1 EGGC4214 Systems Engineering & Economy Lecture 2 Cost Concepts and Economic Environment

2 Cost Concepts 1. Fixed, Variable, Average, and Marginal Costs 1. Fixed, Variable, Average, and Marginal Costs - Variable Costs: Costs that vary with the level of activity or with time Costs that vary with the level of activity or with time Examples: labor, material, … Examples: labor, material, … - Fixed Costs: Costs that do not vary with the level of activity Costs that do not vary with the level of activity Examples: rent, property tax, insurance, or interest expense. Examples: rent, property tax, insurance, or interest expense. - Total Costs: The total sum of variable cost(s) and fixed cost(s).

3 Cost Concepts (continued) - Average Costs:  Computed as total costs divided by the number of units produced  Typically decreases with increased quantity produced (may increase at higher production) - Marginal Costs: The change in total costs that arises when the quantity produced changes by one unit. “ The cost of the next unit produced ”.

4 2. Recurring vs Non-recurring Costs - Recurring Costs: Costs occurring repetitively over the life of the project/activity - Non-recurring Costs: One-time costs

5 3. Direct vs Indirect (Overhead) Costs 3. Direct vs Indirect (Overhead) Costs - Direct Costs: costs directly associated with product or service - Indirect (overhead) Costs: costs that cannot easily be allocated to specific activity or service 4. Sunk Costs 4. Sunk Costs - Past costs that is irrelevant for current analysis

6 5. Opportunity Costs 5. Opportunity Costs Potential loss of benefits, revenue or income based on next best use of money 6. Life-cycle Costs 6. Life-cycle Costs Summation of all costs over all phases of the lifetime of project, from conception, design, construction, operation and service, to replacement or disposal: Phases of lifecycle costsPhases of lifecycle costs Potential for cost savings at different phasesPotential for cost savings at different phases

7 7. Incremental Costs Differences in costs between alternative investments or activities 8. Cash Costs Versus Book Costs - A cash cost requires the cash transaction of money out of one person ’ s pocket into the pocket of someone else. Example: When you buy dinner for your friends or make your monthly car payment, you are incurring a cash cost or cash flow. - - Book costs do not require the transaction of money. They are cost effects from past decisions that are recorded in the accounting books of a firm (asset depreciation) - - Cash costs and cash flows are the basis of engineering economic analysis

8 9. The Break Even Point 9. The Break Even Point It is the point where total revenue received equals total costs associated with the sale of the product (i.e., TR = TC). A break even point is typically calculated in order for different businesses to determine if it would be profitable to sell a proposed product. 10. Cost Estimating 10. Cost Estimating Approximating the cost of resources 11. Cost Budgeting 11. Cost Budgeting Allocating costs to tasks 12. Cost Control 12. Cost Control Controlling changes to budget elements

9 Economic Environment 1. Supply Function - Fixed costs - Variable costs - Total and average costs 2. Demand Function - Fixed price - Price as a function of demand - Alternate demand functional forms - Total revenue function

10 3. Demand-Supply Interaction 3.1 Fixed selling price: - Break even point - How many units if single producer? 3.2 Price as a function of demand: - Break even points - Range of profitable production - Optimal production level Economic Environment

11 The Average Total Cost Curve

12 I want to maximize profits. How much output should I sell, at the given price? The answer is: increase output until P = MP = MC

13 General supply and demand curves with intersection showing free market equilibrium

14 An out- or right- shift in demand changes the equilibrium price and quantity

15 An out- or right- shift in supply changes the equilibrium price and quantity

16 Total utility and marginal utility Total and Marginal Utility

17 Life Cycle Cost Typical