Lecture - 02 - Part 1 and 2
Lecture - 02 - Part 1 and 2
Lecture - 02 - Part 1 and 2
Chapter 2 – Lecture 02
Cost Concepts and Design Economics
Type of Costs:
• Fixed costs:
- Unaffected by changes in activity level over a feasible range of
operations for the capacity or capability available.
Examples:
- Insurance and Taxes on facilities
- Administrative salaries
- License fees
- Interest cost on borrowed capital
- Rent .
Fixed, Variable, and Incremental Costs
• Variable costs:
- Change according to the quantity of a good or service being
produced.
Examples:
-Costs of material and labor used in a product or service
- Sales tax
- Hauling
- Packaging
- Fuel costs
Fixed, Variable, and Incremental Costs
• Incremental costs:
Is the additional cost (or revenue) that results from
increasing the output of a system by one (or more)
units.
- Compare the two sites in terms of their fixed, variable, and total costs. Assume
that the cost of the return trip is negligible. Which is the better site?
- For the selected site, how many cubic yards of paving material does the
contractor have to deliver before starting to make a profit if paid $12 per cubic
yard delivered to the job location?
Direct, Indirect, and Standard Costs
• Direct costs:
Are costs that can be reasonably measured
and allocated to a specific output or work
activity.
Examples:
Labor and material costs directly associated
with a product, service, or construction
activity
Direct, Indirect, and Standard Costs
• Indirect costs:
Are costs that are difficult to allocate to a specific output or work
activity.
Examples:
- Costs of common tools
- General supplies
-Equipment maintenance in a plant
Direct, Indirect, and Standard Costs
• Standard costs:
• Cash Cost:
A cost that involves payment of cash (and
results in a cash flow)
• Book Cost:
A cost that does not involve a cash transaction
but is reflected in the accounting system.
(equipment, machines, Depreciation)
Sunk Cost
• Sunk Cost:
Is one that has occurred in the past and has no relevance to
estimates of future costs and revenues related to an
alternative course of action.
Examples:
- Earnest money on a house
- Money spent on a passport
Opportunity Cost
• Opportunity Cost:
Is the monetary advantage foregone due to limited
resources.
- The cost of the best rejected opportunity.
Example:
-Consider a student who could earn $20,000 for working
during a year but chooses instead to go to school for a year and
spend $5,000 to do so.
The opportunity cost of going to school for that year is
$25,000: $5,000 cash outlay and $20,000 for income
foregone.
Life-Cycle Cost
• Life-Cycle Cost:
It refers to a summation of all the costs related to a product, structure, system, or service
during its life span.
The General Economic
Environment
Consumer and Producer Goods and Services
• Consumer goods and services are those
products or services that are directly used by
people to satisfy their wants. Food, clothing,
homes, cars, television sets, haircuts, opera, and
medical services are examples.
1- Necessities.
2- Luxuries.
Price (P) – Demand (D) Relationship
Price (P) – Demand (D) Relationship
Price (P) – Demand (D) Relationship
p = a - bD
where p is price, D is demand, and a and b are constants that depend on the particular product
or service.
Where a is the intercept on the price axis and −b is the slope. Thus, b is the amount by which
demand increases for each unit decrease in p. Both a and b are constants.
D = (a − p)/b (b ≠ 0).
Competition
Competition
• At any demand D;
Total Cost (CT) = Fixed Cost (CF) + Variable Cost (CV)
CT = CF + CV
Variable Cost (CV) = Variable cost per unit (cv) × Demand (D)
CV =cv × D
Total Cost : CT = CF + cv × D
Scenario 1: Demand is a Function of Price
Scenario 1: Demand is a Function of Price
At any volume (demand), D,
Profit (loss) = total revenue − total costs
= (aD − bD2) − (CF + cvD)
= −bD2 + (a − cv)D − CF
for 0 ≤ D ≤a/b and a > 0, b > 0.
2.Total revenue (TR) must exceed total cost (CT) for the period involved.
Scenario 1: Demand is a Function of Price
To find the maximum profit:
d profit
= a − cv − 2bD = 0
dD
d2 profit
= −2b € 0
dD 2
Total revenue = total cost (breakeven point) aD − bD2 = CF +cvD −bD2 + (a − cv)D − CF =0
1/2
− a − cv ± a − cv 2 − 4 −b −C F
D‘ =
− 2b
Scenario 2: Price and Demand are Independent
Summary