ECONOMICS 

PRINCIPLES Of ENGINEERING ECONOMY: 

The study of how limited resources is used
1. Develop the Alternatives 
to satisfy unlimited human wants. 
The study of how individuals and societies The final choice or decision is among
choose to use scarce resources that  nature alternatives. The alternatives need to
and previous generations have provided.  be  identified and then defined for
subsequent analysis. 
RESOURCES: 
2. Focus on the Differences 
 Land (water, air, minerals, sunshine,
plant and trees, and land itself) Only the differences in expected future
outcomes among the alternatives are 
 Labor (efforts, skills, and
relevant to their comparison and
knowledge) 
should be considered in the decision. 
 Capital (tools, buildings, machinery,
assets, money, education and 3. Use a Consistent Viewpoint 
training)
The prospective outcomes of the
alternatives, economic and other, should
ENGINEERING ECONOMICS 
be  consistently developed from a defined
viewpoint or perspective.
 Involves the systematic evaluation
of the economic merits of 4. Use a Common Unit of Measure 
proposed solutions to engineering
problems.  Using a common unit of measurement to
enumerate as many of the prospective 
 It is the application of economic outcomes as possible will make easier the
factors and criteria to evaluate analysis and comparison of  alternatives. 
alternatives by computing a specific
measure of worth of estimated 5. Consider All Relevant Criteria 
cash flows over a specific period of
time.  Selection of a preferred alternative
(decision making) requires the use of a 
 Engineering economics, previously criterion. 
known as engineering economy, is a
subset of economics concerned 6. Make Uncertainty Explicit 
with the use and application of
economic principles in the analysis Uncertainty is inherent in projecting
of engineering decisions. As a (estimating) the future outcomes of the 
discipline, it is focused on the alternatives and should be recognized in
branch of economics known as their analysis and comparison.
microeconomics in that it studies
the behavior of individuals and 7. Revisit Your Decisions 
firms in making decisions regarding
the allocation of limited resources.
Thus, it focuses on the decision
making process, its context and
environment.
Improved decision making results from an
adaptive process; to the extent 
practicable, the initial projected outcomes
of the selected alternative should be  level of activity or pattern or technology or
subsequently compared with actual results
achieved.
ENGINEERING ECONOMY AND THE DESIGN
PROCESS
An engineering economy study is
accomplished using a structured procedure
and mathematical modeling techniques.
The economic results are then used in a
decision situation that involves two or more
alternatives and normally includes other
engineering knowledge and input. 
Design process is a decision making activity
whereby scientific and technological
information is used to produce a system,
device, or process which is different, in
some degree, from what the designer
knows to have been done before and
which is meant to meet human needs. Also
we want to meet the human needs
economically as emphasized in the
definition of engineering.
COST CONCEPTS for DECISION MAKING  5. Opportunity Cost
1. Marginal Cost 
Marginal cost is the total of variable costs,
i.e., prime cost plus variable overheads. It is
based on the distinction between fixed and
variable costs. Fixed costs are ignored and
only variable costs are taken into
consideration for determining the cost of
products and value of work-in-progress and
finished goods.  6. Imputed Costs
2. Out of Pocket Costs  Notional costs or imputed costs are those
This is that portion of the costs which
involves payment to outsiders, i.e., gives
rise to cash expenditure as opposed to
such costs as depreciation, which do not
involve any cash expenditure. Such costs
are relevant for price fixation during
recession or when make or buy decision is
to be made.
3. Differential Costs 
The change in costs due to change in the
process or method of production is known
as differential costs. If any change is
proposed in the existing level or in the
existing methods of production, the
increase or decrease in total cost as a result
of this decision is known as differential cost.
If the change increases the cost, it will be
called incremental cost. If there is decrease
in cost resulting from decrease in output,
the difference is known as decremental
cost.
4. Sunk Costs 
A sunk cost is an irrecoverable cost and is
caused by complete abandonment of a
plant. It is the written down value of the
abandoned plant less its salvage value.
Such costs are historical which are incurred
in the past and are not relevant for decision
making and are not affected by increase or
decrease in volume. Thus, expenditure
which has taken place and is irrecoverable
in a situation is treated as sunk cost. 
 
It is the maximum possible alternative
earning that might have been earned if the
productive capacity or services had been
put to some alternative use. In simple
words, it is the advantage, in measurable
terms, which has been foregone due to not
using the facility in the manner originally
planned.
 
costs which are notional in character and
do not involve any cash outlay, e.g.,
notional rent charged on business premises
owned by the proprietor, interest on
capital for which no interest has been paid. 
7. Replacement Cost 
It is the cost at which there could be
purchase of an asset or material identical to
that which is being replaced or revalued. It
is the cost of replacement at current
market price.

8. Avoidable Cost and Unavoidable Cost 

Avoidable costs are those which can be
eliminated if a particular product or
department, with which they are directly
related, is discontinued. For example,
salary of the clerks employed in a particular
department can be eliminated, if the
department is discontinued. 

Unavoidable cost is that cost which will not

be eliminated with the discontinuation of a
product or department. For example, salary
of factory manager or factory rent cannot
be eliminated even if a product is
eliminated. 

9. Relevant Cost and Irrelevant Cost 

A cost that is relevant to a decision is called
relevant cost. Past costs are not generally
relevant costs because they are sunk costs
or costs already incurred. Thus, the book
value of an asset or depreciation charged in
accounts in respect of an asset is not
relevant cost. On the other hand, the fall in
the resale value of an asset as a result of
using it, as also the running expenses
incurred to make use of the asset are
relevant costs.