Chapter 2 Summary

Chapter 2: Engineering Cost and Cost Theory
1. Engineering Cost: Understanding engineering costs is fundamental for economic analysis in

engineering projects. This chapter defines essential cost concepts, including fixed and
variable costs, marginal and average costs, sunk and opportunity costs, recurring and
nonrecurring costs, and incremental cash costs.
2. Major Risks in Large-Scale Projects: One major risk in private sector development projects,
such as pipelines, is accurately estimating costs. Additionally, volatile energy prices and
uncertain demands pose significant risks. Projects must compete for private investors' capital
with other global investment opportunities.
3. Fixed, Variable, Marginal, and Average Costs: Fixed costs remain constant regardless of the
level of activity, while variable costs depend on the level of output. Marginal cost is the cost
for producing one more unit, and average cost is the total cost divided by the number of
units.
4. Sunk Costs: Sunk costs are expenses already incurred due to past decisions and should be
ignored in economic analysis as they cannot be changed.
5. Opportunity Costs: Opportunity costs are associated with using resources in one activity
instead of another. They represent the benefit forgone when resources are used in a
particular way.
6. Recurring and Nonrecurring Costs: Recurring costs occur at regular intervals and can be
estimated, while nonrecurring costs are irregular and may be challenging to anticipate.
7. Incremental Costs: Economic analysis focuses on the differences between competing

alternatives, emphasizing incremental costs.
8. Cost Estimating: Cost estimating is essential for future-focused engineering economic

analysis, involving estimates of various parameters like purchase costs, annual revenue,
maintenance, interest rates, labor costs, etc.
9. Short-Term Production Cost Theory: This section covers concepts related to cost functions,
average cost, marginal cost, break-even point, and closure point.
10. Long-Term Production Cost Theory: In the long run, all production factors are variable,
leading to the analysis of long-term total cost, long-run average cost, long-run marginal cost,
and returns to scale.
11. Long-Term Supply Function: In the long run, the firm can choose to stay in the industry or
exit based on profit maximization. The relevant part of the long-run supply curve is
determined by the firm's marginal cost and average cost.
Formulas:
1. Fixed Costs (FC):
 No mathematical rule, as they remain constant regardless of output.
2. Variable Costs (VC):
 VC = f(Q) where Q is the quantity of output, and f(Q) is a function that describes the
relationship between variable costs and quantity.
3. Marginal Cost (MC):
 MC is the derivative of the total cost function with respect to quantity:
 MC = dTC / dQ
4. Average Cost (AC):
 AC is the total cost divided by the quantity of output:
 AC = TC / Q
5. Sunk Costs:
 No mathematical rule; they are costs incurred in the past.
6. Opportunity Cost:
 Opportunity cost depends on the specific context and alternatives, so there is no

fixed mathematical rule.
7. Recurring Costs:
 Recurring Cost = ∑ (Cost per Period), where the sum is taken over regular intervals.
8. Nonrecurring Costs:
 There's no general mathematical rule as nonrecurring costs depend on specific

expenses and timing.
9. Incremental Costs:
 The focus is on the cost difference between two alternatives:
 Incremental Cost = Cost of Alternative A - Cost of Alternative B
10. Cost Estimating:
 No specific mathematical rule; it involves various estimation methods based on the

type of cost being estimated.
11. Short-Term Average Total Cost (ATC):
 ATC = TC / Y, where Y is the quantity of output.
12. Short-Term Marginal Cost (MC):
 MC is the derivative of the short-term total cost function with respect to quantity,
similar to MC in general economics.
13. Break-Even Point (BEP):
 BEP = Fixed Costs / (Price - Variable Costs), a simple equation to determine the point
where revenue equals expenses.
14. Closure Point:
 The closure point depends on the cost and revenue structure of the business and
may vary.
15. Long-Term Average Cost (LRTAC):
 LRTAC = LRTC(Y) / Y, where Y is the quantity of output in the long run.
16. Long-Term Marginal Cost (LRMC):
 LRMC = δLRTC(Y) / δY, representing the change in long-run total cost with a change
in quantity in the long run.

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Chapter 2: Engineering Cost and Cost Theory

1. Engineering Cost: Understanding engineering costs is fundamental for economic analysis in

7. Incremental Costs: Economic analysis focuses on the differences between competing

8. Cost Estimating: Cost estimating is essential for future-focused engineering economic

1. Fixed Costs (FC):

 No mathematical rule, as they remain constant regardless of output.

2. Variable Costs (VC):

 MC is the derivative of the total cost function with respect to quantity:

4. Average Cost (AC):

 AC is the total cost divided by the quantity of output:

 No mathematical rule; they are costs incurred in the past.

 Opportunity cost depends on the specific context and alternatives, so there is no

 There's no general mathematical rule as nonrecurring costs depend on specific

 The focus is on the cost difference between two alternatives:

 Incremental Cost = Cost of Alternative A - Cost of Alternative B

10. Cost Estimating:

 No specific mathematical rule; it involves various estimation methods based on the

11. Short-Term Average Total Cost (ATC):

 ATC = TC / Y, where Y is the quantity of output.

12. Short-Term Marginal Cost (MC):

13. Break-Even Point (BEP):

14. Closure Point:

 LRTAC = LRTC(Y) / Y, where Y is the quantity of output in the long run.

16. Long-Term Marginal Cost (LRMC):

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