Inventory Control Models

Introduction
1
An Inventory can be defined as a stock of goods which is held for the purpose of future or
sales. The stock of goods may be kept in the follow ing form

 Raw materials
 Partially finished products
 Finished products
 Spare sprats etc.

What are the factors that affect inventory level?

Inventory models can be classified according to the following factors:

The Basic Deterministic Inventory Models

Mode l I - Economic Orde r Quantity Mode l with Uniform Dema nd

To derive an economic lot size formula and the minimum average cost under the
following assumption:

Assumptions and Notations

1. D=Demand rate is uniform over time and is know n with certainty.

2. The inventory is replenished as soon as the level of the inventory reaches to zero. Thus
shortages are not allowed.
3. Lead time is zero.
4. The rate of inventory replenishment is instantaneous.
5. Quantity discounts are not allowed.
6. TC = Total average inventory cost
7. C3 = Set up cost per production run.
8. C1 = Cost of holding stock per unit per period of time.
9. Shortages are not allowed.

Let q be the units of quantity produced (or order) per product ion run at interval t.

Therefore, the quantity produced per production run (q) =Dt.

1
Total cost per production run= (holding cost + set up cost) = ( qt )C1 C 3
2

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 Inventory Control Models
1
C1 q C 3
2 1 C3 D 2
The average total cost (TC) C1q
t 2 q

This equation is known as cost equation. For minimum value of TC,

d 1 C3 D
(TC ) C3 0 2C 3 D
dq 2 q2 , Therefore q
C1

d2 2C 3 D 2C 3 D
(TC ) 0 For q
dn 2 q3 C1

* 2C3 D
Therefore, the optimum quantity is given by q q , which is know n as Econom ic
C1
lot size formula.

* q* 2C 3
The optimum time of t is given by t
D C1 D

The minimum total cost per unit time is given by

1 2C 3 D C1
TCmin = C1 C3 D 2C1C 3 D
2 C1 2C 3 D

Mode l II - Economic lot size mode l with uniform dema nd, finite rate of reple nishment
(production) having no shortage

Assumptions and Notations

1. D=Demand rate is uniform over time and is know n with certainty.

2. The inventory is replenished as soon as the level of the inventory reaches to zero. Thus
shortages are not allowed.
3. Lead time is zero.
4. The rate of inventory replenishment is instantaneous.
5. Quantity discounts are not allowed.
6. T= Total cost of inventory.
7. TC = Total average inventory cost
8. C3 = Set up cost per production run.
9. C1 = Cost of holding stock per unit per period of time.
10. K=production rate (>D).

If, q be the units of quantity produced per production rum, then the production will continue
for time (t 1 ) =q/k - - - - - - - (1)
And the time of one complete production run (t 1 ) =q/D

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 Inventory Control Models

If Q is the inventory level at moment of production is completed (i.e. at the end time of time
t1 )
Then Q = q - Dt 1
Dq
= q
K
D
= q 1 - - - - - - - - - -(3)
K
The holding cost for the period t = C1 *(area of OAB)
1
= C1 tq
2
qt D
= 1 C1 ---- - - - - (4)
2 K
The total cost (T) =<holding cost> + <setup cost>
qt D
= C3+ 1 C1
2 K
C3 q D
The average total cost (TC)= + 1 C1
t 2 K
C 3D q D
= + 1 C1 .This equation is know n as cost equation.
q 2 K

For minimum value of TC,

d C3 D C1 D
(TC ) 1 0 2C3 D K D
dq 2
q 2 K , Therefore q
C1 K

d2 2C 3 D 2C3 D K D
(TC ) 0 For q
dn 2 q3 C1 K

* 2C3 D K D
Therefore, the optimum quantity is given by q q , which is known as
C1 K
Economic lot size formula.

The minimum total cost per unit time is given by

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 Inventory Control Models

C1 K K C1 K 2C3 D K D K
TCmin= C3 D 1 2C1C3 D 1 . 4
2C3 D K D 2 D C1 K D

q* 2C3 K
The optimum time of t is given by t*
D C1 D K D

Example 1: Find the Optimum Quantity for the following EOQ model.

Annual usage 500 pieces

Cost per piece Rs. 100
Ordering cost Rs. 10 per order
Inventory holding cost 20% of A verage Inventory

Solution
Given that Demand (D) = 500 pieces
Set up cost (C3 ) = 10,
I=20%
Purchasing cost (P) =100
Holding cost (C1 ) =IXP= 100 X 20% = Rs. 20
2C3 D 2 10 500
EOQ= , EOQ = 22 pieces (rounded)
C1 20
Exercise

1. What are inventories?

2. What are the objectives that should be fulfilled by an inventory control system?

3. A company uses annually 48000 units of a raw material costing Rs. 1.2 per unit. Placing
each order cost Rs. 45 and the carrying cost is 15% per year of the average inventory. F ind
the economic order quantity. Supposing that the company follows the EOQ purchasing policy
that it operates for 300 days a year, that the procurement time is 12 days and the safety stock
is 500 units, find the reorder point, the maximum, minimum and average inventories.
5.(a) Discuss the Economics Order quantity model (EOQ) where the demand rate is uniform,
production rate is infinite and shortage are not allow.

(b) A particular item has a demand of 90 00 units/ year. The cost of one procurements is Rs.
100.00 and the holding cost is Rs. 2.40/ year/ unit. The replacement is instantaneous
and no shortage is allowed. Determine
(i) Economics lot size (q*)
(ii) No. of orders/ year (n*)
(iii) The time between orders (t*)
(iv) The total cost/ year if the cost of 1 unit is Rs. 1.00. (TC*)

6. Determine EOQ in an inventory control problem having

a) Constant rate of demand
b) Instantaneous replenishment and
c) Finite rate of production.

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Introduction: 5
The term 'dynamic programming' refers to a general optimization technique useful for solving a
class of multistage problems

Applications of DP

Production
Inventory control
Allocation of Resources
Equipment replacement polices
Selection of advertising media.

Example-2: Use Bellman’s Principle of optimality to minimize z= y1 +y2 +… +yn , subject to

the constraints: y1 .y2….yn=d?

Solution: Let f n(d) denote the minimu m attainable sum Y 1 +y2-----+Y n when the quantity d is
factorized into n factors.

For n=1, d is factorized into one factor, so f1 (d) =Y1 =d

For n=2, d is factorized into two factors Y 1, Y2 , if Y1 =z and Y2 =d/z, then

f2 (d) = min ( Y1 + Y2 )

Min d
z }
0 z d z

Min d
z f1 ( )}
0 z d z

For n=3, d is factorized into three factors Y 1, Y2 ,y3 , if Y1 =z and Y2 y3 =d/z, then

f3 (d) = min ( Y1 + Y2 +y3 )

Min d
z f 2 ( )}
0 z d z

Preceding likew ise, the recursive relation for n=i become:

f i (d)= min (z+f i-1(d/z)), for all i=2,3,-----n.

Now proceed to solve the functional as follows:

f1 (d)=d,

Min d
f2 (d) z } , By calculus method
0 z d z

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 Inventory Control Models
d
= d 2 d
d 6

Min d
F3 (d) z f 2 ( )}
0 z d z

Min d
z 2 }
0 z d z

1 d 1 1
d 3
2 3d 3
. By Mathematical induction, assume for n=m, f m (d ) md m
.Now the
d1 3
result can be proved for n=m+1 as follows,

Min d
F m+1 (d) z f m ( )} , By calculus method
0 z d z

Min d
z 2m }
0 z d z

1 1 1 1
(m 1)d 1 ( m 1)
. Hence the optimal policy will be d n
d n
.… d n
with f n (d ) nd n

2
Example-3: Solve the following D.P.P Minimize z y 21 y22 y3 CS-511/2003

subject to y1 y2 y3 15
y1 , y 2 , y 3 0

Solution: Decision Variables Y 1 ,Y2 , Y3 and stage Variables S1 , S2 and S3 are defined as:

S3 = Y 1 + Y2 + Y3 15

S2 =Y 1 + Y2 = S3 – Y3

S1 =Y1 = S2-Y2

and

Min 2
F3 ( S 3 ) y 3 F2 ( S 2 )
y3

Min 2
F2 ( S 2 ) y 2 F1 ( S1 )
y2

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Min 2
F1 ( S 2 ) y 1 = (S2-Y1)2 7
y1

Min 2
Thus, F2 ( S 2 ) y 2 (S 2 y2 ) 2
y2

By calculus, Y22 + (S2 -Y2)2 is minimum if it derivative with respect to Y2 is zero.

i.e. 2Y2-2(S2-Y2)=0 which gives Y 2 = S2 /2,Hence F2(S2 )= S22 /2.

Min 2
Now, F3 ( S 3 ) y 3 F2 ( S 2 )
y3

Min 2 (S 3 y3 ) 2
y 3
y3 2

Again using calculus, for minimu m value of single variable y 3 ,2y3-(s3- y3)=0

S3 S 23
Or, y3 = . Hence F3 (s3)= since S3 ≥15. Therefore F 3 (s3 ) is minimum for S3 =15.
3 3

2
The minimum value of z y 21 y22 y 3 becomes 75, Where Y1 = Y2 = Y3=5.

Exercises
1. What is Dynamic Programming? In w hat areas of management can it be applied
successfully?

2. Discus briefly: a) The general similarities between dynamic and linear programming

b) How dynamic programming differs from linear programming?

3. Def ine the follow ing terms Stage, State, Principle of optimality?

4. Solve the follow ing Dynamic Programming: Max Z = X1 .X2 .X3………….. Xn

Subject to the constraints X1 +X2 +X3 +……..+Xn = C. Xj ≥ 0 j=1,2, …,n.

5. State Bellman's Principle of optimality in Dynamic programming Problem and formulates it

mathematically. CS-511/2003

Pre pared by Dr. Dipa k Kumar Ja na

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