1. Chapter 2
Cost Concepts And Design
Economic

2. Fixed, Variable and Incremental
costs.

3. Fixed costs :
 Unaffected by changes in activity level over a
feasible range of operations for the capacity or
capability available.
 Example :insurance and taxes on facilities,
administrative salaries, license fees, and
interest costs on borrowed capital.

4. Variable Costs :
• It vary in total with the number of the output
unite .
• Example :
costs of material and labor used in a product or
service, because they vary in total with the
number of output units even though costs per
unit remain the same.

5. More ways to categorize costs
• Direct: can be measured and allocated to a specific
work activity
(Materials, Labor)
• Indirect: difficult to attribute or allocate to a
specific output or work activity
(overhead, maintenance)
• Standard cost: cost per unit of output,
Standard costs play an important role in cost control and
other management functions.

6. • Cash cost: a cost that involves a payment of cash.
• Book cost: a cost that does not involve a cash
transaction but is reflected in the accounting
system.
( equipments, machines, Depreciation)
• Sunk cost: a cost that has occurred in the past and
has no relevance to estimates of future costs and
revenues related to an alternative course of action.
(money spend on a passport)

7. • Opportunity cost: the monetary advantage foregone due
to limited resources. The cost of the best rejected
opportunity.
( A student can work with 10,000$ Per year.
or goes to the university for a year and spend 5,000$.
Opportunity cost = 15,000$)
• Life-cycle cost: the summation of all costs related to a
product, structure, system, or service during its life
span.

8. Example 2-1

9. Cost Factor Site A Site B •5,000 cubic yards of
Distance 6 miles 4.3 miles asphalt
Monthly $1,000 $5,000 •4 months (17 weeks
rental cost 5- days a week)
Cost (Set up $ $15,000 $25,000 •Compare the
Removing)
Equipment
2 sites??!!!!!
Hauling $1.15/yd3 – $1.15/yd3 – •NOTE:
expenses mile mile •Rent , Set up/
Removal and Flag
Flag person No need $96/day person are Fixed costs
($8,160)
BUT

10. BUT Hauling is variable cost
Site A = 6*5000*$1.15 = $345,000
Site B= 4.3*5,000*$1.15 = $247,250
Then the total cost is

11. 2. Which is the better site? Site B
3. How many cubic yards of asphalt does the contractor have to
deliver before starting to make a profit if paid 8.05$ per cubic yard

12. ‫ سئل الحسن البصري عن سر زهده في الدنيا فقال:‬
‫ أربعة أشياء‬
‫علمت أن عملي ل يقوم به غيري فاشتغلت به.‬
‫وعلمت أن رزقي ل يذهب إلى غيري فاطمأن قلبي.‬
‫و علمت أن ال مطلع علي فاستحييت أن يراني على‬
‫معصية.‬
‫وعلمت أن الموت ينتظرني فاعددت الزاد للقاء ربي.‬

13. The General Economic Environment

14. Goods and service are produced and desired because they
have utility.
Utility: The power to satisfy human wants and needs.
Utility is most commonly measured in terms of value.
Value: the price that must be paid to obtain the particular
item.
Necessities and Luxuries needs.

15. Price And Demand
 Engineering focusing on increasing the utility
(value) of materials by changing their form or
location.
 P : the price that must be paid
 D: is the quantity that must be demanded or
purchased

16. The general price-demand relationship

17. The demand for a product or service is directly related to
its price according to
p = a - bD
for 0 ≤ D ≤ a/b , a > 0, b > 0
where p is price, D is demand, and a and b are constants
that depend on the particular product or service.
a = price axis intercept
-b = slope

18. Total Revenue Function
Total revenue is the product of the selling price per unit,
p, and the number of units sold, D.
TR = p × D
From: p = a – bD
We find:

19. Maximize Revenue
TR = a D − b D 2
d 2TR
2
= − 2b < 0
dD
The demand at maximum revenue: ˆ = a
D
2b
ˆ ˆ a2 a2 a2
Maximum TR = a D − b D 2 = − =
2b 4b 4b

21. Profit
Profit = Total Revenue (TR) – Total Cost (CT)
Total Cost (CT) = Fixed Cost (CF) + Variable Cost (CV)
CT = C F + CV
Variable Cost (CV) = Variable cost per unit (cv) × Demand (D)
CV = cv × D
Total Cost: CT = C F + c v D

22. Maximum profit
Scenario 1: Demand is a function of price ( p = a – bD)
TR = a D − b D 2

23. Profit = Total Revenue (TR) – Total Cost (CT)
and CT = C F + cv D
and TR = a D − b D 2
Then Profit = (a D − b D 2 ) − ( CF + cv D)
Profit = − b D 2 + (a − cv ) D − CF
To find the maximum profit d ( profit )
= a − cv − 2 b D = 0
dD
d 2 ( profit )
2
= − 2b < 0
dD
a − cv
Demand at Max profit: D *=
2b

24. Breakeven points are found when
Total Revenue = Total Cost.
a D − b D 2 = CF + cv D
− b D 2 + (a − cv ) D − CF = 0
The demand at breakeven:
D′ =
[
− ( a − c v ) ± ( a − c v ) − 4 ( − b )( − C F )
2
] 1
2
− 2b

25. Example: A company produces an electronic timing switch. The
fixed cost (CF) is 73,000$ per month. The variable cost per unit
(cv) is 83$. The selling price per unit (p = 180$ – 0.02D).
B. Determine the optimal volume of product?
C. Find the volume at breakeven occurs, what is the range of
profitable demand?
Solution:
A. a = 180, b = 0.02
a − cv 180 − 83
D *= = = 2,425 units per month
2b 2 × 0.02

26. B. Total Revenue = Total Cost.
a D − b D 2 = CF + cv D
− b D 2 + (a − cv ) D − CF = 0
D′ =
[
− ( a − c v ) ± ( a − c v ) − 4 ( − b )( − C F )
2
] 1
2
− 2b
D′ =
[
− 97 ± ( 97 ) − 4 ( − 0.02 )( − 73000 )
2
] 1
2
− 2( 0.02 )
− 97 + 59.74
′
D1 = = 932 unit per month
− 0.04
− 97 − 59.74
′
D2 = = 3,918 unit per month
− 0.04
Range = 932 to 3,918 unit per month

27. Scenario 2: Price and Demand are independent
TR = P × D

28. Example:
Variable cost per service hour = 62$.
Selling price = 85.56$ per hour.
Maximum Hours per year = 160,000 hours.
Fixed cost = 2,024,000$ per year.
F. What is the breakeven point in hours and in % of total capacity?
Total revenue = Total cost (breakeven)
p D′ = C F + cv D′
CF
D′ =
( p − cv )
2024000
D′ = = 85,908 hours per year
( 85.56 − 62)
85,908
D′ = = 0.537 = 53.7% of capacity
160,000

29. B. What is the % reduction In breakeven point (sensitivity) if:
1. Fixed cost reduced by 10%?
0.9( 2024000)
D′ = = 77,138 hours per year
( 85.56 − 62)
85,908 − 77,318
D′ reduction = = 0.1 =10%
85,908
2. variable cost per hour reduced by 10%?
2024000
D′ = = 68,011 hours per year
( 85.56 − 0.9 × 62)
85,908 − 68.011
D′ reduction = = 0.208 = 20.8%
85,908

30. 3. selling price increase by 10%?
2024000
D′ = = 63,021 hours per year
(1.1× 85.56 − 62)
85,908 − 63,021
D′ reduction = = 0.266 = 26.6%
85,908
Then the breakeven point is more sensitive to reduction in
variable cost than fixed cost