Beruflich Dokumente
Kultur Dokumente
Teaching Assistants:
Name
Ms. Xin LIU
Mr. Chong Man TANG
Ms. Weijie WU
Mr. Kairen ZHANG
Office
ERB 814
ERB 905
ERB 905
ERB 514
Phone
3 4438
3 4241
3 4241
3 8319
Email
liuxin@se.cuhk.edu.hk
cmtang@se.cuhk.edu.hk
wwu@se.cuhk.edu.hk
krzhang@se.cuhk.edu.hk
Identifying Costs
Cost elements differ in their frequency of occurrence, relative magnitude and
degree of impact on the problem at hand
Correctly identifying them is crucial in an engineering economic analysis
Broad Categories
cost
cost
units
produced
units
produced
Site A
6 miles
$1,000
$15,000
$1.15/yd3mile
not required
Site B
4.3 miles
$5,000
$25,000
$1.15/yd3mile
$96/day
Fixed
Variable
Site A
$4,000
$15,000
$0
$345,000
Site B
$20,000
$25,000
$8,160
$247,250
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fixed
variable
direct
indirect
cost that is a
cost?
standard
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Sunk Costs
Sunk costs: costs that occurred in the past and have no relevance to estimates
of future costs and revenues related to an alternative course of action
e.g.: money spent on a passport, deposit used to secure a flat
Sunk cost is not part of the prospective cash flows and can be disregarded in an
engineering economic analysis
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Opportunity Costs
Opportunity costs: costs that are measured in terms of the value of the best
alternative that is not chosen (i.e., foregone)
one of the most important concepts in economics
difficult to define (what is the best alternative?) and is often hidden or
implied
Rule of thumb: avoided benefit = cost, avoided cost = benefit
Example
A student who could earn $20,000 for working during a year, but chooses
instead to go to school for a year and pay $5,000 in tuition.
His opportunity cost is $20,000 + $5,000 = $25,000.
Question
By taking a plane Larry can travel from Hong Kong to Guangzhou in 1 hour.
The same trip takes 5 hours by bus. Airfare is $600 and the bus fare is $200.
If Larry is not travelling, he can work and earn $200 per hour.
What is the opportunity cost for Larry if he travels by bus?
ECLT 5930/SEEM 5740 (201314 Second Term)
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LifeCycle Costs
Life cycle: roughly, the life cycle of an economic activity consists of two phases:
acquisition and operation
Acquisition Phase
needs
preliminary detailed design;
assessment;
design;
production
definition of advanced
planning;
requirements prototype
resource
testing
acquisition
Operation Phase
production operation;
retirement
maintenance and disposal
and support
Lifecycle costs: summation of all costs related to an economic activity during
its life span
ECLT 5930/SEEM 5740 (201314 Second Term)
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Cost Function
For simplicity, we assume that the total cost (CT ) is made up of fixed costs
(CF ) and variable costs (CV ), i.e.,
CT = CF + CV .
Since fixed costs essentially do not vary with the amount of activity, we can
treat CF as a constant.
On the other hand, let us assume that the variable costs depend linearly on the
demand, i.e.,
CV = c D,
where D is the demand, and c > 0 is the per unit variable cost.
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total cost
CT = CF + c D
slope = c
CF
demand
Figure 2: Graph of the total cost function, which is a sum of fixed and variable
costs
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Demand Function
Typically, higher the price, lower the demand.
For simplicity, we assume that unit price (p) and demand (D) are linearly related,
i.e.,
p = a b D,
where a, b > 0 and 0 D a/b (why?).
The coefficient b is related to the demand elasticity. Generally, the lower the b,
the more elastic the demand.
Question: What kind of goods have high (or low) demand elasticity?
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price
p= abD
slope = b
demand
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= a.
D
2b
p = a b D = .
2
Question: Is maximizing total revenue the right thing to do?
ECLT 5930/SEEM 5740 (201314 Second Term)
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CostVolume Relationships
cost/
revenue
CT = CF + c D
max
profit
CF
TR = aD bD 2
D D
demand
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Profit Function
By definition, profit is simply the difference between total revenue and total
cost, i.e.,
profit = total revenue total cost
= TR CT
= (aD bD 2) (CF + c D)
= bD 2 + (a c)D CF ,
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ac
D =
.
2b
bD 2 + (c a)D + CF = 0.
.
D =
2b
For this to make sense, we must have (c a)2 4bCF to start with.
ECLT 5930/SEEM 5740 (201314 Second Term)
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Breakeven Points
cost/
revenue
CT = CF + c D
CF
TR = aD bD 2
D1
D2
demand
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29
30
97 59.74
= 932 units per month,
0.04
97 + 59.74
= 3, 918 units per month.
0.04
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32
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CO
= k(400)3/2
n
k = 0.0375.
3/2
n
+ 300, 000 .
v
To minimize the total cost, we take the first derivative of CT with respect to v
and solve
3
n
dCT
1/2
= 0.0375 nv 300, 000 2 = 0,
dv
2
v
i.e.,
300, 000
1/2
= 0.
0.05625 v
v2
Solving this equation yields v = 490.68 mph.
ECLT 5930/SEEM 5740 (201314 Second Term)
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Direct material
Overhead
$120.00
$86.40
$82.00
$288.40
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Whats Next?
Assignment: Read Chapter 2 of the course textbook.
Next: Costestimation techniques (Chapter 3 of the course textbook)
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