Figure 3 on page 202 shows inventory costs versus order quantity with emphasis o
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Question
Figure 3 on page 202 shows inventory costs versus order quantity with emphasis on the total cost, ordering cost, and the carrying cost. Discuss the significance of the shape of each curve and how it can be described in “plain language.” The curves also provide a graphical representation of the optimal order quantity. Discuss the significance of this point and why it coincides with the point of minimum total cost.
Cost Curve for Total Cost of Carrying and Ordering Minimum Total Cost Carrying Cost Curve Ordering Cost Curve Optimal Order Order Quantity in Units Quantity (Q)Explanation / Answer
Carrying cost curve is the curve of the Carrying cost. Carrying cost is the total cost of holding the inventory. This cost includes the cost of warehousing such as rent and utilities, financial cost such as opportunity cost and salaries and inventory cost such as insurance. As the number of units increases, the carrying cost per unit decreases.
Ordering cost curve is the curve of the Ordering cost. Ordering cost includes the procurement cost and inbound logistics costs. Ordering cost per unit is independent of the number of units and hence is a straight line.
Total cost is the sum of ordering cost and carrying cost. Ordering too less or excess quantities is factor affecting the total cost. Ordering less quantities results in increase in repenishment cost and ordering excess quantity leads to increase in carrying cost.
Optimal order quantity is the point where the carrying cost and the ordering costs are equal. The total minimum cost is determined by substituting the optimal quantity and hence it coincides with the point of minimum total cost.
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