Engineering Economics

Cost-Revenue Analysis
Syed Sajjad hussain
Types of Cost

Costs

Fixed
Variable Costs
Costs

2-2
Variable Costs are…

Expenses that are uniform per unit of output

within a relevant time period
As volume increases, total variable costs
increase

2-3
THERE ARE TWO CATEGORIES OF
VARIABLE COSTS

1. Cost of Goods Sold

2. Other Variable Costs

2-4
Variable Costs – Cost of Goods
Sold
For Manufacturer or Provider of Service
 Covers materials, labor and factory
overhead applied directly to production
For Reseller (Wholesaler or Retailer)
 Covers primarily the cost of
merchandise

2-5
Other Variable Costs

Expenses not directly tied to production

but vary directly with volume
Examples include:
 Sales commissions, discounts, and
delivery expenses

2-6
Fixed Costs

Expenses that do not fluctuate with

output volume within a relevant time
period

They become progressively smaller per

unit of output as volume increases

No matter how large volume becomes,

the absolute size of fixed costs remains
unchanged

2-7
THERE ARE TWO CATEGORIES OF
FIXED COSTS

1. Programmed costs
2. Committed costs

2-8
Fixed Costs – Programmed Costs

Result from attempts to generate sales

volume
Examples include:
 Advertising, sales promotion, and sales
salaries

2-9
 Cost-Revenue Analysis
Break-Even Points
The Cost Function, C(q), gives the total cost of producing a
quantity q of some good.

What sort of function do you expect C(q) to be?

The more goods that are made, the higher the total cost, so C(q)
is an increasing function. Costs of production can be separated
into two parts: the fixed costs, which are incurred even if
nothing is produced, and the variable cost, which depends on
how many units are produced.
 Cost-Revenue Analysis
Break-Even Points
Let’s consider a company that makes radios. The factory and
machinery needed to begin production are fixed costs, which
are incurred even if no radios are made. The costs of labor and
raw materials are variable costs since these quantities depend
on how many radios are made. The fixed costs for this company
are $24,000 and the variable costs are $7 per radio. Then,
Total cost for the company = Fixed costs + Variable costs
= 24,000 + 7 • Number of radios,
So, if q is the number of radios produced,
C(q) = 24,000 + 7q.
This is the equation of a line with slope 7 and vertical intercept
of 24,000.
 Cost-Revenue Analysis
Break-Even Points
Example 1: Graph the cost function C(q) = 24,000 + 7q. Label the fixed costs
and variable cost per unit.
Solution: The graph of the cost function is the line in the figure below. The
fixed costs are represented by the vertical intercept of 24,000. The variable
cost per unit is represented by the slope of 7, which is the change in cost
corresponding to unit change in production.
 Cost-Revenue Analysis
Break-Even Points
Notes:

If C(q) is a linear cost function,

1. Fixed costs are represented by the vertical intercept.

2. Variable costs per unit are represented by the slope.
 Cost-Revenue Analysis
Break-Even Points
Example 2: In each case, draw a graph of a linear cost function satisfying the
given conditions:

(a) Fixed costs are larger but variable cost per unit is small.
(b) There are no fixed costs but a large variable cost per unit length.
 Cost-Revenue Analysis
Break-Even Points
Example 2: In each case, draw a graph of a linear cost function satisfying the given
conditions:

(a) The graph is a line with a large vertical intercept and a small slope.
 Cost-Revenue Analysis
Break-Even Points
Example 2: In each case, draw a graph of a linear cost function satisfying the given conditions:

(b) The graph is a line with a vertical intercept of zero (so the line goes through the origin) and a
large positive slope.
 Cost-Revenue Analysis
Break-Even Points
The Revenue Function, R(q), gives the total revenue received by
a firm from selling a quantity, q, of some good.
If the good sells for a price of p per unit, and the quantity sold is
q, then
Revenue = Price • Quantity, so R = pq.
If the price does not depend on the quantity sold, so p is a
constant, the graph of revenue as a function of q is a line
through the origin, with slope equal to the price p.
 Cost-Revenue Analysis
Break-Even Points
Example 3: If radios sell for $15 each, sketch the manufacturer’s
revenue function. Show the price of a radio on the graph.

Solution: Since R(q) = pq = 15q, the revenue graph is a line

through the origin with a slope of 15.
 Cost-Revenue Analysis
Break-Even Points
Example 4: Sketch graphs of the cost function C(q) = 24,000 +
7q and revenue function R(q) = 15q on the same axes. For what
values of q does the company make money? Explain your
answer graphically.

Solution: The company makes money whenever revenues are

greater than costs, so we want to find the values of q for which
the graph of R(q) lies above the graph of C(q). We find the point
at which the graphs of R(q) and C(q) cross:
 Cost-Revenue Analysis
Break-Even Points
Example 4: Sketch graphs of the cost function C(q) = 24,000 +
7q and revenue function R(q) = 15q on the same axes. For what
values of q does the company make money? Explain your
answer graphically.

Revenue = Cost
15q = 24,000 + 7q
8q = 24,000
q = 3000
Thus, the company makes a profit if it produces and sells more than 3000
radios. The company loses money if it produces and sells fewer than 3000
radios.
 Cost-Revenue Analysis
Break-Even Points
Example 4: Sketch graphs of the cost function C(q) = 24,000 +
7q and revenue function R(q) = 15q on the same axes. For what
values of q does the company make money? Explain your
answer graphically.
 Cost-Revenue Analysis
Break-Even Points
The Profit Function:
Decisions are often made by considering the profit, usually
written as π to distinguish it from the price, p. We have
Profit = Revenue - Cost so π = R - C.

The break-even point for a company is the point where the

profit is zero and revenue equals cost. A break-even point can
refer either to a quantity q at which revenue equals cost, or to a
point on a graph.
 Cost-Revenue Analysis
Break-Even Points
Example 5: Find a formula for the profit function of the radio
manufacturer. Graph it, marking the break-even point.

Solution: Since R(q) = 15q and C(q) = 24,000 + 7q, we have,

π(q) = 15q - (24,000 + 7q) = -24,000 + 8q

Notice that the negative of the fixed costs is the vertical

intercept and the break-even point is the horizontal intercept.
 Cost-Revenue Analysis
Break-Even Points
Example 5: Find a formula for the profit function of the radio
manufacturer. Graph it, marking the break-even point.
Break-even Analysis Chart
Dollars
Total Revenue

BE Point
Total Cost
PROFIT

Variable Cost

LOSS Fixed Cost

0 Unit Volume2-25