Demand for an item is 1,000 units per year. Each order placed costs $10; the annual cost to carry items in inventory is $2 each. In what quantities should the item be ordered?

The Economic Order Quantity (EOQ) is used to calculate the quantities that should be ordered each time.

EOQ = the square root of (2 x annual demand x ordering cost)/ holding or carrying cost per unit.

= square root of (2 x 1,000 x $10)/$2

= square root of 10,000 = 100

Explanation:

The EOQ is an important managerial tool for determining the quantity of a good that should be ordered at any point in time.  The use of this formula guides management in deciding the ideal reorder size.

As stated earlier, the EOQ provides the ideal reorder size to minimize costs.  It is at the EOQ point that the carrying cost and the ordering cost are equal, and total cost is minimized.