Set-up costs are incurred each time a new production lot is produced.

Computing the economic order quantity is a matter of minimizing the costs of ordering inventory and the cost of carrying inventory.

The economic order quantity is calculated as follows:

            √ (2 x annual usage x cost of placing an order) ÷ annual unit carrying cost

Stock-out costs are the costs of carrying sufficient inventory.

If orders are placed more frequently for smaller amounts, the average number of units in inventory will fall.  This will have the effect of increasing the total ordering cost and decreasing the total carrying cost.