Basic and Engineering Economy Concepts

(Chapter 1 – Lesson 1)

The Economic Environment

Consumer and Producer Goods and Services
Consumer goods and services are those products or services that are directly used by
people to satisfy their wants.
Producer goods and services are used to produce consumer goods and services or
other producer goods.

Necessities and Luxuries

Necessities are those products or services that are required to support human life and
activities that will be purchased in somewhat the same quantity even though the price varies
considerably.
Luxuries are those products or services that are desired by humans and will be
purchased if money is available after the required necessities have been obtained.

Competition, Monopoly, and Oligopoly

Perfect competition occurs in a situation where a commodity or service is supplied by a
number of vendors and there is nothing to prevent additional vendors entering the market.
Monopoly is the opposite of perfect competition. A perfect monopoly exists when a
unique product or service is available from a single vendor and that vendor can prevent the
entry of all others into the market.
Oligopoly exists when there are few suppliers of a product or service that action by one
will almost inevitably result in similar action by the others.

Flow in an Economy
Households and businesses are the two major entities in a simple economy. Business
organizations use various economic resources like land, labor and capital which are provided by
households to produce consumer goods and services which will be used by them. Business
organizations make payment of money to the households for receiving various resources. The
households in turn make payment of money to business organizations for receiving consumer
goods and services. This cycle shows the interdependence between the two major entities in a
simple economy.

Money payments for consumer goods and services

Consumer goods and services

Businesses Households
1. Provide goods and services to 1. Consume final goods and
consumers services provided by businesses
2. Use resources, inputs provided 2. Provide productive inputs to
by households. businesses

Economic resources

Money payments for economic resources

Supply and Demand
Supply is the quantity of a certain commodity that is offered for sale at a certain price at
a given place and time.
Factors influencing supply
1. Cost of inputs
2. Technology
3. Weather
4. Prices of related goods
Demand is the quantity of a certain commodity that is bought at a certain price at a given
place and time.
Factors influencing demand
1. Income of people
2. Prices of related goods
3. Taste of consumers

The Law of Supply and Demand

The law of supply and demand may be stated as follows:
“Under conditions of perfect competition the price at which a given product will be supplied and
purchased is the price that will result in the supply and the demand being equal.”-

Units
Supply

N
Demand

P Price

Concept of Engineering Economy

Engineering economics deals with the methods that enable one to take economic
decisions towards minimizing costs and/or maximizing benefits to business organizations.

The Economic Efficiency

Economic efficiency is the ratio of output to input of a business system.
Output Worth
Economic Efficiency ( % )= x 100= x 100
Input Cost
Where:
Worth is the annual revenue generated by way of operating the business.
Cost is the total annual expenses incurred in carrying out the business.

For survival and growth of any business, the economic efficiency should be more than
100%.
Economic Efficiency is also called “Productivity”. There are several ways in improving
the productivity.
 1. Increase output for the same input
2. Decrease input for the same output
3. Less proportionate increase in output is more than that of the input
4. When proportionate decrease in input is more than that of the output
5. Simultaneous decrease in input and increase in output

Elements of Cost
(Chapter 1 – Lesson 2)

Cost is defined as the monetary value of goods and services that producers and
consumers purchased. Costs can broadly classified into variable cost and overhead cost.
Variable cost is sometimes referred to as the direct cost/prime cost which is directly affected by
the volume of production. Overhead cost is also known as fixed cost which is irresponsive on
the volume of production.

Costs in production are further classified as shown in the figure below.

COST

Variable Cost Overhead Cost

Material Cost Factory Overhead

Labor Cost Administrative Overhead

Direct Expenses Sales Overhead

Distribution Overhead

Components/Elements of Variable Cost

Material Cost. It refers to the cost of material out of which a product is to be produced or
manufactured.
Labor Cost. It refers to the amount paid to the workers who are directly engaged in the
production of goods.
 Direct Expenses. It refers to the expenses that are specifically incurred by the company to
produce a product. A product cannot be produced without incurring such expenses.

Components/Elements of Overhead Cost

Factory Overhead. It includes Indirect Material Cost, Indirect Labor Cost, and Indirect
Expenses. These are cost indirectly associated with the production but are incurred
in the factory during the production.
Administrative Overhead. It is otherwise called Office Overhead. It refers to the expenses
that are incurred in connection with the general administration of the company.
Sales Overhead. It refers to all expenses incurred in connection with sales.
Distribution Overhead. It refers to all expenses incurred in connection with the delivery or
distribution of goods and services from the producer to the consumer.

The selling price of a product is derived as shown below:

Material Cost + Labor Cost + Direct Expenses=Prime Cost
Prime Cost + Factory Overhead=Factory Cost
Factory Cost + Administrative Overhead =Cost of Production
Cost of Production+ SalesOverhead + Distribution Overhead=Cost of Sales
Cost of Sales+ Profit =Sales
Sales
=Selling Price per Quantity
Quantity

In figure:

Cost of Materials Cost of Labor Direct Expenses

Factory Overhead Prime Cost

Factory Cost Administrative Overhead

Sales Overhead Cost of Production Distribution Overhead

Profit Cost of Sales

Sales