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Lecture5

The document discusses key concepts in engineering economics, focusing on the Law of Diminishing Marginal Returns and Break-Even Analysis. It explains how additional variable inputs affect output and outlines the relationship between costs, production volume, and profit in a business context. The Break-Even Point (BEP) is defined as the production level where total costs equal total revenues, resulting in neither profit nor loss, with a formula provided for calculating the break-even quantity.

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Syeda Huda Munir
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10 views

Lecture5

The document discusses key concepts in engineering economics, focusing on the Law of Diminishing Marginal Returns and Break-Even Analysis. It explains how additional variable inputs affect output and outlines the relationship between costs, production volume, and profit in a business context. The Break-Even Point (BEP) is defined as the production level where total costs equal total revenues, resulting in neither profit nor loss, with a formula provided for calculating the break-even quantity.

Uploaded by

Syeda Huda Munir
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Engineering Economics

Lecture 5
The Law of Supply and Demand
The Law of Diminishing Marginal
returns
• The law states that when additional variable input factors are added
to the fixed or limited input factors of production, then in the
beginning the output increases in a relatively larger proportion, but
beyond an output level, such addition of variable inputs will result in a
less than proportionate increase in output.
Break Even Analysis
Every business firm strives to maximize profit. Profit has
a strong relationship with production cost, volume of
production and product price. Therefore, it is necessary
to examine the relationship of profit with these factors.
Breakeven analysis, which is also known as Cost Volume
Profit (CVP) analysis, is an effective method to establish
cost-volume-profit relationship.
Break Even Analysis
Break-even analysis involves the study of revenues and
costs of a firm in relation to its volume of production or
sales. It involves determination of a specific volume at
which the firm’s cost and revenues are equal.
Break-even analysis shows the relation of fixed cost,
variable cost, output volume, selling price, etc., with the
firm’s profit.
This analysis helps the management to understand the
effect of change in fixed cost, variable cost and selling
price on the output or sales volume.
Break Even Analysis Assumptions
The relationship between cost/volume such as fixed cost, variable cost,
etc., and production volume or sales is linear.
Only fixed costs and variable costs are considered in the analysis.
Selling price of the product remains constant at all sales level.
The cost is affected by quantity only.
The rate of increase in variable cost is constant.
Production and sales quantities are equal.
Break Even point
In order to understand the meaning of break-even point
(BEP), we need to draw a break-even chart. A break-even
chart plots cost/revenue against production volume/sales
volume.
To make this chart, production volume/sales volume is
taken on x-axis and cost/revenue is taken on y-axis. Fig.
1.22 shows a typical break-even chart.
It can be seen from Fig. 1.22 that fixed costs, variable costs, revenue are
all linear as they are represented by straight lines, according to the
assumption. Further, the sales/revenue line intersects the total cost line
at a particular point, which is known as break-even point. At this point
total cost is equal to sales/revenue, which means there is no profit.

Thus, break-even point refers to the production volume/sales volume at


which total cost is equal to sales/revenue and hence there is neither a
profit nor a loss. The quantity produced and sold above breakeven
quantity yields profit and below break-even quantity results in loss.
Mathematically, a formula for break-even quantity can be obtained as:
FC represents the fixed costs,
QB is breakeven quantity,
VC is the variable cost, and
TC is total cost which is sum of fixed costs and variable costs.
i.e., TC = FC + VC
R is the revenue.
P is the selling price per unit.
v is the variable cost per unit.
• At break-even point,
• R = TC
• P.QB = FC + VC
• P.QB = FC + v.QB
• QB = FC/(P – v)

Here (P – v) represents the contribution margin per unit. Total contribution can be obtained
by subtracting total variable costs from actual sales, i.e.,
Total contribution = Actual sales – total variable costs

Thus, Break-even quantity = Fixed cost/contribution margin per unit

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