The economic order quantity and inflation uncertainty

Inflation uncertainty is introduced into a basic EOQ model and its potential to make mischief is explored. Among other things, it is shown that even when the expected rate of inflation is less than the marginal cost of capital, the appropriate discount rate to use in computing a discounted expected total inventory cost will not necessarily be negative. Therefore, the classic EOQ square-root formula may drastically underestimate the optimal lot size. The results may be generalized to the more complex inventory models.