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Definition: Economic Production Quantity (EPQ)
Economic production quantity (EPQ) is the quantity of a product that should be manufactured in a single batch so as to minimize the total cost that includes setup costs for the machines and inventory holding costs.
The basic model of EOQ gives the equation to calculate EOQ as follows,
EOQ= √((2* D*Co*P)/(Ci*(P-D)))
D = Annual demand for the product
P = Annual rate of production
Co= fixed cost per setup or the setup cost
Ci= Inventory holding cost per unit
This is deduced by differentiating and finding the minima for the equation for the total annual cost, which comprises of the setup cost and the inventory holding cost.
With increasing batch production quantity, the number of batches to be produced in the year decreases and thus the setup cost decreases but at the same time the inventory holding cost goes on increasing. At the EPQ value, the total cost comprising of both these costs is at its minimum value.