Cost Concepts &
Terminology
Lecture 2
Check In
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Class work 1 was not HW 1
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Please make sure you complete and submit the correct assignments
Discuss missing deadlines with me
HW 2 will be posted after class
Definitions
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Fixed costs: constant, unchanging regardless of the level of output or
activity
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Variable costs: depend on the level of output or activity
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Rent for warehouse is the same monthly regardless of how much is stored there
Cost of labor will depend on how many employees, how many hours they work and at
what rate
Marginal cost: the variable cost for one more unit. Used to decide whether
an additional unit should be made, purchased, etc.
Average cost: the total cost divided by the number of units
Marginal Cost
Marginal cost: the variable cost for one more unit. Used to decide whether an additional unit should be made,
purchased, etc.
Will is a student Byrgenwerth Institute of Technology. BIT charges full-time students a
cost of $3600 per term for 12-18 hours and a cost of $240 per credit hour for each
credit hour over 18.
Should Will enroll in another course?
If currently enrolled for 12-15 credits, adding one more 3 credit course is free. →
fixed cost for term $3600, $0 marginal cost
If already enrolled in 16 or more credits, adding another 3 credit course will cost
the variable cost of one more course. → fixed cost for term $3600 + ($240 x number of
credit hours) marginal cost
Calculating cost example
A professional organization wants to offer a one-day training course to help students in job
hunting and to raise funds. The organizing committee is sure they can find alumni, local
businesses, and faculty to provide training at no charge. The main costs will be for space,
meals, handouts, and advertising.
The organizers have classified the costs for room rental, room setup, and advertising as
fixed costs. They have also included the meals for the speakers as a fixed cost. Their total of
$900 is pegged to a room that will hold 60 people. So if demand is higher, the fixed costs will
also increase. The variable costs for food and bound handouts will be $20 per student. The
organizing committee believes that $40 is about the right price to match value to students
with their budgets. They are unsure how many students will reserve seats.
Develop equations for total cost and total revenue, and determine the number of
registrations needed to equal cost.
Solution
Let x equal the number of students who sign up.
Total cost = $900 + $20x
Total revenue = $40x
To breakeven, Total cost = Total revenue
$900 + $20x = $40x
$900 = ($40-$20)x
x = 45 students
Total cost = Total fixed cost + total variable cost
Profit-loss breakeven chart
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Breakeven point: the activity level at which total costs are equal to the
revenue (or savings) generated. The level at which one “just breaks even.”
Profit region: the variable x is greater than the breakeven point and total
revenue is greater than total costs
Loss region: the variable x is greater than the breakeven point and total
revenue is less than total costs
Plot y= 40x and y= 20x+900
Sometimes the relationship can be nonlinear. Ex: Employees are often paid at
150% their hourly rate for overtime hours, so that production levels requiring
overtime have higher variable costs. Total cost below is a fixed cost of $3000 plus
a variable cost of $200 per unit for straight-time production of up to 10 units and
$300 per unit for overtime production of 5 or more units.
Sunk Costs
Money already spent as a result of
a past decision. Must be ignored in
engineering economic analysis
because current decisions cannot
change the past.
Becomes important when an asset
is sold or disposed of - the sunk
cost is important in figuring out how
much is owed in taxes.
Other cost definitions
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Opportunity costs: associate with using one activity instead of another
Recurring costs: any expense that is known and anticipated and occurs at
regular intervals
Nonrecurring costs: one of a kind expenses that occur at irregular
intervals and thus are sometimes difficult to plan for or anticipate from a
budgeting perspective
Incremental costs: the differences between alternatives in a choice
Incremental Cost example
Phil is leasing a car. He is choosing between model A, a budget model, and
model B, a model with more features and a higher purchase price. What
incremental costs would Phil incur if he chose model B instead of the less
expensive model A?
Solution
Subtract model A costs from model B costs for each category.
Positive incremental costs indicate that model B costs more than model A.
Negative incremental costs mean that there would be a savings if model B were
chosen instead.
Example
Identify the fixed and variable
costs using the following
information. Construct a table.
Then, conduct a breakeven
analysis to determine how much
money or what % of turnover is
needed to begin making a profit.
Solution
Solution
Life-Cycle costs
A product’s sales volume and revenues follow a life cycle. All products and
projects follow some version of this and recognizing this can ensure that all
costs and benefits are included in the economic analysis.
Typical product life cycle
Design changes and cost impacts
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The later design changes are made, the higher the costs
Decision made early in the life cycle tend to “lock in” costs and benefits
that will be incurred later
Internal vs. External costs
Internal costs are incurred and paid by the firm and are used to calculate the
production cost.
External costs are outside the firm’s normal cost accounting and thus do not
directly affect the price of goods or services.
Green engineering focuses on the environmental impacts of inputs, such as
electric power, or outputs, such as discarded packaging.
Examples: costs of disposal, decommissioning, landfilling, effects on animals &
habitats, degradation of air/water quality, managing wastes and pollutants
Example
JPL Enterprises Co. includes potential environmental costs in their design
process. From the following list, identify the internal and external costs
associated with a new mountain top ski resort project.
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Site costs
Land costs
Water quality costs
Legal costs
Community costs
Design costs
Habitat costs
Recreational costs
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Administrative costs
Roadway costs
Labor costs
Materials costs
Equipment costs
Overhead costs
Construction costs
Social costs
ie. full time workers who need
Medicaid or EBT/SNAP, poor working
conditions and communities impacted
by layoffs, plant closures, etc.
Costs that are paid through taxes
rather than by employers.
Trade-offs exist between internal &
external costs - but the point is to
lower external costs by thoughtful
attention and to lower internal costs
by innovation.
Role of economic analysis
Identifying phases of the project life cycle and categorizing costs allows us to
more holistically assess a project.
Example: highway construction
See files on Canvas: worksheet descriptions 1 & 2
Identify 3 unique analyses a project engineer would have to present on a
highway construction project
Hint: What questions are we investigating or trying to answer when we
design for transportation?
Case Study: Grumman
This timeline dates back to the 1930s, so it is difficult to analyze the situation in objective
terms. We did not know as much about contamination at the time or the detrimental effects it
would have on the local community.
Watch the 15 minute video linked in this article
Read the article
Create a timeline of events: 1930s, 1940s, 1970s, 1980s, 1990s, 2000s, 2012, 2016, 2017, 2018,
present
Summarize the key points: what happened, what decisions were made & why, what are the
cost consequences (differentiate between internal and external costs)? What are the
questions engineering economists should have been asking at each stage in the timeline?