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Inflation affects the EOQ model in two major ways. First, while the EOQ model can be modified to assume constant price increases, many times major price increases occur only once or twice a year and are announced ahead of time. If this is the case, the EOQ model may lose its applicability and may be replaced with anticipatory buying - that is buying in anticipation of a price increase in order to secure the goods at a lower cost. Of course, as with most decisions, there are trade off associated with anticipatory buying. The costs are the added carrying costs associated with the inventory that you would not normally be holding. The benefits of course, come from buying the inventory at a lower price. The second way inflation affects the EOQ model is through increased carrying costs. As inflation pushes interest rates up, the cost of carrying inventory increases. In the EOQ model this means that C increases, which results in a decline in the optimal economic order quantity. Determination of Optimum Production Quantity: The EOQ Model can be extended to production runs to determine the optimum production quantity. The two costs involved in this process are: (i) set up cost and (ii) inventory carrying cost. The set-up cost is of the nature of fixed cost and is to be incurred at the time of commencement of each production run. The larger the size of the production runs, the lower will be the set-up cost per unit. However, the carrying cost will increase with increase in the size of the production run. Thus, there is an inverse elationship between the set-up cost and inventory carrying cost. The optimum production size is at that level where the total of the set-up cost and the inventory carrying cost is the minimum. In other words, at this level the two costs will be equal. The formula for EOQ can also be used for
determining the optimum production quantity as given below:
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