Chapter 1

Engineers decisions and

economy

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Objectives
• The student will be able to identify the
selection process between alternatives
associated to technical work
– Distinguish between simple and complex
problems.
– Discuss the role and aim for economic analysis in
engineering
– Describe and identify de 9 phases of decision
process
– Selecting the adequate criteria for each situation.
– Solving simple problems associated with selection
between alternatives in technical frameworks

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 Index
• Introduction
1. Typology of problems
1. Simple Problems
2. Intermediate Problems
3. Complex problems
2. The Role of economic analysis in Engineering
1. Examples on Economic Analysis for engineers
3. The Decisions process
1. Rationale decision making
4. Economic selections based upon Actual Cost.

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Introduction: Engineering
Economic Decisions
Manufacturing Profit

Planning Investment

Marketing

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Introduction
1. Technical design is the result of a trade off
between competitive characteristics of the
solution
– Structures are the result of a compromise between
strenght and self-weigth.
• Ability to resist external pressures
• Cost
– A transport vehicle is designed through a trade off
between utile and carburant charge.
• Trade offs and decisions are essential
characteristics of technical work even before
economic analysis lands on the field.

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Introduction
2. Any technical design is an answer to the question of
how much risk we would like to accept.
• Total security is never accessible:
• Pressures and problem are never determined 100%
• Solutions are very unavailable
• Risk exists, we cannot avoid it, our only possibility is
to manage it.
• Decisions about risk are not based upon facts but on
perceptions and assessment.
– Human been is not a perfect rationale in decision process
– Imperfect information establishes a limit for rational decision
making
• The aim of this subject is to provide a rational
decision making instrument, not to avoid engineers to
run decisions.
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Some questions:
• When coming to this class you have assumed
a risk, ¿Is it greater or smaller than the risk
derived from eating peanuts?
• ¿Can you identify the technical trade offs that
have to be considered when designing?:
– An skyscraper
– A warship passive protection and shielding
– F1 automobile

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DECISIONS THAT INCREASE

RISK UNTIL 10-6
Smoking 1,4 Cigarettes CANCER –EPOC
Drinking ½ L wine CIRROSIS HEPATICA

Spending 1 Hour in a coal mine PULMONARY DISEASE

Spending 3 Hours in a coal mine ACCIDENT
Living 2 days in London or NY ACCIDENT
Rowing in a Kayak for 6 minutes ACCIDENT
Riding 15 KM on a bike ACCIDENT
Travelling 500 KM by car ACCIDENT
Travelling 1.500 KM by Jet ACCIDENT
Travelling 10.000 KM by Jet CANCER BY COSMIC RADIATION
Living in a stone building for two months CANCER BY NATURAL RADIATION
Taking a X-Ray Image from your lung CANCER
Living for two months with an smoker CANCER, EPOC
Eating 40 spoons of peanuts butter CANCER BY AFLATOXINA
Drinking water from Paris Municipality supply system for 6 months CANCER BY CLOROFORMO
Living near a nuclear facility for 5 years CANCER
Living near a PVC plant for 20 years CANCER
Eating 100 beefstakes CANCER BY BENZOPIRENO

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Principles of Engineering Economics
1.Develop the Alternatives
2.Focus on the Differences:
3.Use a Consistent Viewpoint:
4.Use a Common Unit of Measure:
5.Consider All Relevant Criteria:
6.Make Risk and Uncertainty Explicit
7.Revisit Your Decisions:

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Principles of Engineering Economics

• Develop the Alternatives: Carefully define the problem!
Then the choice (decision) is among alternatives. The
alternatives need to be identified and then defined for
subsequent analysis.
• Focus on the Differences: Only the differences in expected
future outcomes among the alternatives are relevant to
their comparison and should be considered in the decision.
• Use a Consistent Viewpoint: The prospective outcomes of
the alternatives, economic and other, should be
consistently developed from a defined viewpoint
(perspective).
• Use a Common Unit of Measure: Using a common unit of
measurement to enumerate as many of the prospective
outcomes as possible will simplify the analysis of the
alternatives.
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Principles of Engineering Economics
• Consider All Relevant Criteria: Selection of a preferred
alternative (decision making) requires the use of a criterion
(or several criteria). The decision process should consider
both the outcomes enumerated in the monetary unit and
those expressed in some other unit of measurement or
made explicit in a descriptive manner.
• Make Risk and Uncertainty Explicit: Risk and uncertainty
are inherent in estimating the future outcomes of the
alternatives and should be recognized in their analysis and
comparison.
• Revisit Your Decisions: Improved decision making results
from an adaptive process; to the extent practicable, the
initial projected outcomes of the selected alternative should
be subsequently compared with actual results achieved.

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Typologies of problems in
Engineering
• Lots of criteria could be selected, but the simplest would be the degree of difficulty.
• Simple problems:
– Paying with cash or Credit Card
– Repairing a car or buying a new one
– Defining the optimal lot if we need a total annual supply of X
• Intermediate Problems
– ¿How can we finance future investments?
– ¿Which solution can be adopted for a technical problem?
– ¿Which technical equipment shoud we select?
• Complex Problems :
– What can we do when facing an obsolete plant?
– Who should we married with? Should we married anybody?
– ¿How should we distribute our budget among different departments?
• The main differences that we have to keep in mind to deal with these questions could
be:
– Level of information on the consequences of election
– Level of certainty on the consequences of election
– Level of dependence from others decisions
– Nº of affected agents.
– Cost of the consequences
– How important are the consequences for us
– Nº of viable alternatives

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 The General Relationship between the Engineering Economic
Analysis Procedure and the Engineering Design Process

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Typical decisions in EE.

• Equipment or Process Selection.
– This class of engineering decision problems involves selecting the best course
of action out of several that meet a project’s requirements
• which of several proposed items of equipment shall we purchase for a given purpose?
• Equipment Replacement:
– This category of investment decisions involves considering the expenditure
necessary to replace worn-out or obsolete equipment.
• New Product or Product Expansion.
– Investments in this category increase company revenues if output is increased.
One common type of expansion decision includes decisions about expenditures
aimed at increasing the output of existing production or distribution facilities.
• Cost Reduction.
– A cost-reduction project is a project that attempts to lower a firm’s operating
costs. Typically, we need to consider whether a company should buy
equipment to perform an operation currently done manually or spend money
now in order to save more money later.
• Improvement in Service or Quality
– The decision techniques we develop in this book are also applicable to various
economic decisions related to improving services or quality of product.
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Predicting the Future
• Required investment
• Forecasting product
demand
• Estimating selling
price
• Estimating
manufacturing cost
• Estimating product
life
Engineers decisions and economy 15

Role of Engineers in Business

• Participate in a variety
of decision-making
processes, ranging from
manufacturing, through
marketing, to financing
decisions
• Plan for the acquisition
of equipment
• Design products from
the concept to shipping

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A Large-Scale Engineering
Project
• Requires a large
sum of investment
• Takes a long time to
see the financial
outcomes
• Difficult to predict
the revenue and
cost streams

Engineers decisions and economy 17

Types of Strategic Engineering

Economic Decisions
• Equipment and Process Selection
• Equipment Replacement
• New Product and Product Expansion
• Cost Reduction
• Service Improvement
• Public Works
• Cost Effectiveness

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Equipment & Process
Selection
• How do you choose between Plastic
SMC and Steel sheet stock for the auto
body panel?
• The choice of material will dictate the
manufacturing process for the body
panel as well as manufacturing costs.

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Which Material to Choose?

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Equipment Replacement
• Now is the time to
replace the old
machine?
• If not, when is the
right time to replace
the old equipment?

Engineers decisions and economy 21

New Product and Product

Expansion
• Shall we build or
Gillette’s MACH3
acquire a new Project
facility to meet the
increased demand?
• Is it worth spending
money to market a
new product?

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Cost Reduction
• Should a company
buy equipment to
perform an
operation now done
manually?
• Should spend money
now in order to save
more money later?

Engineers decisions and economy 23

Service Improvement
• How many more jeans would Levi need to sell to
justify the cost of additional robotic tailors?

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Ethical issues

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Some questions 1. Information on the consequences of the elections

2. Certitude about the consequences of the election
3. Dependence on third parties
4. Number of affected people
Select the relevant parameters 5. Degree of potential damaged derived from the
in each case consequences
6. Self assessment of privated consequences
7. Nº de possible alternatives

Problems 1 2 3 4 5 6 7
Payment in cash or Credit Card
Repair or replacement of damaged car x x
Optimal supply schedule for a total need of x units/year
Financial alternative for a replacement process
Technical solution for an specific problem
Production equipment for a plant
What shall we do with an obsolete production plant x
Who should we marry with?. Shall we marry ?
How should we distribute budget among departments? x

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The role for economic analysis in
engineering

• This discipline is valid for the following

situations:
– Problems important enough so that its
worth to dedicate some time to think about
them.
– Problems complicated enough so that
formal treatment is needed.
– Problems with great economical impact

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Examples on Economic Analysis

for engineering
• All the technical decisions you have to take in your work share some specific
characteristics
– Their consequences usually imply some costly activity
– They produce some benefit or cost Saving
– Both flows of costs and benefits are unequally distributed along the time:
• Costs are usually immediate
• Benefits usually take long time to collect.
• Conventional arithmetic provides a limited instrument to compare those
magnitudes flows.
• Economical Engineering includes financial mathematics techniques to solve these
needs.
• Some examples on economical engineering :
– Which projects should we promote?.
– When is it worth developing a certain project?
– Which is the most profitable alternative?
– Can we optimize a certain design to improve efficiency?
• Some personal decisions that can be improved with an analytical instrument:
– What part of our income should we save?
– Which financial instrument should we select to finance our house?
– What are the most appropriated retributive instruments: salary, commissions, stock
options? Does it change with taxes?

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Decision making process
• Economics analysis show to be a powerful instrument for technical
decision when:
1. Alternatives exist
2. It is possible to select among them
3. Rational arguments are needed to justify our selections.
• Usual methodology to produce a rational process of decision
between alternatives can be explained through the following phases:
I. Recognize the Problem
II. Define the goal or objective to pursue
III. Assemble relevant data
IV. Identify feasible alternatives
V. Define the criterion to select between alternatives
VI. Construct a model
VII. Predict each alternative consequences
VIII. Choose the best alternative
IX. Audit the result.

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Which Car to Lease?

1. Recognize a decision • Need a car
problem
2. Define the goals or • Want mechanical
objectives security
3. Collect all the relevant • Gather technical as
information well as financial
4. Identify a set of data
feasible decision • Choose between
alternatives Saturn and Honda
5. Select the decision • Want minimum total
criterion to use cash outlay
6. Select the best • Select Honda
30 alternative

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I. Recognize the Problem
• Let’s Analyze next situation:
– Our community is discussing what to do with a marsh:
• The historical view of the problem suggest to drain land so that
mosquitoes are rejected
• Modern View promotes preservation of humid landscapes
• Urbanism agents insist on the unhealthy influence on near urban
settings.
• Ecologists vote against any action we could suggest except pure
preservation
– A labors accident has to be analyzed:
• Problem on Project developing
• Problem on building
• Designer inadequacy
• ….
• All of them might be right
– Why are their points of view so different?.

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II. Define the goal or objective

to pursue
• Defining the global objective of a project may be the key
argument to establish the selected approach.
– We might be searching growth.
– We might be searching gross benefit.
– We might be searching profitability.
• When we are trying to pursue a global objective specific
measures might be derived instruments:
– Minimum delay for payment of invoices: 2 months .
– Deadline for assembly of structure 3 months
• These instrumental objectives define the conditions of our work.
– The tasks we need to have done
– Restrictions to comply with
• The set of alternative objectives is a key factor for our process

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 III. Collecting and assembling
relevant data
• Information is the basic matter in this phase:
– Formal
– Non-formal
– produced Information
• The selected information we need to develop a robust
model has to meet several requirements.
– Certitude. We need to be sure of the meaning of the data we
have collected
– Pertinent: we are tired of documents filled with mountains of
irrelevant data.
– Efficiency: it is nonsense to spend a lot of resources to obtain an
irrelevant data
– Opportunity: data provided have to be useful for present
decisions, not for past ones that cannot be revised.

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III. Collecting and assembling

relevant data
• Here are some examples of situations where we can discuss how
data are collected
1. A manager shows to be reluctant to contract a project until Costs are
known with perfect precision
2. An engineer asks for a complete geotechnical analysis that will be
available in six months instead of an overall recognition that can be
handed in a week.
3. The Seismic analysis can improve the quality of any design projected In
any non seismic areas
4. A program for preventive maintenance is temporarily stopped until the
problem of defining the affected devices is approved.
5. An infrastructure economic life is defined according with
• The service it has to provide
• The quality of the maintenance that will be applied
6. Salvage value of an equipment with 10 years live depends on
• The actual life of this specific unit
• The market conditions for second hand and recycling materials at the end of life period
7. The nominal capacity of a productive device for next years is fixed
according with the last 5 years historic performance.

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 Qualify the previous
Certainty Pertinency Adequacy Efficiency Comments

1
2
3
4
5
6
7

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Data Sources
• We need to obtain the relevant data we need for decisions
– From general knowledge in the industry.
– From accounting registers in the firm
• Collecting historical performance.
• Including a lot of internal distribution criteria that drive costs to specific
sinks where they are normative collected
– From Observed economic activity
• Supplying estimates for future general economic performance
• Supplying estimates for future industry performance.
– From extra-market consequences we can identify measured through
shadow prices.
– From valuation of non physical assets . What will be the consequences
for Coca Cola if loosing New York airport contract for vending
machines?

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 Example for cost asignation
• Acording to cost accounting registers the printing department in our firm
shows a monthly cost as:
– Direct Labour: 6,000
– Raw Materials: 7,000
– Indirect Cost: 5,000
– TOTAL: 18,000
• The Marketing Department has recieved an internal imputation note for
1.000 copies with a total amount of:
– Direct Labour: 7.60
– Materials: 9.80
– Indirect Cost: 9.05
– TOTAL: 26.45
• As this charge looks too high, after several attempts this department has
received an external offer for the same services with a total amount of
22.95
• We have to analize the proposal to externalize this service for a total
printing need of 30.000 copies.

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Answers
• The internal cost is not the real cost involved in the decision. If we take a look
at the accounting concepts we realize that:
– The indirect cost of 5.000 will be supported by the firm irrespective of the decision
made.
– Direct Labor: will be employed by the firm in any alternative, only if we can actually
reduce this cost the savings have to be considered
• Distribution of cost
– Direct Labor: 7.60
– Materials: 9.80
– Indirect Cost: 9.05
– TOTAL: 26.45
• The relevant data we need to assemble in the model is the cost that can be
recovered
• Through this lens we have to compare this slightly different numbers that show
a new picture of the situation:
– Internal process with an additional cost of 9.80+7.60
– External process with an additional cost of 22.95

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 IV. Identify alternatives
• This is a critical phase for the problem:
– If any alternative is rejected a priori we can hardly select it
at the end
– The do nothing alternative although quiet obvious isn´t
always considered.
• We cannot suply any procedure for avoiding mistakes
other than been imaginative an careful.
– Brainstorming techniques can be helpful
• A diferent problem comes if we introduce an amount
of non useful alternatives that can be discarded after
a superficial comparation,
– They include obvious inconsistencies
– Even if they are feasible they will never be optimal.

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V. Select the criterion to choose

• At this point we have to establish our desires, we might want to:
– Create the least disturbance on environment
– Improve wealth distribution
– Minimize expenditure
– Pursue global efficiency
– Minimize temporal availability
– Maximize profit
• The context of decision will establish three categories of problems
– Problems related with a fixed input:
• Examples:
– How to distribute classes and students in this building so that we can maximize the number of lessons taught
– How to distribute the investment budget among departments in a firm so that we can obtain the maximum profit.
– Problems related with a fixed output:
• Example:
– How to organize the canteen of the University so that all the students and staff are fed in 60 minutes (and they survive).
– How to assign several water resources so that we can cover the demand with a standard quality
– Problems where we can decide over input and outputs in order to obtain a certain result.
• A civil engineer firm has too much work available for his limited capacity has to decide between paying increasing extra
hours to the personnel, recruiting more engineers in the near future, avoiding new contracts…
• Conclusions
– Problems related with a fixed input: we maximize the output
– Problems with a fixed output: Minimize the inputs
– Problems where we can decide over input and outputs in order to obtain a certain result: Maximize the Profit
(difference)

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VI. Constructing the model
• Through a sintesys process we develop a comprehensive model:
– Objetive
– Relevant Data
– Alternatives
– Selection criterion
• Go to the bank and ask for a loan to finance your house
– Duration
– Interest
– Amount financed
– Will stablish your monthly payment that you compare with your
financial posibilities
• A mathematical expresion will supply us with a relationship that
helps to understand the consequencies of each alternative.

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VII.Predicting the outcomes of

each alternatives
• Once we have developed a synthesis model we can now predict
the consequences of each alternative:
– If we ask for a 15 years loan with fixed interest for 100.000 € we
will pay …
– If we ask for a 20 years loan with fixed interest for 100.000 € we
will pay …
– If we choose variable interest we will pay a quantity between x and
y depending on the evolution of the market interest rate.
– If we do nothing we won´t have a place for living so we will have
to rent one.
• As a general idea we can include consequences in one of three
alternatives:
– Market consequences that can be observed through direct
monetary fluxes
– Non market consequences that can be evaluated indirectly
– Intangible consequences derived from non monetary prices

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 VIII.Choosing the best
alternatives
• Once criteria have been stablished, we should have no problem to propose
an order for the alternatives.
• There are certain problems to deal with:
– Including quantitative and intangible data in models is always a subjective
process.
– Discarding dominated alternatives can sometimes be a way of predetermination of
the solution.
– When the process is collective previous phases may include personal points of
view that could be treated as collective positions (agency and influence problems)
– When the process takes a long time to develop, we may find different points o
view with the available information at the beginning and at the end.
• Innovation
• Technology
• Situations of volatile information.
• Sometimes you need to work with a suboptimal objective:
– Trying to avoid selection problems through the process
– Trying to avoid strategic errors due to information changes

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IX. Audit the results

• We have developed a process for decision.
– We have established a prediction for the
results of each proposed alternatives
– We should now check about
• The accuracy of the prediction for the selected
alternative
• The accuracy of the prediction for rejected
alternatives (obviously for the scenery)

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4. Economical selections
based upon Actual Cost.
• The typical situation of an engineer is
been in front of a design with several
alternatives trying to select the most
appropriate.
– Through a criterion for selection
– Through a clear alternative trade off

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Some examples
• A concrete aggregate mix is required to contain 31%
sand. We have two possibilities for the supply:
– Material A with 25% of sand at a prize of 3$/vol unit
– Material B with 40% of sand at a prize of 4,4 $/vol unit
• Output is clearly stablished (31% ) if we define a
blending ratio that produces exactly this result the
question is solved:
• 0.25x+0.4(1-x)=0.31
• x=0.60 Cost= 0.6*3+0.4*4.4=3.56

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Some examples
• At the present a component for engines is produced at a cost of
0.4 $/unit for material and 0,15 $/unit for direct labor.
– We have to produce 3 million pieces
– The needed equipment costs $ 500.000 that will be useless after
work is done
– When 50% of work is done we have a possibility to invest
additional $ 100.000 to reduce Cost to 0.34 $ y 0,10 $ respectively
– Additional cost can be computed as 2.5 labor costs
• Express the alternatives and select

Alt. A Alt B
Investment N/A 100.000 100.000
Material 1.500 x 0.4 600.000 1.500 x 0.34 510.000
Labor 1.500 x 0.15 225.000 1.500 x 0.10 150.000
other 2.5 x 225.000 562.000 2.5 x 150.000 375.000
Sum 1.387.500
Economic Decision Analysis
1.135.000
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