03/09/2022

ENGINEERING
ECONOMICS
ENGG 404
Introduction to
Engineering Economy
Part 2

Kristine Mariel B. Bejasa, REE

Lecturer

Cost Terminology
Fixed Costs
 unaffected by changes in activity level over a feasible range
of operations for the capacity or capability available.
 A cost that does not change with an increase or decrease in
the number of goods or services produced or sold.
 Examples: insurance & taxes on facilities, mortgage or lease
payments, employee salaries, interest cost, license fees

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Cost Terminology
Variable Costs
 Associated with an operation that varies in total with the
quantity of output or other measures of activity level.
 A corporate expense that changes in proportion to how
much a company produces or sells-they rise as production
increases and fall as production decreases.
 Examples: the cost of material and labor used in a product or
service

Cost Terminology
Variable Costs
Example: Let’s assume that it costs a bakery Php 840.00 to make a cake – Php
280.00 for raw materials and Php 560.00 for the direct labor involved in making
one cake. The table below shows how the variable costs change as the number of
cakes baked varies.
1 cake 2 cakes 7 cakes 10 cakes 0 cakes
Cost of sugar, Php 280.00 Php 560.00 Php 1,960.00 Php 2,800.00 0
flour, butter,
and milk
Direct labor Php 560.00 Php 1,120.00 Php 3,920.00 Php 5,600.00 0

TOTAL Php 840.00 Php 1,680.00 Php 5,880.00 Php 8,400.00 0

VARIABLE
COST

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Cost Terminology
Incremental Costs
 It is the additional cost that results from increasing the
output of a system by one(or more) units.
 Also known as marginal cost

Cost Terminology
Incremental Costs
Example: A company is considering increasing its production of goods but needs
to understand the incremental costs involved. Below are the current production
levels as well as the added cost of the additional units.
Cost per unit Total cost
10,000 units $30 $300,000
12,000 units $27.50 $330,000
Thus, the total incremental cost to produce additional 2000 units is
$30,000 ($330,000-$300,000). The incremental cost per unit is $15
($30,000/2,000 units).

The reason there’s a lower incremental cost per unit is due to certain costs, such
as fixed costs remaining constant. Although a portion of fixed costs can increase
as production increases, usually, the cost per unit declines since the company
isn’t buying addt’l equipment or fixed costs to produce added volume.

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Cost Terminology
Direct Costs
 It is the cost that can be reasonably measured and
allocated to a specific output or work activity.
 Ex: labor and material costs directly associated with a
product, service, or construction activity

Cost Terminology
Indirect Costs
 It is the cost that is difficult to allocate to a specific output
or work activity.
 May also be called overhead cost
 Ex: cost of common tools, general supplies, and equipment
maintenance in a plant.

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Cost Terminology
Standard Costs
 It is the planned cost per unit of output that is established
in advance of actual production or service delivery.
 Developed from anticipated direct labor hours, materials,
and overhead categories (with their established cost per
unit).

Cost Terminology
Standard Costs
 Typically used in:
(1) Estimating future manufacturing costs
(2) Measuring operating performance by comparing actual cost
per unit with the standard cost per unit
(3) Preparing bids on products or services requested by
customers
(4) Establishing the value of work in progress and finished
inventories

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Cost Terminology (Cash Cost vs Book Cost)

Cash Cost
 Involves payment of cash (and results in cash flow)
 Are estimated from perspective established for the analysis and
are future expenses incurred for the alternatives being analyzed

Book Cost
 Are cost that does not involve cash payments but rather represent
the recovery of past expenditures over a fixed period of time.
 Ex: depreciation charged for the used assets.

Cost Terminology
Sunk Cost
 Occurred in the past and has no relevance to estimates of
future costs and revenues related to an alternative course
of action.

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Cost Terminology
Sunk Cost
 Ex: Joe finds a motorcycle he likes and pays $40 as a down payment, which

will be applied to the $1300 purchase price, but w/c must be forfeited if he

decides not to take the cycle. Over the weekend, Joe finds another

motorcycle he considers equally desirable for a purchase price of $1230. For

the purpose of deciding w/c cycle to purchase, the $40 is a sunk cost and
thus would not enter into decision, except that it lowers the remaining cost of

the 1st cycle. The decision then is between paying an additional $1260
($1300-$40) for the first motorcycle vs. $1230 for the second motorcycle.

Cost Terminology
Opportunity Cost
 The potential benefits that an individual, investor, or business
misses out on when choosing one alternative over another.

Life-Cycle Cost
 Refers to a summation of all the costs related to a product,
structure, system, or service during life span.
 Investment Cost; Operation & Maintenance Cost; Disposal Cost

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Cost Terminology (Gen. Economic Environment)

Consumer goods and services
 These are products or services that are directly used by people to
satisfy their wants. Ex: food, clothing, homes, cars, haircuts and
medical services

Producer goods and services

 These are used to produce consumer goods and services or other
producer goods. Ex: machine tools, factory bldgs., buses and farm
machinery.

Cost Terminology (Gen. Economic Environment)

Price of goods and services
 It is defined to be the present amount of money or its equivalent
which is given in exchange for it.
Demand
 It is the quantity of a certain commodity that is bought at a certain
price at a given place and time.
Supply
 It is the quantity of a certain commodity that is offered for sale at a
certain price at a given place and time.

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Cost Terminology (Market Structure)

Perfect competition
 Occurs in a situation in w/c any given product is supplied by a large
number of vendors and there is no restriction in additional suppliers
entering the market.
Perfect monopoly
 It is when a unique product or service is only available from a single
supplier and that vendor can prevent the entry of all others into the
market
Oligopoly
 It is when there are few suppliers and any action taken by anyone of
them will definitely affect the course of action of the others.

References:
• Sullivan, William, et al.(2014), Engineering Economy 16th
Edition, Pearson Education, Inc.

• Blank, Leland T.(2014).Basic of Engineering Economy, 2nd

edition, Mc Graw-Hill, New York

• Sta. Maria, Hipolito B. (2000),Engineering Economy Third

Edition

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