Section 2

Background:

• In principle, economics deals with the interactions between men and wealth, how individual/firm/nation make choices on allocating scarce resources to satisfy their unlimited wants.

• Engineering is concerned with maximizing the benefit from the wealth or natural resources, or find cost-effective ways to achieve a target.

• Thus, the objectives of economics and engineering works are almost similar and linked.

Section 2

1

Topic:Fundamentals and concepts of Economic theories

Economy and Economics

2

Economy• An economy is the activities related to the

production, exchange, saving, distribution and consumption of goods and services in a particular geographic region.

• An economy also consists of the economic systems of a country or other area; the labor, capital, land resources and manufacturing, trade and investment of goods of that area.

• Economy is the condition of wealth, goods and services whereas Economics is the subject which deals with economy.

3

Economics• Economics is the science (social science) that analyzes the

production, distribution, and consumption of goods and services.

• Economic analysis may be applied throughout society, as in business, finance, health care, and government, but also to such diverse subjects as, crime, education, the family, law, politics, religion, social institutions, war, science and engineering.

• Economics explains how people interact within markets to get what they want or accomplish certain goals.

• The following are the economic goals. • A high level of employment • price stability • efficiency • an equitable distribution of income and • growth

Economics and Finance

4

• Finance is the science that describes the management of money, banking, credit, investments, and assets.

• Basically, finance looks at anything that has to do with money and market.

• Generally, finance focuses on the study of prices, interest rates, money flows and financial markets.

• Finance is the study of how investors allocate their assets over time under conditions of certainty and uncertainty

• Economics and finance are interrelated, and inform and influence each other.

5

Economic Efficiency

• Economic efficiency is the ratio of output to input of a business system.

• Worth is the annual revenue generated by way of operating the business and

• Cost is the total annual expenses incurred in carrying out the business.

• For the survival and growth of any business, the economic efficiency should be more than 100%.

• Economic efficiency is also called productivity.

100100(%) Cost

Worth

Input

OutputEfficiencyEconomic

6

• There are several ways of improving productivity. Increased output for the same input

Decreased input for the same output

By a proportionate increase in the output which is more than the proportionate increase in the input

By a proportionate decrease in the input which is more than the proportionate decrease in the output.

Through simultaneous increase in the output with decrease in the input

Demand and Supply • Supply and demand are the most fundamental tools

of economic analysis.

• Supply and demand is also considered as a basic economic concept, as well as a vital part of a free market economy

• The market price of an item is determined by both supply and demand of that item.

• The relationship between supply and demand has a good deal of influence on the price of goods and services.

7

8

Demand

• Demand represents how much (quantity) of an item (product or service) is desired by buyers.

• Demand is the amount of the product or service that buyers want to purchase.

• The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time.

Supply

• Supply is the amount of something, such as a product or service, that a market has available.

• Supply is defined as the quantity of a product that a producer is willing and able to supply onto the market at a given price in a given time period.

Demand curve• Graphical presentation of quantity demanded of a good

versus price is termed as demand curve. • In economics, the demand curve is the graph depicting the

relationship between the price of the good and the amount or quantity of it.

• The demand curve indicates negative relationship between price and quantity.

9

0

2

4

6

8

0 20 40 60 80

Quantity demanded

Pri

ce

Law of demand• In economics, the law of demand is an economic law, which

states that consumers buy more of a good when its price is lower and less when its price is higher, if other factors remaining constant.

• The Law of demand states that the quantity demanded and the price of a commodity are inversely related.

• This is Because, the price of a good or service increases, consumer demand for the good or service will decrease and vice versa.

• This law summarizes the effect price changes have on consumer behavior. For example, a consumer will purchase more pizzas if the price of pizza falls. The opposite is true if the price of pizza increases.

10

Supply curve• In economics, supply curve is the graphic representation of

the relationship between product price and quantity of product that a seller is willing and able to supply.

• Product price is measured on the vertical axis of the graph and quantity of product supplied on the horizontal axis.

• The supply curve shows an upward slope, meaning that the higher the price, the higher the quantity supplied.

11

0

2

4

6

8

0 20 40 60 80

Quantity supplied

Pri

ce

Law of Supply

• The law of supply is a fundamental principal of economic theory which is that quantities respond in the same direction as price changes.

• In other words, the law of supply states that (all other things unchanged) an increase in price results in an increase in quantity supplied.

• This happens because at a higher price, the producer will earn more revenue by selling higher quantity.

• This law describes the behaviour of producers.

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Relationship between demand and supply• The relationship between demand and supply underlies the

forces behind the allocation of resources. • In understanding market forces, supply and demand refers the

concept of need and supply of goods and services in the market.

• The law of demand states that, if all other factors remain equal, the higher the price of a product, the less people will demand that product or good.

• Therefore, the higher the price, the lower the quantity demanded.

• The amount of goods that consumers purchase at a higher price is less because as the price of goods increase, so does the opportunity cost of buying that product.

• As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else that they value more. 13

Market Equilibrium• According to principles of economics, when the supply and

demand curves intersect, the market is in equilibrium. • This is where the quantity demanded and quantity supplied

is equal.• The corresponding price is the equilibrium price or market-

clearing price, the quantity is the equilibrium quantity.

14

Demand Supply

0

2

4

6

8

0 20 40 60 80

Quantity

Pri

ce

of g

oo

d (

$)

Cost• Cost is an amount that has to be paid or given up

in order to get something.• In business and accounting, cost is the monetary

value that a company has spent in order to produce something.

• The term costs refers the monetary value of expenditures for raw materials ,supplies, services, labor, products, equipment and other items purchased for use by a business or other accounting entity.

• It does not include the mark-up for profit. • The term “cost estimating” is frequently used to

describe the process by which the present and future cost consequences of engineering designs are forecast.

15

Revenue• Revenue is the total amount of money received by the

company for goods sold or services provided during a certain time period.

• It also includes all net sales, exchange of assets; interest and any other increase in owner's equity and is calculated before any expenses are subtracted.

• Revenue = cost + profit or net benefit (for a period of time)

• It is the "top line" or "gross income" figure from which costs are subtracted to determine net income.

• In the case of government, revenue is the money received from taxation, fees, fines, inter-governmental grants or transfers, securities sales, mineral rights and resource rights, as well as any sales that are made.

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Cost Curve• In economics, cost curve is the graphical presentation of the

costs of production as a function of total quantity produced.• Total cost is the cost of producing some output at some

particular rate. • Average cost is the cost per unit item.

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0

100

200

300

0 2 4 6 8 10

Quantity produced (nos)

Cos

t ($)

Total cost

Av.cost

Revenue Curve• Revenue curve or benefit curve is the graphical presentation

of the revenue obtained from the quantities produced. • The vertical difference between cost curve and revenue curve

represents the net financial benefit

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Total benefit

0

100

200

300

400

500

0 2 4 6 8 10 12

Quantity produced

Tot

al c

ost o

r be

nefit

Total cost

• The net benefit is the difference between total cost and total income or revenue, i.e.

Net benefit = total revenue - total cost

• Maximum net benefit can be determined by constructing cost and revenue curve, and measuring the vertical difference between them.

• The cost and revenue curves help in identifying input condition for maximizing net benefit

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Components of total cost

Main steps in cost estimation are:

- To identify the cost components

- To identify approach/technique of cost estimation

Total cost of production of a particular item can be

divided into two portions:

(i) Fixed cost, and

(ii) Variable cost

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Fixed Cost• Fixed cost is the portion of the total cost that requires

regardless of the amount of production.

• Fixed costs are those costs which are unaffected (remain constant) due to change in activity level within the capacity.

Examples are - licence fee, rent of the office building, tax and insurance of facilities, different types of salaries etc.

Variable Cost• Variable costs are those costs which vary directly with the

activity level or quantity of output.

• It increases with the increase in production, and decreases with the decrease in production.

Examples are labour cost, interest on running capital, etc.

• Fixed costs and variable costs comprise total cost. 21

22

Classification of Cost• There are several types of costs that a firm may consider

relevant under various circumstances.

• For the purposes of decision-making, it is essential to know the fundamental difference between the main cost concepts along with the conditions of their use in decision-making.

• Such costs include: direct costs indirect costs opportunity costs sunk costs fixed costs variable costs standard costs private costs social costs common costs, etc.

Economic consideration

• For economic production process, one must use the least costly combination of inputs for a particular level of output.

• The optimum mix of output achieves for a given level of benefits at least cost, or

• In other word, the maximum level of benefit for a given level of cost.

• In economic terms, the cost of a scarce resource (e. g. water) has two broad components:

the cost of its provision [including both fixed (investment) and variable costs (operation and maintenance)], and

its opportunity cost, or the production value forfeited/offered in alternate use

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Opportunity cost• Opportunity cost is the sacrifice related to the

second best choice available to someone.

• It is monetary advantage/gain of a resource in an alternative uses.

• Under resource limiting condition, opportunity cost need to be considered when comparing alternative options.

• Consider a student who could earn $20,000 for working during a year, but chooses instead to go to school for a year and spend $5,000 to do so. The opportunity cost of going to school for that year is $25000: $5,000 cash outlay and $20,000 for income foregone. 24

Additional cost

• In addition to, initial or first cost, running cost, semi variable costs, future costs, accounting costs. Incremental cost, recurring cost, non-recurring cost and environmental cost of the resource should also be taken into account.

• These costs are real and unavoidable, and someone have to pay - the user, the taxpayer or future generations.

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Initial cost or first cost

• It is the installed cost of the asset including purchase price (including tax, if applicable), carrying, installation fees, and other costs (direct and indirect) required to make ready the asset for use/production.

Running cost

• It is cost required to operate/run the system and keep in service/production.

• The amount regularly spent to operate an organization, used for things such as salaries, utilities, and rent.

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Project cost element - example

27

Project Cost elements

First cost / Initial cost Running cost

Dam - Cost for land

acquisition

(lease/acquire, if

needed)

- Construction cost

- Cost for sluice gate

- Installation cost of

sluice gate

- Maintenance cost

- Salary for sluice gate

operator

- Opportunity cost of the

catchment area (to be

flooded) (if applicable)

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Project Cost elements

First cost / Initial cost Running costHydro-electric power plant

- Cost for dam

- Plant/Equipment cost

- Delivery charges of the equipment

- Import tax (if applicable)

- Cost for water intake pipe

- Installation and in-house training cost

- Salary of staffs- Maintenance/repair

cost- Stand-by generator

cost- Upgrading cost (if

applicable)

- Opportunity cost of the catchment area (to be flooded) (if applicable)

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Cost Factor Site A Site BAverage hauling distance 6 miles 4.3 milesMonthly rental of site RM1000 RM5000Cost to set up and remove equipment

RM15000 RM25000

Hauling expense RM1.15/yd3-mile

RM1.15/yd3-mile

Plagperson Not required RM96/day

Example 1In connection with surfacing a new highway, a contractor has a choice of two sites on which to set up the asphalt-mixing plant equipment. The contractor estimates that it will cost RM1.15 per cubic yard per mile (yd3/mile) to haul the asphalt-paving materials from the mixing plant to the job location. Factors relating to the two mixing sites are as follows in Table. The job requires 50,000 cubic yards of mixing-asphalt-paving materials. It is estimated that four months (17 weeks of five working days per week) will be required for the job. Compare the two sites in terms of their fixed, variable, and total costs. Assume that the cost of the return trip is negligible. Which is the better site?

Table

Components of total revenue

Direct revenue• The revenue earned in routine business activities is

known as direct revenue e.g. sales.• Direct revenue comes from interest on loans and

fee income.

Indirect revenue• Indirect revenue is revenue earned through

external affiliate programs which is paid periodically.

• Monthly deposits generate indirect revenue.

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Cost and revenue function curve

Cost function• In mathematically, the relationship between cost and input

variable is termed as cost function. • The cost function is a function of input prices and output

quantity.• Its value is the cost of making that output given those input

prices.

Revenue function

• Similarly, relationship between revenue and input variable is known as revenue function.

• A revenue function R(x) is set up as follows: R(x)=( price per unit) x (number of units produced or sold)

• When they are plotted in graph, they are called cost and revenue curve, respectively.

31

Benefit-cost ratio (BCR)• Benefit-Cost ratio is the ratio of total benefit (B) to the

total cost involved (C). • The benefit-cost ratio is computed by dividing the annual

benefit by the annual cost. • A benefit-cost ratio is an indicator, used in the formal

discipline of cost-benefit analysis that attempts to summarize the overall value for money of a project or proposal.

• A benefit-cost ratio greater than 1.0 is considered economically justified.

• If B/C <1.0, the project is not economically acceptable.• In calculating benefit-cost ratio, all pertinent costs and

associated benefits should be taken into account. 32

C

BBCR

33

Example 2

The total annual cost for a medium size irrigation project of the region of Kedah is RM134,100,000. The annual net benefit for the project considering the pre and post irrigation facilities is found to be RM224,300,000. Calculate the benefit-cost ratio for the project. Is this project is economically viable?

Marginal cost and benefit

Marginal cost • Marginal cost measures the change in cost over the change

in quantity (or activity). • Marginal Cost is governed only by variable cost which

changes with changes in output. • Marginal cost which is really an incremental cost can be

expressed in symbols.

That is:

34

Q

CM c

where,Mc = Marginal cost

ΔC = Change in cost corresponding to change in quantity produced (Change in total cost)

ΔQ = Change in quantity produced (Change in output)

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Units of Output Total Cost (Dollars) Marginal Cost (Dollars)

1 5 5

2 9 4

3 12 3

4 16 4

5 21 5

6 29 8

Table

Exercise:

The total cost of producing one pen is $5 and the total cost of producing two pens is $9, then the marginal cost of expanding output by one unit is $4 only (9 - 5 = 4). The marginal cost of the second unit is the difference between the total cost of the second unit and total cost of the first unit. The marginal cost of the 5th unit is $5. It is the difference between the total cost of the 5th unit and the total cost of the 4th unit and so forth.

36

Example 3

The cost of production of 100 tons of cement is RM 15000 and it is RM 16000 for 110 tons. What is the marginal cost of production?

Marginal benefit • Marginal benefit is a measure of the change in benefits

over the change in quantity. • Marginal benefit is basically the extra amount a person

is willing to pay for a product.• That is, at each level of production, the marginal benefit

refers any additional or reduced benefits incurred for the production of next unit.

For example, assume there is a consumer wishing to purchase an additional burger. If this consumer is willing to pay $10 for that additional burger, then the marginal benefit of consuming that burger is $10. The more burgers the consumer has, the less he or she will want to pay for the next one. This is because the benefit decreases as the quantity consumed increases.

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Cost estimation

Importance of cost estimation• Cost estimation is the iterative process of developing an

approximation of the monetary resources needed to complete project activities.

• Accurately forecasting the cost of future projects is vital to the survival of any business or organization planning future construction.

• Cost estimating is one of the most important steps to establish the base line of the project cost at different stages of development of the project.

• The managers, professional design team members, business owners or construction contractors need cost information to make budgetary and feasibility determinations. 38

Elements of a Cost Estimate

Project teams should estimate costs for all resources that will be charged to the project. The elements are as follows:

• Quantities of various materials required• Labour hours• Labour rate • Material prices• Equipment cost• Subcontractor quotes• Software cost• Hardware cost• Indirect cost

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Direct and Indirect Costs

Direct Cost• The direct or traceable or assignable costs are the ones that

have direct relationship with a unit of operation like a product, a process or a department of the firm.

• In other words, the costs which are directly and definitely identifiable are the direct costs.

Indirect cost• The indirect or no traceable or common or non-assignable

costs are those whose course cannot be easily and definitely traced to a plant, a product, a process or a department.

• For example, in operating railway services the cost of station, track, equipment, staff, etc., cannot be assigned to either passenger or goods transportation; these are indirect costs.

40

41

• Indirect costs consist of labour, material, and equipment items required to support the overall project.

• For the owner: Design fees, permits, land acquisition costs, legal fees, administration costs, etc.

• For the contractor and subcontractor: Mobilization, staffing, on-site job office, temporary construction, temporary utilities, equipment, small tools and consumables, etc.

Factors affecting cost and return

• All the cost components can affect the total cost.

• In addition, the ‘time’(due to time value of money) and inflation or deflation can affect the total cost of a project.

• Similarly, the ‘time’ and inflation/deflation can affect the total return of a project.

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Factors affecting value of money

The factors affecting value of money include:

• Time

• Interest rate

• Inflation/deflation

• Local/regional/international economy

• Supply of goods/services and their price

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Value of money

• Value of money is influenced by time. We all will agree that 100 dollar today is better than 120 dollar 20 years later.

• Supply of goods and/or services and their price temporarily increase or decrease the value of money (called temporary effect or local effect).

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Inflation • Inflation is defined as a sustained increase in the

general level of prices for goods and services.

• Inflation means that the cost of an item tends to increase over time, or, to put in another way, the same dollar amount buys less of an item over time.

• It is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.

• It is measured as an annual percentage increase. 45

46

Two types of inflation rate. They are:

• General inflation rate ( )

• Specific inflation rate or average inflation rate ( )

The general inflation rate ( ) can be calculated with the following equation:

f

jf

f

1

1

n

nn

CPI

CPICPInf

nf where = the general inflation rate = the consumer price index at the end period n = the consumer price index at the base periodn = the end period

nCPI

1nCPI

47

The specific inflation rate ( ) can be defined with the following equation:

jf

1

1

0

nn

j CPI

CPIf

where

= the specific inflation rate

= the consumer price index at the end period

= the consumer price index for the base period

n = the year

nCPI

0CPI

jf

48

Example 4

The following Table shows a utility company’s cost to supply a fixed amount of power to a new housing development; the indices are specific to the utilities industry. Assume that year 0 is the base period. Determine the inflation rate for each period, and calculate the average inflation rate over the 3 years.

Year Cost (RM)0 504,0001 538,4002 577,0003 629,500

Deflation• A general decline in prices, often caused by a

reduction in the supply of money or credit.

• Deflation is the opposite of inflation.

• It occurs when the inflation rate falls below 0% (a negative inflation rate).

• Deflation can be caused also by a decrease in government, personal or investment spending.

• Deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

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Economic life or effective life ‘Effective life’ or ‘effective service life’ or ‘economic

life’ or ‘economic service life’ of an asset • It is the life-span (number of years) of an

asset/goods during which it can provide its intended service/production with economic efficiency (i.e. reasonable service/production without much maintenance or updating cost).

• The point where the total cost is minimum is called the economical life of an asset.

• Estimating the economic life of an asset is important for businesses.

• The concept of economic life is relevant in both replacement and new investment studies. 50

• The economic life of an asset is determined by the period of time the asset will provide the lowest cost of service compared to other alternatives.

• In numeric term, it is the number of years up to the minimum annual worth (AW) of costs.

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0

1

2

3

4

5

6

7

8

1 2 3 4 5 6 7 8 9 10 11

AW

of

cost

('0

00 $

)

yearEconomic service life

52

• The economic life is also referred to as the economic service life or minimum cost life.

• When n years have passed, the economic life indicates the asset should be replaced to minimize overall costs.

• To perform a replacement study correctly, it is important that the economic life of the defender be determined, since their n values are usually not pre established.

• The economic life of an asset is determined by calculating the total annual worth (AW) of costs if the asset is in service 1 year, 2 year, 3 year, and so on, up to the last year the asset is considered useful.

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• Total AW of cost is the sum of capital recovery (CR), which is the AW of the initial investment and any salvage value, and the AW of the estimated annual operating cost (AOC), that is,

Total AW = - capital recovery – AW of annual operating costs

= - CR – AW of AOC

• The economic life is the n value for the smallest total annual worth (AW) of costs. The AW values are cost estimates, so the AW values are negative numbers.

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The economic life or effective life of various engineering structures is as follows:

No. Engineering Structure or Asset

Economic or effective life (Year)

1 RCC Road 15 - 182 Asphalt/bituminous Road 18 -203 RCC Bridge 75 - 1004 Brick/cement concrete canal 15 - 255 RCC Building 75 - 1006 Water Supply Pump 25 - 407 Steel structure (bridge, column

beam etc)50 - 100

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Example 5

A firm is considering replacement of equipment, whose first cost is RM 4000 and the scrap value is negligible at the end of any year. Based on experience, it was found that the maintenance cost is zero during the first year and it increases by RM 200 every year thereafter. Determine the economic life of the equipment. When should the equipment be replaced if interest (i) is 0%?

Tax• Income tax• Tax is to impose a financial charge or other levy upon a

taxpayer (an individual or legal entity) by a state or the functional equivalent of a state such that failure to pay is punishable by law.

• A tax is not a voluntary payment or donation, but an enforced contribution imposed by government.

• Income tax is the amount of taxes based on some form of income or profit levied by government.

• For individuals, private farm, or corporation, income is taxable.

• Tax rate for each country/state varies, normally incremental tax rate with the increase in income.

• For public (Govt.) works or projects, income/revenue is not taxable. 56

• Tax rate is a percentage, or decimal equivalent, of taxable income owed in taxes.

• The tax rate is graduated; that is, higher rates apply as taxable income increases.

Taxes = Taxable income (TI) x applicable tax rate (T)

= (TI) (T) • Tax should be deducted from the income for that year, as:

Operating cash flow = Gross profit – Tax

• Tax for imported items• Tax may also be charged on imported (foreign) items for

capital item or operating inputs. In that case, the price or cost of the item should be taken as the sum of actual/cited price and tax.

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Calculation of income tax

• Tax should be calculated on ‘taxable income’. • Taxable income (TI) is the amount upon which

income taxes are based.• For corporation, depreciation D and operation

expenses E are tax-deductible

Taxable income (TI) = gross income – expenses - depreciation

= GI – E - D• ‘Depreciation’ of the capital items is a cost, and that

should be deducted from the gross income.

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Depreciation

• Depreciation means reduction in value of an asset due to age and/or uses. After some uses, the originality of an asset (e.g. building, instrument, car, etc.) is decreased, and consequently the value is decreased.

• It declines the market value of an asset• Depreciation is important in economic analysis primarily

because it is used for income-tax computation purposes.

• Two types of depreciation are commonly used (application based) for the purpose of describing the reduced asset value:

– Tax depreciation– Book depreciation

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Tax depreciation • Tax depreciation is term used to describe the

purpose for reducing asset value.

• It is used for after-tax economic analysis.

• In many industrialized countries, annual depreciation of the assets of the industry/ company/ corporation is tax deductable (termed as ‘tax depreciation’).

• Tax depreciation is deducted from the income when computing tax.

• Tax depreciation must be calculated using government approved method/ guidelines/rules.

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Book depreciation

• Book depreciation is a term that refers to the decline in value of a capital good specifically for tax purposes.

• Book depreciation is used by company, corporation, organization, and business-farm for their internal financial accounting.

• It is the reduction of value/price of the asset based upon the usages pattern and effect/productive life of the asset.

• The book depreciation of an asset results in tax-deductible benefits that will save the company money.

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Calculation of Book depreciation

Straight line method• Straight line method is considered the standard

against which other depreciation methods are compared.

• The straight-line method provides the easiest computation for an asset's depreciation.

• The life of the equipment and its residual value are estimated when it is purchased.

• According to this method, the value of an asset decreases linearly with time. That is, the annual depreciation amount is constant throughout its effective life or recovery period.

62

Straight line method

• The formula for calculating annual straight line depreciation is

Annual

where

DSL= annual depreciation charge

F = first cost of the asset,

S = salvage value of the asset,

n = the effective life or economic life of the asset in year.

63

n

SFDDep SLSL

• The formula for depreciation and book value are as follows:

where

BVt = book value of the asset at the end of the period t

t = year

64

𝐵𝑉𝑡 = 𝐹− (𝐹− 𝑆𝑛 ) × 𝑡

65

Example 6

A company has purchased an equipment whose first cost is RM 100,000 with an estimated life of eight years. The estimate salvage value of the equipment at the end of its lifetime is RM 20,000. Determine the depreciation charge and book value at the end of various years using the straight line method of depreciation.

66

Example 7

The initial cost of an asset is RM 12000, the expected economic life is 20 years, and salvage value is expected to RM 2000. Calculate the depreciation rate and the value of the asset after 15 years.

Depletion• Depletion is the reduction in value of natural resources

occurring with land, such as ground water, coal, oil, mineral, natural gas, or timber.

• The objective of depletion is the same as that of depreciation: to amortize the cost in a systematic manner over the asset’s useful life.

• Depletion is calculated for tax-deduction and bookkeeping purposes

There are two methods (types) available for calculating depletion:

- cost depletion, and

- percentage depletion.

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Cost depletion

• Cost depletion, also called factor depletion is based on the level of activity or usage not time as in depreciation.

• It may be applied to most types of natural resources.

• The cost depletion factor (pt) for a particular year t, is:

• Annual depletion cost,

• The annual cost depletion for some common natural resources are timber, oil, gas wells, ground water and so on.

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𝑝𝑡 = 𝑓𝑖𝑟𝑠𝑡 𝑐𝑜𝑠𝑡𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑜𝑟 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑖𝑙𝑖𝑡𝑦

𝐴𝑡 = 𝑝𝑡 × (𝑦𝑒𝑎𝑟′𝑠 𝑢𝑠𝑎𝑔𝑒 𝑣𝑜𝑙𝑢𝑚𝑒)

Percent depletion

• Percentage depletion, the second depletion method, is a special consideration given for certain mineral properties.

• The percentage depletion is an allowance of a percentage of the gross income from the property.

• For given mineral property, the depletion allowance calculation is based on a prescribed percentage of the gross income from the property during the tax year.

• The annual depletion amount is calculated as

• The annual percentage depletion for some common natural deposits are Sulfur, uranium, lead, nickel, gold, silver, copper and so on.

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𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝑑𝑒𝑝𝑙𝑒𝑡𝑖𝑜𝑛 𝑎𝑚𝑜𝑢𝑛𝑡 = 𝑝𝑒𝑟𝑐𝑒𝑛𝑡× 𝑔𝑟𝑜𝑠𝑠 𝑖𝑛𝑐𝑜𝑚𝑒 𝑓𝑟𝑜𝑚 𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑦

Salvage value

• Salvage value (SV) is the estimated value of a property at the end of its useful life.

• It is the expected selling price of a property when the asset can no longer be used productively by its owner.

• The value is used in accounting to determine depreciation amounts and in the tax system to determine deductions.

• In economics, commerce or accounting, salvage value is an important concept.

• Calculating salvage value is an important part of asset management, as well as tax calculation.

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Example 8

The following estimated element costs for a proposed engineering project are as given in Table. Determine the cost of the proposed project.

Table

No. Cost Amount (RM)1 Instrument cost 252002 Instrument installation &

Training5100

3 Operation & maintenance cost for the effective life

22200

4 Indirect cost 200005 Opportunity cost for the

land resource 10100

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Example 9

A dam has been proposed to build in a hilly remote area to supply water for agricultural purposes. The cost of construction (initial cost), if spread out to its effective life, becomes RM 3000 per annum. The operating cost of the project is expected to RM 2000 per annum, and the opportunity cost of the land resources used for dam construction is about RM 500 per annum. The yearly water supply capacity of the dam is 5 x 104 m3. The government has decided to operate the system as “no profit - no loss” principle; that is, the total cost must be recovered from the sale value of the water. What would be the price of unit volume of water to satisfy the above condition?

Some relevant economic terms

GDP (Gross Domestic product)• Gross domestic product (GDP) refers to the market value of

all officially recognized final goods and services produced within a country in a given period.

• GDP is usually calculated on an annual basis.• It is commonly used as an indicator of the economic health

of a country, as well as to gauge a country's standard of living. 

• It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. 

• Malaysia Gross Domestic Product is worth 278.67 billion US dollars or 0.45% of the world economy in 2011, according to the World Bank. 73

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Gross domestic product (GDP) is calculated as

GDP = C + G + I + NX

where:

C is equal to all private consumption, or consumer spending, in a nation's economyG is the sum of government spendingI is the sum of all the country's businesses spending on capitalNX is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports).

GNP (Gross National Product)

• GNP is an economic statistic or indicator that includes GDP, plus any income earned by residents from overseas investments, minus income earned within the domestic economy by overseas residents.

GNP = GDP + resident’s overseas earns – overseas resident’s earn within country

• GNP is a measure of a country's economic performance, or what its citizens produced (i.e. goods and services) and whether they produced these items within its borders.

• Malaysia Gross National Product is worth 438.25 billion US dollars in 2011, according to the World Bank.

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Economic Growth Rate

• Economic growth rate is a measure of economic growth from one period to another in percentage terms.

• This measure does not adjust for inflation, it is expressed in nominal terms.

• The economic growth rate provides insight into the general direction and magnitude of growth for the overall economy.

• GDP real growth rate in Malaysia 5.2% (2011) 

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𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒= 𝐺𝐷𝑃2 − 𝐺𝐷𝑃1𝐺𝐷𝑃1