Quantity discount model:
(Production order quantity) (Fixed period model)
Quantity discount: A price reduction to encourage buying in large
quantities.
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Quantity discount forms:
1- % reduction of sales price for specific quantities (2 % for Q = 200 <
400), (4 % for Q > 400)
2- Different prices for different quantities. (Price breaks).
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TC = (D / Q) X S + (Q / 2) X H + D X C (C after discount)
Assumptions of quantity discount model:
1- Determine the EOQ total cost on the basis of the basic price (Without
discount).
2- If the computed Q is within a discount range, compute the total cost
on the basis of the discounted price. Then compute the total cost for the
minimum quantities required to benefit from higher discounts (lower
prices), and select the lowest total cost quantity.
3- If the computed Q falls below the discount range, choose the
minimum quantity in that discount range.
4- If the computed Q falls after the discount range, eliminate (Neglect =
Discard ) this discount range.
Notes:
*H could be mentioned as an absolute figure or as a percentage.
* In case of the absolute figure, holding cost will remain constant during
all discounts. (Not changed).
*In case of the percentage, holding cost percentage is always a
percentage of the purchase price whether mentioned or not. Holding
cost will change. (Multiply by the different purchasing price of different
discounts.
* In quantity discount model, EOQ must be computed in order to be
taken as a criterion against other quantities.
EX (Specific quantities):
D = 18,000 units Setup cost per order (S) = $20
Holding cost per unit per year (H) = $2 (Constant).
Cost per unit (C) = $10
Quantity discount (QD) schedule:
2 % for Q (1800 - < 3000)
3% for Q (3000 - < 6000)
4% for Q (> = 6000)
What is the best option?
First we calculate EOQ, and then its total cost:
2𝐷𝑆 2 𝑋 18,000 𝑋 20
EOQ = = = 600 units.
𝐻 2
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EOQ (TC) = (D / Q) X S + (Q / 2) X H + D X C =
(18,000 / 600) (20) + (600 / 2) (2) + 18,000 X 10
= 600 + 600 + 180,000 = 181,200
EOQ = 600 falls below the discounted quantities. In this case we
calculate the total costs depending on the lowest quantities of
each discount.
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TC (2% - 1800 (Lowest quantity)) =
(18,000 / 1800) (20) + (1800/2) (2) + (18,000) (10) (0.98)
= 200 + 1800 + 176,400 = 178,400
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There is a discount of 2% so it = (1-2%) = 0.98
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Note that Q = 1800 is 3 times larger than EOQ = 600
since Q increased, then H increase by 3 and S decrease by 1 /3
TC (3% - 3000 (L .Q)) = (18,000 / 3000) (20) + (3000/2) (2) + (18,000) (10) (0.97) =
120 + 3000 + 174,600 = 177,720
Note that Q = 3000 is 5 times larger than EOQ = 600 since Q increased,
then H increase by 5 and S decrease by 1 /5
So H = 600 X 5 = 3000 and S = 600 / 5 = 120
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TC (4% - 6000 (L . Q))= (18,000 / 6000) (20) + (6000/2) (2) + (18,000) (10) (0.96) =
60 + 6000 + 172,800 = 178,860
Note that Q = 3000 is 10 times larger than EOQ = 600 since Q increased,
then H increase by 10 and S decrease by 1 /10
So H = 600 X 10 = 6000 and S = 600 / 10 = 60
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Conclusion: (Extremely important)
1- EOQ cannot be used if any of its
assumptions is violated.
2- Higher discount is not always better.
3- Lowest price is not always better.
Another example (Different prices for different quantities): You have the following
information:
D = 3,600 S= 100
H = 20% (Percentage = not constant, so must be calculated for each price)
Price per unit Quantity range
$12 < 300
$10 300 < 500
9$ 500 < 800
$8.5 800 < 1200
$8.25 1200 < 1800
$8.15 > = 1800
What is the best option?
Step one: Find the optimal order quantity for each discount level.
(Use the formula)
Step two: For each discount level, modify quantity as follows:
* If Q is lower than the smallest quantity that qualifies for the discount,
increase Q to that level.
* If Q is greater than the largest quantity that qualifies for the discount,
eliminate this level from further consideration.
Step three: Substitute the modified Q value in the total cost formula TC
(Q)
Step four: Select the Q that minimizes TC (Q)
Solution: D = 3600 H = 20% of unit price S = 100
Price per Quantity
HC / Unit / Year EOQ TC
unit range
2 𝑋 3600 𝑋 100
EOQ > Q.
$12 < 300 20% X 12 = 2.4 = 548
2.4 SO, Eliminate
EOQ > Q.
$10 300 < 500 20% X 10 = 2 600
SO, Eliminate
(3600/ 632)(100) +
(632 / 2) (1.8) +
9$ 500 < 800 20% X 9 = 1.8 632
(3600 X 9) = 33540
(Q = 632)
$8.5 800 < 1200 20% X 8.5 = 1.7 650 31,730 (Q = 800)
$8.25 1200 < 1800 20% X 8.25 = 1.65 661 30,990 (Q = 1200)
$8.15 > = 1800 20% X 8.15 = 1.63 665 31,700 (Q = 1800)
The optimal quantity is 1200 units TC = 30,990
Examples
1- D = 5000 S = 49 H = 20 %
the discount schedule as follows:
Quantity Unit price
0 to 999 $5
1000 to 1999 $4.8
2000 and over $4.75
What is the best option?
