University:
California State University, Northridge
Course:
ECON 310 | Price Theory and Applications
Academic year:

2024
Views:

280

Pages:

25
Author:

esbrinavatb2

CHAPTER 2 COST CONCEPTS AND THE ECONOMIC ENVIRONMENT Part 2 CAPITAL AND INVESTMENT • Investment Cost – Capital (money) required for most activities of the acquisition phase • Working Capital – Refers to the funds required for current assets needed for startup and subsequent support of operation 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 non-recurring costs of shutting down the operation GENERAL FORMULA • Life Cycle Cost = Investment Costs + Working Capital + O&M Costs+ Disposal Costs or Salvage Value (if any) CONSUMER GOODS AND PRODUCER GOODS AND SERVICES • CONSUMER GOODS AND SERVICES – Directly used by people to satisfy their wants; • PRODUCER GOODS AND SERVICES – Used in the production of consumer goods and services: machine tools, factory buildings, buses and farm machinery are examples UTILITY AND DEMAND • Utility – Measure of the value which consumers of a product or service place on that product or service; • Demand – Reflection of this measure of value, and is represented by price per quantity of output Price a Price equals some constant value minus some multiple of the quantity demanded: p = a - b D a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b Price Demand Total Revenue = p x D = (a – bD) x D =aD – bD2 Demand Price a Price equals some constant value minus some multiple of the quantity demanded: p = a - b D a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b Price TR = Max Demand Total Revenue = p x D = (a – bD) x D =aD – bD2 dTR / dD = a –2bD = 0 Demand D*=a/2b Profit is maximum where Total Revenue exceeds Total Cost by greatest amount Maximum Profit Cost / Revenue Total cost Profit Ct= Cf + Cv Where Cv=cvD Total Revenue Cf D’1 D* D’2 Demand D’1 and D’2 are breakeven points PROFIT MAXIMIZATION D* • Profit maximization can be shown algebraically • Profit (loss) = total revenue-total costs • = (aD-bD2) – (CF+CvD) = -bD2+(a-cv)D-CF • Occurs by taking d(profit)/dD =a-cv-2bD=0 • D* = [ a - (Cv) ] / 2b BREAKEVEN POINT D’1 and D’2 • Occurs where TR = Ct • ( aD - D2 ) / b = Cf + (Cv ) D • - D2 / b + [ (a / b) - Cv ] D - Cf • Using the quadratic formula: D’ = - [ ( a / b ) - Cv ] + { [ (a / b ) - Cv ] 2 - ( 4 / b ) ( - Cf ) }1/2 -----------------------------------------------------------------------2/b • Given: Example-Problem 2-8 – Relationship between price and demand is: • D = 780 - 10p (units/month) – Fixed Cost (CF) = $800/month – Variable Cost per Unit (cv) = $30/unit • Assumptions: – All units produced will be sold • Find: – a) D* = number of units produced to maximize profit – b) Maximum profit per month for the product; and – c) Range of profitable demand (production) in units/month • Part a – – – – – Solution Profit = TR - CT = pD - CF – cvD, solving for p: p = 78 - 0.1D Profit = (78 - 0.1D)D - 800 - 30D=48D - 0.1D2 - 800 Take first derivative and set = 0 dProfit/dD = 48 - 0.2D* = 0 D* = 48/0.2 = 240 units/month, or D* = 240 units/month • Part b – Using equation for profit from part a) and D* = 240, Profit = 48D 0.1D2 - 800 – Profit = 48(240) - 0.1(240)2 - 800 = $4,960 – Maximum Profit = $4,960/month • Part c – Breakeven points occur when TR = CT (profit = 0) – Profit = 48D - 0.1D2 - 800 = 0 – = D2 - 480D + 8000 = 0 COST-DRIVEN DESIGN OPTIMIZATION • Must maintain a life-cycle design perspective • Ensures engineers consider: – Initial investment costs – Operation and maintenance expenses – Other annual expenses in later years – Environmental and social consequences over design life COST-DRIVEN DESIGN OPTIMIZATION PROBLEM TASKS 1. Determine optimal value for certain alternative’s design variable 2. Select the best alternative, each with its own unique value for the design variable COST-DRIVEN DESIGN OPTIMIZATION PROBLEM COST TYPES 1. Fixed cost(s) 2. Cost(s) that vary directly with the design variable 3. Cost(s) that vary indirectly with the design variable Simplified Format of Cost Model With One Design Variable Cost = aX + (b / X) + k a is a parameter that represents directly varying cost(s) b is a parameter that represents indirectly varying cost(s) k is a parameter that represents the fixed cost(s) X represents the design variable in question GENERAL APPROACH FOR OPTIMIZING A DESIGN WITH RESPECT TO COST 1. Identify primary cost-driving design variable 2. Write an expression for the cost model in terms of the design variable 3. Set first derivative of cost model with respect to continuous design variable equal to 0 4. Solve equation in step 3 for optimum value of continuous design variables 5. For continuous design variables, use the second derivative of the cost model with respect to the design variable to determine whether optimum corresponds to global maximum or minimum. PRESENT ECONOMY STUDIES • Rules for comparing alternatives for one year or less (time on money is irrelevant) • Rule 1 – Revenues and other economic benefits are present and vary among alternatives – Choose alternative that maximizes overall profitability based on the number of defect-free units of output • Rule 2 – Revenues and economic benefits are not present or are constant among alternatives – Consider only costs and select alternative that minimizes total cost per defect-free output PRESENT ECONOMY STUDIES • Total Cost in Material Selection – Selection among materials cannot be based solely on costs of materials. Frequently, change in materials affect design, processing, and shipping costs Example • After machining, the finished volume of a certain metal part is 0.17 cubic inch • Data for two types of metal being considered for manufacturing the part are given below: • Determine the cost per part for both types of material and recommend which material to use • Brass: Solution • Labor: (0.64 min/pc)($12.00/hr)(1 hr/60 min) = $0.128/pc • Material: ($0.96/lb) (0.31 lb/ in3 ) (0.3 in3 ) -(0.3 in3 / pc - .17 in3 / pc)($0.24/lb)(0.31 lb/in3)= $0.079/pc • Total Cost = $0.207/pc • Aluminum: • Labor: (0.42 min/pc)($12.00/hr)(1 hr/60 min) = $0.084/pc • Material: ($0.52/lb - $0.00/lb)(0.10 lb/in3) (0.45 in3)= $0.023/pc • Total Cost = $0.107/pc • (Choose Aluminum to minimize total cost) PRESENT ECONOMY STUDIES • Alternative Machine Speeds – Operate at different speeds, resulting in different rates of product output – Lead to present economy studies to determine preferred operating speed PRESENT ECONOMY STUDIES • Make Versus Purchase Studies • if: • Direct, indirect or overhead costs are incurred regardless of whether the item is purchased from an outside supplier, and • The incremental cost of producing the item in the short run is less than the supplier’s price • The relevant short-run costs of the make versus purchase decisions are the incremental costs incurred and the opportunity costs of resources Example • The company is currently purchasing a part and is considering manufacturing the part in-house • This company is not operating at full capacity, and no other use for the excess capacity is contemplated • Unit costs are given below: • Should the part be made in-house or purchased? Solution • Assumptions: • Utilizing the excess capacity has no opportunity costs • This product will not change fixed overhead for the plant • Solution: Focus on differences - what really changes? • The incremental cost to make the product in-house is actually $3.75 per unit versus $7.50 to purchase Next Agenda • Concentrate on the concepts of moneytime relationships and economic equivalence • Consider the time value of money in evaluating the future revenues and costs associated with alternative uses of money

Cost Concepts and the Economic Environment, Part 2

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