Engineering Economics

What is Economics?????
Economics
Economics is the science that deals with the production and consumption of goods
and services and the distribution and rendering of these for human welfare.
The following are the economic goals.
Microeconomics is the study of economics at an individual, group or company
level, business level.
• Efficiency
• Equity

Macroeconomics, on the other hand, is the study of a national economy as a whole

• Employment
• Stability
• Growth
Flow in Economy
Law of Supply and Demand
Demand and supply of a product are interdependent and they are
sensitive with respect to the price of that product.

When there is a decrease in the price of a product, the demand for the
product increases and its supply decreases.
 Law of Supply and Demand

• Lowering of the price of the product makes the producers restrain from
releasing more quantities of the product in the market. Hence, the supply of
the product is decreased.

• The point of intersection of the supply curve and the demand curve is
known as the equilibrium point.

• At the price corresponding to this point, the quantity of supply is equal to

the quantity of demand. Hence, this point is called the equilibrium point
Factors Influencing Demand

•Income of the people

•Prices of related goods
•Tastes of consumers

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Factors Influencing Supply

•Cost of the inputs

•Technology
•Weather
•Prices of related goods

1–8
Engineering Economics

Engineering economics deals with methods that

enable one to take economic decisions towards
minimizing cost and maximizing benefits to
business organizations.

It involves systematic evaluation of economic

merits of proposed solution to engineering
problems.
1–9
Scope of Engineering Economics
• Efficiency
• Ratio of output to input
Types of Efficiency
• Technical Efficiency
• Economic Efficiency
Technical Efficiency
It is the ratio of output to input of physical system.
Physical system may be a diesel engine , a
machine working in a shop floor, computer system

Technical Efficiency(%)= Output/input

Technical Efficiency(%)=Heat eq. of mechanical
energy produced/Heat eq. of fuel used
Economic Efficiency
• It is the ratio of output to input of a business
system.
Economic Efficiency(%)= Output/Input
= Worth/Cost
 Productivity
Economic Efficiency is also called productivity.

• Productivity Improvement Techniques

Increased output for the same input
Decreased input for the same output.
Proportionate increase in output which is more than proportionate
increase in input.
Proportionate decrease in input which is more than proportionate
decrease in output.
Through simultaneous increase in output with decrease in the input.
Cost of a Product
 Elements of Costs
COST

Variable Overhead
Cost Cost

Direct
Direct Direct Factory Administr
Material Selling Distribution
Labor Cost Expense Overhead ative
Cost
Variable Cost
Cost that vary with production volume
Direct Material Cost: Cost of material that are used to produce the product.
Examples:
• Timber in furniture making.
• Cloth in dress making.
• Bricks in Construction
Direct Labor Cost: Amount of Wages paid to direct labor involved in
production activities.
Examples:
• Carpenters and helping staff
• Tailor Master
• Masons,contractors,welders etc.
Variable Cost
Direct Expense Cost: Those expenses that vary in relation to the
production volume other than direct labor cost and direct material
cost.
Examples:
Labor and payroll taxes paid based on the number of units produced
The commission and payroll taxes related to the sale of goods or
services
The cost of the freight needed to transport goods to and from a
manufacturing facility
Overhead Cost
Overhead cost is fixed irrespective of production volume.

Example
Overhead expenses include accounting fees, advertising,
insurance, interest, legal fees, labor burden, repairs, taxes etc
Overhead Cost
Factory Overhead Cost: It is the aggregate of indirect material cost,
indirect labor and indirect expenses.
Examples:
• Utilities to operate the factory equipment,
• Depreciation on the factory equipment and building.
Administration Overhead Cost: Costs that are incurred in
administering the business
Examples:
• Front office and sales salaries, wages, and commissions
• Administration of sales office .
• Administration of travel and entertainment.
 Overhead Cost
Selling Overhead Cost: Total expense incurred in administering
the promotional activities and expenses related to sales force.
Examples:
• Warehouse rent and expenses.
• Depreciation of delivery vans.
Distribution Overhead Cost: Total cost of shipping the item
from factory site to customer site.
Examples:
Freight and Carriage
Sales Representatives
 Some useful cost terminology
• Cash cost: a cost that involves a payment of cash and
results in cash flow.
• Book cost: a cost that does not involve a cash transaction
but is reflected in the accounting system.
• Book costs represent the recovery of past expenditures over
a fixed period of time.
• Sunk cost: a cost that has occurred in the past and has no
relevance to estimates of future costs and revenues, this is
known as the past cost of an equipment/asset.
 More useful cost terminology
• Opportunity cost: the monetary advantage foregone
due to limited resources. The cost of the best rejected
opportunity.
• Life-cycle cost: the summation of all costs related to a
product, structure, system, or service during its life
span.
BREAK-EVEN ANALYSIS
The main objective of break-even analysis is to find the
cut-off production volume from where a firm will make
profit.
BREAK-EVEN ANALYSIS
The total sales revenue (S) of the firm is given by the following formula:
S=sxQ
The total cost of the firm for a given production volume is given as
TC = Total variable cost + Fixed cost

= v x Q + FC

Profit = Sales – (Fixed cost + Variable costs)

= s x Q – (FC + v x Q)

s = selling price per unit

v = variable cost per unit
FC = fixed cost per period
Q = volume of production
Break Even Analysis
 Break Even Analysis

Example#1
Example#2

Fixed factory overhead Cost=Rs. 60000

Fixed selling overhead cost=Rs. 12000
variable manufacturing cost per unit= Rs.12
variable selling cost per unit=Rs. 3
Selling price per unit= Rs. 24
Example#3
Gandhara Industries is a major producer of diverter dampers used in the gas turbine
power industry to divert gas exhausts from the turbine to a side stack, thus reducing the
noise to acceptable levels for human environments. Normal production volume is 60
diverter systems per month, but due to significantly improved economic conditions in
Asia, production is at 72 per month. The following information is available

Fixed costs = Rs. 2.4 million per month

Variable cost per unit = Rs. 35,000
Revenue per unit = Rs. 75,000

a). How does the increased production volume of 72 units per month compare with the
current breakeven point?
Exapmle#4

PNG electric company manufactures a number of electric products.

Rechargeable light is one of the PNG’s products that sells for
Rs.180/unit. Total fixed expenses related to rechargeable electric light
are Rs.270,000 per month and variable expenses involved in
manufacturing this product are Rs.126 per unit. Monthly sales are 8,000
rechargeable lights

Compute break-even point of the company in (Quantity)

Sol 2
Sol 3
Sol 4
• Sales = Variable expenses + Fixed expenses
• $180Q = $126Q + 270,000
• $180Q – $126Q = $270,000
• $54Q = $270,000
• Q = $270,000/$54
• Q = 5,000 Units