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Engineering Economics helps in the study of economic principles and its application from a behavioral point of view. It deals with the economic decision-making process of individuals and firms and proposes feasible solutions to the engineering problems related to the operations of an organization.
The concept of cost is very vital to the study of engineering economics. It is used in various contexts and has different meanings. The term cost can be used in engineering economics in the following ways:-
- Fixed And Variable Cost,
- Average and Marginal Cost,
- Opportunity and Sunk Cost, and
- Explicit and Implicit Cost.
Fixed and Variable Cost:
Fixed Costs refer to those costs that are not affected due to any change in the volume of production. These costs are incurred on the fixed factors of production such as land, labor, capital, etc. These costs are generally experienced in the short run. Fixed costs are also called indirect costs.
Examples of fixed costs are rent, insurance premiums, salaries of permanent workers, and depreciation of machinery and equipment.
Variable Costs are those costs that are directly related to any change in the volume of production. In the long run, all costs are variable in nature. Variable costs are also called direct costs.
Examples of variable costs are costs incurred on raw materials, power, fuel, direct labor, etc.
The sum of fixed and variable cost represents the total costs incurred by a firm.
Average and Marginal Cost:
Average Costs refers to the cost per unit incurred due to the production of a good. These are found by dividing the total costs of the firm with the quantity produced.
Marginal costs refer to the net addition to total costs by producing an additional output unit. These are found by taking the derivative of the total cost changes with respect to changes in output. Marginal costs are only affected by changes in variable costs and not fixed costs.
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