Economic Order Quantity - EOQ

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DEFINITION of 'Economic Order Quantity - EOQ'

An inventory-related equation that determines the optimum order quantity that a company should hold in its inventory given a set cost of production, demand rate and other variables. This is done to minimize variable inventory costs. The full equation is as follows:

Economic Order Quantity (EOQ)

where :
S = Setup costs
D = Demand rate
P = Production cost
I = Interest rate (considered an opportunity cost, so the risk-free rate can be used)

BREAKING DOWN 'Economic Order Quantity - EOQ'

The EOQ formula can be modified to determine production levels or order interval lengths, and is used by large corporations around the world, especially those with large supply chains and high variable costs per unit of production.

Despite the equation's relative simplicity by today's standards, it is still a core algorithm in the software packages that are sold to the largest companies in the world.

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