IE343 Chapters 2 & 4 Notes.docx

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Industrial Engineering
IE 34300
Agostino Capponi

IE343 Notes Chapter 2: Cost Concepts and Design Economics 2.1 Cost Terminology 2.1.1 Fixed, Variable, and Incremental Costs • Fixed costs: costs unaffected by changes in activity level over a feasible range of operation for the capacity of capability available o Includes insurance and taxes on facilities, general management and administrative salaries • Variable costs: costs associated with an operation that varies in total with the quantity of output or other measures of activity level o Includes costs of material and labor used in a product or service • Incremental costs: additional cost that results from increasing the output of a system by one (or more) units 2.1.2 Direct, Indirect, and Standard Costs • Direct costs: costs that can be reasonably measured and allocated to a specific output or work activity o Labor and material costs directly associated with a product, service, or construction activity are direct costs • Indirect costs: costs that are difficult to attribute or allocate to a specific output or work activity o Costs of common tools, general supplies, and equipment maintenance in a plant • Standard costs: planned costs per unit of output that are established in advance of actual production or service delivery 2.1.3 Cash Cost versus Book Cost • Cash cost: a cost that involves payment of cash • Book costs: costs that do not involve cash payments but rather represent the recovery of past expenditures over a fixed period of time o Examples: depreciation 2.1.4 Sunk Cost • Sunk cost: one that has occurred in the past and has no relevance to estimates of future costs and revenues related to an alternative course of action o Examples: nonrefundable cash outlays, such as earnest money on a house or money spent on a passport 2.1.5 Opportunity Cost • Opportunity cost: incurred because of the use of limited resources, such that the opportunity to use those resources to monetary advantage in an alternative us is foregone 2.1.6 Life-Cycle Cost • Life-cycle cost: refers to a summation of al the costs related to a product, structure, system, or service during its life space • Begins with identification of the economic need or want • Ends with retirement and disposal activities • Can be divided into two general time periods: o The acquisition phase: begins with an analysis of the economic need or want  Involves detailed design and planning for production or construction  The greatest potential for achieving life-cycle cost savings is early in this phase o The operation phase: the production, delivery, or construction of the end items and their operation or customer use occur  Ends with retirement from active operation • Investment cost: capital required for most of the activities in the acquisition phase • Working capital: refers to the funds required for current assets that are needed for the start-up and support of the operational activities • Operation and maintenance cost: includes many of the recurring annual expense items associated with the operation phase of the life cycle • Disposal cost: includes those nonrecurring costs of shutting down the operation and the retirement and disposal of assets at the end of the lifecycle 2.2 The General Economic Environment 2.2.1 Consumer and Producer Goods and Services • Consumer goods and services—products or services that are directly used by people to satisfy their wants • Producer goods and services—used to produce consumer goods and services or other producer goods 2.2.2 Measures of Economic Worth • Goods and services are produced and desired because they have utility—the power to satisfy human wants and needs 2.2.3 Necessities, Luxuries, and Price Demand • As the selling price per unit (p) is increased, there will be less demand (D) for the product and vice versa • p=a-bD 2.2.4 Competition • perfect competition occurs in a situation in which any given product is supplied by a large number of vendors and there is no restriction on additional suppliers entering the market • perfect competition may never occur in actual practice, because of a multitude of factors that impose some degree of limitation upon the actions or sellers, or both • monopoly is at the opposite pole from perfect competition o a perfect monopoly exists 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 2.2.5 The Total Revenue Function • total revenue, TR, results from a business venture during a given period o product of the selling price per unit, p, and the number of units sold, D o TR = price x demand = p * D o TR=(a-bD)D=aD-bD^2 • From calculus, the demand that will produce maximum total revenue can be obtained by solving dTR/dD=a-2bD=0 2.2.6 Cost, Volume, and Breakeven Point Relationships • Fixed costs remain constant over a wide range of activities, but variable costs vary in total with the volume of output • Thus, at any demand D, total cost is Ct=Cf+Cv • Scenario 1: At breakeven point D prime, total revenue is equal to total cost, and an increase in demand will result in a profit for the operation. Then at optimal demand, profit is maximized. At breakeven point D prime 2, total revenue and total cost are again equal, but additional volume will result in an operating loss instead of a profit. o Profit(loss)=total revenue-total costs o =(aD-bD^2)-(Cf+cvD) o =-bD^2+(a-cv)D-Cf o In order for a profit to occur, two conditions must be met:  (a-cv)>0, the price per unit that will result in no demand has to be greater than the variable cost per unit  TR must exceed total cost (Ct) for the period involved o Breakeven point: total revenue=total cost  aD-bD^2=Cf+cvD Chapter 4: The Time Value of Money 4.2 Simple Interest • when the total interest earned or charged is linearly proportional to the
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