Lecture 10

INVENTORY MODELS (Part II)

Deterministic Probabilistic
Model Model
Forecast of Demand

Aggregate Planning

Master Production Schedule

Inventory Control

Operations Scheduling

Vehicle Routing 1
Demand Pattern in Inventory Model
Variation, V = (Standard deviation / Mean) x 100
1) Deterministic + constant (static) with time
 Average monthly demand is approximately constant
and V is reasonably small (< 20%)

2) Deterministic + variable (dynamic) with time

 Average monthly demand varies among different
months but V is reasonably small

3) Probabilistic + stationary over time

 Average monthly demand is approximately constant
and V is high(> 20%)

4) Probabilistic + non-stationary over time

 Average and V vary month to month
2
 EOQ Model with Price Breaks
• Assumed that the unit cost is independent of
the order quantity.
• Supplier encourages larger order sizes by
providing price discounts. Such quantity
discounts are common for many consumer
products.
• Two types of discounts:
– All units: discount is applied to all units.
– Incremental units: discount is applied to the
additional units beyond the breakpoint.

3
 EOQ Model with Price Breaks
The difference between the two types of discounting:
 Suppose that the charge for photocopying is $0.10 per
copy for 0-9 copies and $0.08 per copy for 10-49 copies.
If 12 copies are made the total charge is computed as
follows:
– All units: each of the 12 units is charged $0.08.
Total charge = $0.08  12 = $0.96
– Incremental units: the first 9 copies is charged
$0.10 each and the remaining 3 units are charged
$0.08 each.
Total charge = $0.10  9 + $0.08  3 = $1.14.

4
 EOQ Model with Price Breaks
• With all units discount schedule, the total charge may
be less if a larger quantity is ordered.
• If 9 units are ordered, Total charge = $0.10  9 = $0.90.
If 10 units, Total charge = $0.08  10 = $0.80.
• Even if you need 9 units, order 10 units, throw away the
10th unit and save $0.10.
Total Charge (All Units)

4.5
4
Total Charge $

3.5
3
2.5 $0.10/unit
2 $0.08/unit
1.5
1
0.5
0
0 10 20 30 40
Quantity Ordered 5
 EOQ with Price Breaks
0 q ∞

c1 (y < q) c2 (y > q)
KD hy KD hy
TCU1 ( y)  Dc1   TCU 2 ( y)  Dc2  
y 2 y 2

2 KD
ym 
h

TCU1 (ym) = TCU2 (Q)

EOQ with Price Breaks
c1 (y < q)
c2 (y > q)
EOQ with Price Breaks
 If y < b1, each item costs c1 dollars
 If b1  y < b2, each item costs c2 dollars
 If b2  y < b3, each item costs c3 dollars
b1, b2 and b3 are the price break points and c1>c2>c3
0 b1 b2 b3

c1 c2 c3

2 KD
1) Start from lowest price (ci), compute EOQ = h
2) IF EOQ < min. quantity for discount price, y = min. quantity;
ELSE y = EOQ KD hy
ci D  
3) Compute total cost (TCU) = y 2

Compare all total cost & choose lowest cost quantity.

 EOQ with Price Breaks
ServCar specializes in fast automobile oil change.
The garage buys car oil in bulk at RM 3 per gallon
discounted to RM 2.50 per gallon if the order
quantity > 1000 gallons.

The garage services 150 cars per day & each oil
change takes 1.25 gallons. ServCar stores bulk oil
at the cost of RM 0.02 per gallon per day. The cost
of placing an order is RM 20. There is a 2-day lead
time for delivery. Determine optimal inventory
policy.

Find D, h, K, L, c1, c2 & q.

 EOQ with Price Breaks
D= 150 x 1.25 = 187.5 gallons per day
h = RM0.02 per gallon per day
K = RM 20 per order L = 2 days
c1 = RM 3 c2 = RM 2.50 q = 1000 gallons

2 KD
1) Start from lowest price (ci), compute EOQ = h
2) If EOQ < min. for discount, y = min. for discount

KD hy
3) Compute total cost = ci D  
y 2
Compare all total cost & choose lowest cost quantity.
 EOQ with Price Breaks
D= 150 x 1.25 = 187.5 gallons per day
h = RM0.02 per gallon per day
K = RM 20 per order L = 2 days
c1 = RM 3 c2 = RM 2.50 q = 1000 gallons

2 KD
c2 = RM 2.50 EOQ = = 612.37 gallons
h
EOQ < q, y = q = 1000 gallons
Total cost2 = c D  KD  hy = RM 482.50
i
y 2

c1 = RM 3 EOQ = y = 612.37 gallons

Total cost1 = c D  KD  hy = RM 574.75
i
y 2

Compare all total cost & choose lowest cost quantity.

 EOQ with Price Breaks
D= 150 x 1.25 = 187.5 gallons per day
h = RM0.02 per gallon per day
K = RM 20 per order L = 2 days
Lowest TCU = RM 482.50 for y* = 1000 gallons
*
Cycle y L
t  n= =0
*
= 5.33 ≈ 6 days
Length 0 D t0
*

Effective Lead Le  L  nt 0
*
= 2 – 0(6) = 2 days
Time

Reorder Point, R = LeD = 2x187.5 = 375 gallons

Optimal Inventory Policy:

Order 1000 gallons whenever inventory level drops to 375 gallons
 EOQ with Price Breaks
y* = 612.37 gallons
Cycle Length, t0 = 6 days Le = 2 days
Policy: Order 1000 gallons whenever inventory level
drops to 375 gallons

375

6
Probabilistic Model
Use a buffer stock to count probabilistic
demand (Buffer Stock Model)

L = Lead time
XL= Random variable represent demand
 L = Average demand during
 L = Standard deviation of demand lead
 = Maximum allowable probability time
of running out of stock
B = Buffer stock size
“Probabilitized” EOQ Model
Continuous Distribution

Mean = 20
Standard deviation = 2.49
Continuous Distribution

The figure below shows

an example of uniform
distribution.
“Probabilitized” EOQ Model
 Demand per unit time is normal with mean D and
standard deviation 
 Demand, XL during lead time L is normally distributed
with mean  L & standard deviation  L

Probability to determine Buffer stock size:

Z B
L
From table: P(z > K) = α
B
=K
L
B = K/ L
“Probabilitized” EOQ Model
Neon lights of A campus are replaced when a
fault occurs. The physical plant orders the neon
lights periodically. It costs RM100 to initiate a
purchase order. A neon light kept in storage is
estimated to cost about RM0.02 per day. The lead
time is 12 days. Suppose the daily demand is
normally distributed with mean 100 and
standard deviation as 10, find the buffer stock
size such that the probability of running out of
stock during lead time is at most 0.05.

Find D ~ N( D , ), h, K & L.