The basic inventory decision model is Economic Order Quantity (EOQ) model.  This model is given by the following equation:

Where:    Q is the economic order quantity
    D is the annual demand in units
    Co is the cost of placing and receiving an order
    Cn is the cost of holding inventories per unit per order

The total cost of operating the economic order quantity is given by total ordering cost plus total holding costs.

TC = ½QCn +

Where:    Total holding cost = ½QCn
    Total ordering cost =

The holding costs include:

1. Cost of tied up capital
2. Storage costs
3. Insurance costs
4. Obsolescence costs

The ordering costs include:

1. Cost of placing orders such as telephone and clerical costs
2. Shipping and handling costs

Under this model, the firm is assumed to place an order of Q quantity and use this quantity until it reaches the reorder level (the level at which an order should be placed).  The reorder level is given by the following formulae:

Where:    R is the reorder level
    D is the annual demand
    L is the lead time in days