Sujit Subhash & Tejaswi Materla

EOQ with
Finite
Production
Rate

The EOQ with Finite Production rate or

Economic Production Quantity (EPQ)
Model is a simple extension of the
classical EOQ model, and the EPQ is
defined as the optimum production
quantity, which minimizes the total cost
of both the holding cost associated with
the storage of a product produced at a
rate Q per cycle of production and the
setup cost for setting up each cycle of
production.

EPQ

EOQ with Finite Production Rate

Introduction
The Economic Order Quantity (EOQ) Model is an inventory control model used to calculate
optimum quantity that needs to be ordered to minimize the total cost of both the inventory
holding cost and the setup cost associated with the ordering of a single product. Industries have
been using this model and extensions of this model for over a century to optimize their purchases
or productions.
The EOQ with Finite Production rate or Economic Production Quantity (EPQ) Model is a simple
extension of the classical EOQ model, and the EPQ is defined as the optimum production
quantity, which minimizes the total cost of both the holding cost associated with the storage of a
product produced at a rate Q per cycle of production and the setup cost for setting up each cycle
of production. The EPQ model like the EOQ model is based on the demand rate being
deterministic and is a single product inventory control method.
With increasing batch production quantity, the number of production cycles per year decreases,
thus decreasing the setup costs but at the same time the inventory holding cost goes on
increasing. At the EPQ value, the total cost comprising of both these costs is at its minimum
value.
The key difference between the EOQ model and EPQ Model is that the EPQ model seeks to
optimize the production quantity per batch of production cycle and that the company produces its
own parts or receives them while they are being produced whereas in the classical EOQ model a
company seeks to minimize the total costs by optimizing the order quantity per cycle.
In the EOQ model, the inventory replenishment is immediate and fresh order are delivered in full
spontaneously when the inventory level reaches zero. But the orders in the EPQ model are
received gradually over time. This situation occurs often in a manufacturing environment where
the manufacturer is also the consumer (buyer or customer of the inventory).

EOQ Model Inventory

level

Formulation
In the EPQ model, the products are being consumed at a rate per year as they are being
produced at a rate P per year; the inventory buildup is gradual at rate P-. When the inventory
reaches its maximum value H production is stopped and the inventory is allowed to be consumed
till it reaches zero after which production is resumed at its normal rate. The cycles are assumed
to be repetitive.

In v e n to r y

S lo p e = P -
H

S lo p e = -

T1

T im e

T2
T

The cycle length is T given by Q/ , The uptime T1 is the time required to produce quantity
Q,
T 1=Q /P .

The holding cost/unit/year is given by h. Since the inventory level is increasing at a rate P-,

H
=P
T1

H =T1(

Total Cost = Inventory Cost + Setup Cost

H=

( QP )( P)

H=

Q 1

The average cost function given by G(Q) as a function of the quantity Q is minimized to obtain
the EPQ.
G ( Q )=

A Hh
+
T 2

A
,Hh
isthe setup cost function
isthe average holding cost function
T
2

G ( Q )=

A h

+
Q 1
Q 2
P

( )( (

( )( (

A Q

+
h 1
Q
2
P

G ( Q )=

))

))

A Q h'
+
Q
2

Where h '

is

h 1

Solving the EPQ model

'

A Q h
G ( Q )= +
Q
2

The objective of the EPQ model is to obtain the production quantity Q, which minimizes the
average cost function G(Q)
To minimize the average cost function we take the first order derivative of G(Q) with respect to
Q and equate it to zero. To ensure that we are finding the minimum value of G(Q), we must
check if the second order derivative of G(Q) with respect to Q is > 0 at Q*.
'

G ( Q )=

A h '
+
2
Q2

G ' ' ( Q )=

G' ( Q )=

2A
3
Q

A h '
+ =0
2
2
Q

Solving the above equation for Q, we obtain the EPQ value of Q*, where
Q =

2 A
h'

''
To check for minimization we use Q* in the equation for G ( Q )

''

G ( Q )=

Q =

2A
Q3

2 A
h'

G' ' ( Q ) >0 as all the valuesthe equation are positive

Hence, Q* gives the production quantity at which cost is minimized.

Therefore Q =

2 A
h'

'
is the EPQ. [ where h is

is

h 1

As the graph indicates, the cost vs quantity equation has a fairly flat range near the EPQ value
Q*, it can also be observed that the holding costs and setup costs are equal at Q*, this shows that
in minimizing the cost function we try to obtain a balance between the inventory cost and setup
cost.

Applications
Applications of the EPQ model can be found in companies that produce to meet its own demand
requirements, where the demand and production rate can be controlled, and the production cycles
can be kept repetitive and constant.
Some of the industries that use the EPQ Model to optimize its production is listed below,

Processed food

Window Manufacturing Factory

Toolkit production for cars

Automobile Parts

Fertilizer industry

Chemical Production companies

Steel Manufactures

Toy Manufactures

Electronic Appliances

FMCGs (Fast Moving Consumer Goods) Shampoos, Detergents, etc

Specialty Products (Customizable Products)

Example
A manufacturer R of chemical preservatives uses the EPQ model to produce his product X1.
He sells them in only 1lb packets to his clients, he supplies exclusively to a fixed number of elite
customers who have an understanding to buy a combined total of 400 1lb packets a year.
Rs factory produces at constant rate of 600 1lb packets a year. Rs rented warehouse charges him
$11 per lb per year and his factory has a setup cost for each production cycle of $44.
Find his Optimum production quantity of X1 using the EPQ Model.

Solution:
P = 600 packets per year
= 400 packets per year
A = $44 per cycle
h = $11 per packet per year

h' =h 1

h' =11 1

400
600

'

h =3.67
According to the EPQ model his optimum production quantity is,
Q =

2 A
h'

Q =

244400
3.67

Q = 9600
Q =97.97 98
Therefore according to the EPQ model, R should produce 98 1lb packets of X1 per production
cycle.

References
http://home.ubalt.edu/ntsbarsh/Business-stat/otherapplets/Inventory.htm
http://www.freewebs.com/economic_order/illustrate2.html
http://en.wikipedia.org/wiki/Economic_order_quantity
http://en.wikipedia.org/wiki/Economic_production_quantity