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1.A company always determines its order quantity for a raw material by using Economic Order Quantity (EOQ) model.
What would be the effects on the EOQ and the total annual holding cost of a decrease in the cost of ordering a batch of raw material?
EOQ Annual holding cost
A. Higher Lower
B. Higher Higher
C. Lower Higher
D. Lower LowerMy answer is B but the correct answer is D but I’m a little bit confused . In my mind, i thought a high EOQ , means we order less . If we order less then we have less ordering cost . Thus holding cost will be high .
You are correct that with a lower EOQ then there will be more orders per year. However, the problem is that the cost of each order will be lower 🙂
The best way to be convinced is to make up a little example.
Try this one:Suppose the demand is 5,000, the holding cost is $2, and the order cost is $10.
You will find that the EOQ is 223.6, the total holding cost is $223.6 and the total order cost is $223.6. (At the EOQ the two annual costs are always the same).Now try the same example, but with the order cost as only $8.
You will find that the EOQ is lower at 200. The total holding cost is $200 and the total order cost is $200 (again they are both the same).The total cost is lower at the new EOQ, and both the total holding cost and the total order cost will also be lower.
I hope that helps 🙂
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