Exchange curve (or optimal policy curve) is an effective technique to look at the inventories at an aggregate level in the organization. It is a plot between the total number of orders (TO) per year and the total investment in inventories (TI) per year. The rationale is that for an optimal inventory policy the trade-off between total inventory and total procurement effort as indicated by the total number of replenishment orders per year must be made such that if total number of order is prescribed, we minimize total investment in inventories. Alternatively, if the total investment in inventories (TI) is prescribed then a rational inventory policy must aim at minimizing (TO). Optimal inventory policy must exchange (TI) for (TO) in such a manner that
(TI) . (TO) = K = constant Value of constant K is given by
Where Di = Annual requirement of ith item,
V, = Unit price for ith item, i = 1….N
Thus a plot between (TI) and (TO) is a rectangular hyperbola and is called as `Exchange curve’ or `optimal policy’ curve, Figure V shows a typical exchange curve for a situation where the ordering cost is not explicitly known. It shows that any point on the exchange. Curve is an optimal trade-off between investment in inventories and total number of orders.
Uses of Exchange Curve
Exchange curve is an effective instrument for aggregate inventory analysis to quickly determine the rationality (or otherwise) of our existing stock provisioning policies. We first plot the exchange curve by computing the value of K for a chosen group of items. Then we determine the total number of orders (TO) and total investment in inventories (TI) under current practice.
If the current practice is at point C (in Figure V) above the exchange curve then it shows that our present procurement policies are not rational. If we want to rationalize these then there are two possible paths-AC or BC; so that we reduce inventory to B for the same ordering effort or reduce number of orders to A for the same inventory. Thus an exchange curve is a useful device at macro-level.
