential goods s uch as luxur y item s Autom obiles ,
Ornam ents etc . As for exam ple th is above eff ec t has an im pac t not on ly on
the
Gro wth
Rates
of
Indus tr ial
pro duction
of
India
bu t a ls o on
the
globa liza tion of Indi an econom y. The struc ture of interes t (loa n) rates and
the gro wth ra tes of industria l produc tio n in India ar e c ite d in T able (1) .
The
m odels
developed
in
th is
pap er
has
tak en
c are
of
the
s im ultane ous eff ec t of incom e c hange and ; loan f ac ilities on c las sic al
inv en tor y m odels . This c onc ept has ver y m uc h im portanc e to the s toc kies t to
go f or a better m argin of pr of it and im provem ent in their sale.
If E 1 is the inc om e and loan av ai labil ity E las tic it y, th en f rom its def ini tion .
E1 = Proportionate change in demand/ Proportionate change in (Income + loan availability)
D = Bu yer s annua l dem and;
D 1 = Buyers an nual dem and af ter d is c ount to c us tom er.
D 2 =Buyer s ne w annu al dem and af ter th e eff ect of inc om e and lo an
ava il ab ili ty elas tic it y.
Thus, New annual demand = Old demand (Change in income + loan availability)
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D 2 = D 1 + (E 1 prop ortionate c hange in (inc om e + Loa n avai lability) /100) D 1

D2 = D1 [1+ E1 proportionate change in (income + Loan availability) /100]
D 2 = D 1 (1+ Y+L) where
L = (E 1 propor tionate c hang e i n loan av ailab ility /100)
(1)
W here Y = (E 1 pro portionate c hang e in inc om e/100)

P = Suppliers reg ula r pr ic e per unit; P 1 = Bu yer s regular pr ice per un it;
P 2 = Buyer s s ale (reduc ed) pr ice per un it; C = ordering c os t p er ord er,
H = PF = Holding c ost per unit per year; F = Annual h olding c ost as a
f rac tion of unit c os t (carry cos t param eters ); E.O .Q. = the s i ze of an order
that m inim izes th e to tal invent or y c os t is k nown as ec onom ic order qua nti ty.
Q = Lo t s ize or order quantity in units (a s pec ial order q uantit y) ;
Tc = Total ann ua l c o st
Q r = Regular o ptim al order quantity = (2CD/PF)
(2)
Further if , d is the am ount wh ic h s upplier off ers on his s ale pric e a nd Qd is

regular optim al or der qu an tit y us ing the r educ ed pric e.
If inc om e and loan availa bi lit y elastic ity eff ec t is there, the n
Qd = [2D 2 C/(p-d) F]
= [2D 1 (1+Y+L) C/( P d) F]
(3)
If however the incom e and loa n availab ili ty elas tic ity ef f ec t is not there then
Y = 0;
Qd = [2D 1 C/(P d) F]
(4)
Q 0 = Special op tim al ord er qua nti ty wh en rem nant inven tor y i s zer o.
Q q = Special op tim al ord er qua nti ty wh en rem nant inven tor y i s not zero .
G r = G ain ass oc iated wi th regular pol ic y during Ts ;
Gs = Ga in as s oc iate d with s pecial order during T S .
T S = T he tim e interval betwee n th e tim e the bu yer rec eiv es the s pecial order
of size Q and his n ext re pl en is hm ent tim e.
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Optima l Special O rder Q uantit y w hen Remnant Inventor y is zero and

effect of income a nd lo an Av ailabilit y Elast ic ity is significant .
Suppose D 2 is the buyers ne w ann ua l d em and af ter c hange in incom e
and loa n availability elas tic ity of the c ustom er. At replen is hm ent tim e buyer
places an order of Q units at reduc ed pric e (off ered by s upplier). So the
buyer too off ers a disc ount to his cus tom ers on all the Q units . T S is the tim e
in terva l af ter whic h the s upp liers reduc ed pr ic e is not availab le an d b uyer
reverts to his us ual ordering polic y.
Now the gain ass oc iated wi thin the tim e interv al T S
G s = [P 2 (P-d)] Q [Q 2 (P d) F]/[2D 1 ( 1+Y+L) ] C
(5)
If suppliers reduc ed pric e and buyers dis c ount were perm anen t th en
c las sic al in ven tor y f orm ula of E.O.Q c ould be us ed to determ ine optim al
order qu an tity. As a res ult th es e are temporar y bus ines s m anoeuvirs and s o
th is c annot be us ed , but th es e c an be taken as rudim entar y too l to obta in
optim al po lic y f or s pec ial order Q d.
If d be the disc ount of fered on Qd units then purc has e cost of thes e Qd
units would b e (P d) Qd .
The num ber of units bought at us ual regu lar pr ic e during
T s = [D/D 1 (1+Y+L) ]( Q Qd)
(6)
Theref ore, the total buying cos t is

(P d) Qd+[PD/D 1 ( 1+Y+L) ](Q-Qd)
(7)
The holding c os t of the f irs t order is

Qd 2 (P-d) F /2D 1 (1+Y+L)
(8)
The holding c os t dur ing th e res t of Ts is

[Qr(Q-Qd)PF]/[2D 1 (1 +Y+ L)]
(9)
The to ta l ho ld in g c ost during Ts is

[Qd 2 (P-d) F ]/[2D 1 (1+Y+L)]+[Q r(Q-Qd)PF]/[2D 1 (1+Y+L)]
(10)
The num ber of order s plac ed d urin g Ts is

(1+D (Q-Qd)/D 1 (1+ Y+L) Q r]
(1 1)
The ordering c os t as soc iated wi th th is order wil l be giv en by

C[1+D(Q-Qd)/D 1 (1+ Y+L)Q r]
(1 2)
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The gain as s oc iate d with the usual (regular) order ing po lic y during Ts is
giv en by:
Gr=[P 2 (P-d)]Q d+(P 1 -P)D(Q-Qd)/D 1 (1+Y+L)-(P-d)FQd 2 /2D 1 (1+Y+L)
-Qr(Q-Qd)PF/2D 1 (1+Y+L)-C[1+D(Q -Q d)/D 1 (1+Y+L)Qr ]
(1 3)
In order to m axim ize gain the dif f erenc e betwee n Gr and G s s hould be
m axim ized.
G = [P 2 (P-d)] Q -Q 2 (P-d) F/2D 1 (1+ Y+L)-C
-[P 2 (P-d)]Q d-(P 1 -P)D(Q-Qd)/D 1 (1+Y+L)+(P-d)F Qd 2 /2D 1 (1+ Y+L)
+Qr(Q -Qd)PF/2D 1 (1+Y+L)+C[1+D(Q-Qd)/D 1 (1+ Y+L)Q r]
(14)
Diff erentiating G with res pec t to Q and e qua ting dG /dQ = 0 , we get
Q 0 = [D 1 (1+ Y+L) (P 2 -P+d)-(P 1 -P) D]/[(P-d) F]+[Qr P/(P-d)]
Putting Q 0 in Equation (14) to get the optimal value of G = C (Q 0 - Qd) 2 /Qd 2
Optimal Special Order Quantity w hen Remnant Inventory is not zero

and Effect of Income and Loan Availability Elasticity are significant.
If eff ec t of inc om e and l oan availability elas tic ity is c ons ider able and
ther e is suff ic ient rem nant inven tor y, then bu yer has two optio ns either to
buy at the reduc ed pric e of s upplier and s ubs equently of f er dis c ount to his
c us tom er or j us t avoid the bus iness ploy and foll ow h is us ual op tim al order
polic y.
If q b e the lev el of rem nant inventor y th en to determ ine s pecial order
quanti ty the d iff erenc e between Gr and G s s hould be m axim ized . If per
c apita inc om e ris ed and loan availab ility ris es inc rease in purc has ing po wer
of c us tom er, th e g ain as s oc iated with s pec ia l order qu an tity (Gs ) and ga in
ass oc iated wi th us ua l order in g po lic y (Gr) is expres s ed as Gs =Q(P 2 P+d)q 2 PF/2DqQ(P-d)F/D-[(p-d)FQ 2 ]/[2D 1 (1+Y+ L)]C
(1 5)
Gr=[DQ (P 1 -P)/D 1 (1+Y+ L)-(q 2 PF/2D)]

-(QrQPF/2D 1 (1+ Y+L)]- [DQC/D 1 (1+ Y+L )Q r]
(16)
The i nc reas e i n gain due to spec ial order is G = Gs G r.

G =Q (P 2 - P+d) - q 2 PF /2D- qQ( p- d) F/D- ( p- d)FQ 2 /2D 1 ( 1+Y+L) - C
DQ( P 1 - P) /D 1 ( 1+Y+ L)+q 2 PF /2D+Qr Q PF/2D 1 ( 1+Y+L) +DQ C/D 1 ( 1+ Y+L) Q r
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(17)
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To maximize profit differentiating G with respect to Q and equating dG/dQ = 0

Q q=[(P 2 -P+d)D 1 (1+Y+ L)-D(P 1 -P)]/[(P-d)F]
+QrP/(P-d)-qD 1 (1+Y+L)/D
(18)
Q q=Qo-[qD 1 (1+ Y+L)/D]
(19)
To determ ine the optimal tim e for placing spe cia l order Q q, a th eorem is
deduced: Theor em 1. Higher the income a nd loan ava ilability e lasticit y sma ller
the level of remnant inventory and it determines the optimal t ime for
pla cing optim al spe cial or der.
Proof : W hen rem nant inventor y is q the s pec ia l ord er qua nti ty is Q q
W hen
rem nant
inventor y
is
q - 1
the
op tim al
order
is
giv en
by
Qq+D 1 (1+Y+L) /D.

If E i is inc om e and l oan avai lability elas tic it y the n n ew dem and due to it is D 2
giv en by D 2 = D 1 (1+Y+L).
Using the gain equation 17 , p utting Q=Q q when rem nant inv entor y is q uni ts
and gain G as G q and Q = Q q - 1 when rem nan t inventor y is (q - 1 ) units and gain
G as G q - 1 .
W here Q q
-1
= Qq+[D 1 (1+Y+L) /D]
Equatio n 17
Gq= Qq(P 2 -P+d) qQq(P-d)F/D - (P-d)FQq 2 /2D 1 (1+Y+L)
C-DQq(P 1 -P) /D 1 (1+Y+L)+QrQqPF/2D 1 (1+Y+L)+DQqC/D 1 (1+Y+L)Qr
(20)
For rem nant inve ntor y (Q q - 1 )

Equatio n 17
G q - 1 = Q q - 1 (P 2 -P+d)-(q - 1 )Q q - 1 (P-d)F/D- (p-d)F(Q q - 1 ) 2 /2D 1 (1+Y+ L)
+QrQ q - 1 PF/2D 1 (1+Y+L)+DQ q - 1 C/D 1 (1+Y+L)Qr
- DQ q (P 1 -P)/D 1 (1+Y+L) -C
(21)
Here we need to Prove G q - 1 > G q i.e. G q - 1 G q = positiv e.

G q - 1 G q = D 1 (1+Y+L ) (P 2 -P+d)/D-D 1 (1+ Y+L)q (P-d)F/D 2
+D 1 (1+ Y+L)(P-d)F/2D 2 -P 1 +P+QrPF/2D+C/Qr
(22)
Using equation (1 8) in e quation (22) we get

[G q - 1 G q ][D/(P-d)F]= Qq+D 1 (1+ Y+L)/2D
W hic h is a positive valu e, th is proves the the orem .
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(23)
(Proved)
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Theor em 2
Higher the income and loan a va ilab ility elast icit y larger the leve l
of remnant invento ry and higher is the cost of sav ing w hen pr ice rise is
imminent.
Proof: If the supp li er changes his s ale polic y and he s to ps the d is c ount
giv en to c us tom er an d a nnounces a new inc reased sale pr ic e.
Let P be th e am ount b y wh ic h s upplier tends to i nc reas e his sale pric e
at som e date ti. The uni ts purc has ed bef ore ti will cos t p bu t purchase af ter
ti wil l c os t (P+p).
If D be the annu al d em and and Ei be th e inc om e and loa n a vailabilit y
elastici ty an d q be leve l of rem nant inventor y.
New demand due to income and loan availability elasticity = Old demand +change in demand
*
D =D(1+ Y+L)
(24)
The opt im al order qu antity b ef ore pric e inc reas e
Qr=(2CD * /PF) =[2CD(1+Y+L) /PF]
(25)
The opt im al order qu antity af ter the pr ic e ris e wi ll be :

Qr * =[2CD * /(P+p)F] =[2CD(1+Y+ L)/(P+p)F]
( 26)
To obtain optim al s pecial order s ize, i t is nec es s ary to m axim ize th e c os t

dif f erenc e during td tr with an d without s pec ial tim e order.
Total c os t = Purchased cos t+ Holding cost + O rdering c os t
Tcr=PQs+[QsPFq/D(1+Y+L)]+Qs 2 PF/2D(1+Y+L)]+[q 2 PF/2D(1+Y+L)]+C
(27)
If no s pec ial order is plac ed prior to ti the to tal c os t of the s ys tem

during tr to td when several purc has es of Qr* are m ade a t ne w pric e (P+p)
Tcs =(P+p)Qs+ (Qr* /2)(P+p)F(Q s/D*)+(q/2)PF(q/D*)+(Qs /Qr*)C
Using equation (2 4) and Equation (26)
Tcs = (P+p)Qs +( ) [2CD(1+Y+L) /(P+p)F]
(P+p)
F[Qs /D(1+Y+L )]+q 2 PF/2D(1+Y+L)+(Qs /Q r*)C
(28)
To find the op tim al order s i ze the dif f erenc e be tween Tc r and Tcs s hould be
m inim ized G = T cs-Tc r
G =Qs [p+C[F(P+p)/2D(1+Y+ L)]
-PFq/D(1+Y+L)- [PFQs 2 /2D(1+Y+L) ]- C
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(2 9)
46 | Page

Diff erentiating wi th respec t to Qs and puttin g dG /dQs = 0 , we get optim al

s pec ial order q uanti ty Qs o.
Qs o=Qr*/2+p/2PF[2D(1+ Y+L)+Qr*F ]-q
(30)
This is optim al s pecial or der s ize , putting equatio n 30 in eq uation 29 we ge t

the optim al cos t of s aving ass oc iated wi th Q so
GQs o[p+[CF+(P+p)/2D(1+ Y+L)] 1 / 2 PFq /D(1+Y+L) ]- PFQs o 2 /2D(1+ Y+L)]-C
Theor em 3:
If tf <tr the optima l ordering pol icy is
(i)
To order Q q at tf if Qq > Qd otherw ise
(ii)
Order Qr at tr
Proof: The valu e of the r em nant inven tor y Qr f or wh ic h G r and G s are equal
c an be d eterm ined by equating equa tio n 15 and 16.
Q(P 2 -p+d)-q 2 PF/2D-qQ (P-d)F/D-[(P-d)FQ 2 ]/[2D 1 ( 1+Y+L) ]-C
=[DQ(P 1 -P)/D 1 (1+Y+L)]-[q 2 PF/2D]- [QrQPF/2D 1 (1+Y+L) ]-[DQC/D 1 (1+Y+L)Qr]
Sim plif yi ng an d pu tting Q =Qq an d q=qc us ing equatio n (18) we g et
Qq/2=Qd 2 /2Qq=Q q 2 =Qd 2
(3 1)
Sinc e G s> Gr f or any Qq> Q d as long as Equation 31 ho lds g ood an d optim al

order si ze Qq a t tf would m axim ize the gain. O therwis e the us ual (regular)
ordering po lic y will be op tim al.
47 | Page
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Conclusions
W hen a s upplier red uc es his s ale pric e tem porarily, then bu yer m ight
f ollo w a polic y wh ic h inc reas es his dem and. Ho wever due to inc om e and loan
ava il ab ili ty elas tic ity eff ec t, the c hange in dem and m a y b e m uc h grea ter th an
expecte d. In f ac t inc om e and e las tic ity brings produc t c lass if ic ation, whic h is
an
im portan t
ec on om ic
c ons ideration.
The
m athem atic al
treatm ent
of
inf luenc e of inc om e elas tici ty of a bu yer s polic y is dis c uss ed. W e determ ine
the cas e of f inding optim al order quan tity an d prof it when supp li er reduced
his s ale pric e i n b oth s itu ation i.e. wi th/without r em nant inven tory. The
s pec ial cos t of s aving is determ ined when ris e in price is imm inent a nd
f inal ly order in g po lic y is d is c uss ed.
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48 | Page

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An Optimal Inventory Model: Income and Loan Availability Elasticity

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International Journal of Research in Engineering and Science (IJRES)

ISSN (Online): 2320-9364, ISSN (Print): 2320-9356