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COST TERMINOLOGY

(Taken from De Garmo, et al, Engineering Economy, 8th


Ed., McMillan Publishing Co., New York, 1988.)

Sunk cost 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.
a past expenditure that cannot be recovered, or capital that has already
been invested and cannot be retrieved.

Opportunity cost is the cost of the best


rejected (i.e., foregone) opportunity. It is
incurred because of limited resources
such that the opportunity to use those
resources to monetary advantage in an
alternative use is foregone.
Fixed costs unaffected by changes in activity
level over a feasible range of operations
for the capacity or capability available.
(E.g., insurance, general administrative
salaries, license fees, etc.).
Variable costs those associated with an
operation that will vary in relation to
changes in the quantity of output or other
measures of activity level. (E.g., labor
and material costs).

CE 22 Engineering Economy General Economic Environment

Incremental cost/revenue the additional cost


or revenue that will result from increasing
the output of a system by one or more
units.
Recurring costs repetitive and occur when
an organization produces similar goods
or services on a continuing basis.
Nonrecurring costs not repetitive although
total expenditure may be cumulative over
a relatively short time period.
Direct costs those that can be reasonably
measured and allocated to a specific
output or work activity
Indirect costs difficult to attribute or allocate
to a specific output or work activity
cost elements closely linked to support of
operations;
costs incurred for the general operation of
the business

Overhead costs all expenditures that are not


direct costs. (E.g., indirect costs, general
and administrative costs)

CE 22 Engineering Economy General Economic Environment

Standard costs representative costs per unit


of output that are established in advance
of actual production or service delivery.
Cash costs involves actual payment of
money
Book costs does not involve an actual
transaction but is reflected only in the
accounting system. (E.g., depreciation)
Life-cycle cost refers to the summation of all
the costs, both recurring and nonrecurring related to a product, structure,
system, or service during its life span.

The Concept of Utility


The concept of utility is used to represent
the attractiveness of the alternatives. Utility
being defined tautologically as what the
individual seeks to maximize.
Example:

PERFORMANCE CHARACTERISTICS

QUALITY OF SERVICE IN TRANSPORTATION - refers to


the degree with which the passengers enjoy the
services rendered. Quality in terms of COMFORT,
CONVENIENCE,
AESTHETICS,
CLEANLINESS,
ATTITUDE OF CREW, SIMPLICITY IN USING THE
SYSTEM and other amenities.

Transportation provides goods with place, time and


quality utility.
Place Utility - creation of value by changing position
or location.
Time Utility - creation of value by enabling
movement during its specifically required time period.

The General Economic Environment


Consumer goods and services are those
products or services that are directly used
by
other
people to satisfy their
wants/needs.
Producer goods and services are used to
produce consumer goods and services or
other producer goods.
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Quality Utility creation of value by preserving a


particular goods state of being.
Utility is most commonly measured in terms of
value.
Value is represented by the price that must be
paid to obtain the item or avail the service.
Much business activity focuses on increasing the
utility of materials and products.
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Total Revenue Function

Economic Breakeven Analysis

Case 1: When Price is a function of Demand

Demand

Inelastic when a change in the selling price produces


little or no effect on the demand.

Price Demand Relationship

Units of Output (or Activity Level), D

Total Revenue Equation:

Price

TR

Revenue, P

Elastic when a decrease in the selling price results in a


considerable increase in the sales

TR = pD = (a bD)D
TR = aD bD2

b = slope

Case 2: When Price is constant

Revenue, P

Demand

Price Equation:

TR

p = a bD
Units of Output (or Activity Level), D

TR = pD
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CE 22 Engineering Economy General Economic Environment

Total Cost Function

Breakeven Analysis
Case 1: When Price is a function of Demand

Cost, P

CT

CF
Units of Output (or Activity Level), D

CT

TR

Revenue/Cost, P

CV = cvD

CV = cvD

CF

Total Cost composed of Total Variable Cost and


Total Fixed Cost

BEP1

BEP2

Units of Output (or Activity Level), D

CT = CV + CF = cvD + CF
Where:
CT = total cost
CV = total variable cost
cv = variable cost per unit
D = units of output
CF = total fixed cost

Breakeven Condition:

TR = CT
aD bD2 = cvD + CF
0 = bD2 + (cv a)D + CF
D1, 2 =

(c v a ) (c v a ) 2 4bC F
2b

where D1,2 corresponds to the two breakeven points

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CE 22 Engineering Economy General Economic Environment

Case 2: When Price is constant


CT

Revenue/Cost, P

TR

CV = cvD

CF
BEP1
Units of Output (or Activity Level), D

Breakeven Condition:

TR = CT
pD = cvD + CF
CF
D* =
p cv
where D* corresponds to the two breakeven points

CE 22 Engineering Economy General Economic Environment