MODULE 1
1.1. The Economic Environment
Engineering Economy
It is the analysis and evaluation of the factors
that will affect the economic success of
engineering projects to the end that a
recommendation can be made which will
ensure the best use of capital.
Consumer and Producer Goods and Services
Consumer goods and services are those
products or services that are directly used by
people to satisfy their wants.
Producer goods and services are used to
produce consumer goods or services or other
producers' goods.
Necessities and Luxuries
Necessities are those products or services that
are required to support human life and
activities that will be purchased in somewhat
the same quantity even though the price varies
considerably.
Luxuries are those products or services that are
desired by humans and will be purchased if
money is available after the required necessities
have been obtained.
Demand
It is the quantity of a certain commodity that is
bought at a certain price at a given place and
time.
Elastic demand occurs when a decrease in
selling price results in a greater than
proportionate increase in sales.
Inelastic demand occurs when a decrease in a
selling price produces a less than proportionate
increase in sales.
Unitary elasticity of demand occurs when a
mathematical product of volume and price is
constant.
Competition, Monopoly and Oligopoly
Perfect competition occurs in a situation where
a community or service is supplied by a number
of vendors and there is nothing to prevent
additional vendors entering the market.
A monopoly is the opposite of perfect
competition. A perfect monopoly exists when a
unique product or service is available from a
single vendor and that vendor can prevent the
entry of all others into the market.
An oligopoly exists when there are so few
suppliers of a product or service that action by
one will almost inevitably result in similar action
by the others.
Law of Supply and Demand
Supply is the quantity of a certain commodity
that is offered for sale at a certain price at a
given place and time.
"Under conditions of perfect competition, the price
at which a given product will be supplied and
purchased is the price that will result in the supply
and the demand being equal."
This is the graph of the Law of Supply and
Demand.
Law of Demand
States that " if all other factors are equal, the
higher the price of a good, the less people demand
that goods." In other words, the higher the price
the lower the quantity demanded.
Law of Supply real earning potential of alternative investment over
time
States that "the higher the price, the higher the
quantity supplied"
Interest

It is the amount of money paid for the use of

borrowed capital or income produced by money
that has been loaned.

Simple interest

Simple interest is calculated using the principal only,

ignoring any interest that had been accrued in
preceding periods.
The Law of Diminishing Returns
I=Pni
"When the use of one of the factors of production but
is limited, either in increasing cost or by absolute
quantity, a point will be reached beyond which an F=P+I
increase in the variable factors will result in a less
F=P+Pni
than proportionate increase in output."
F = P (1 + n i)

Where

F = future worth or accumulated amount

I = interest

P = principal amount

n = no. of interest period

i = rate of interest per interest period

https://youtu.be/G6iRy-AISZs Types of Interest

ECONOMIC ENVIRONMENT a). Ordinary simple interest

It is computed on the basis of 12 months, 30 days

each or 360 days per year.
1.2. Simple Interest and Money-time One (1) interest period = 360 days
Relationship
b). Exact simple interest
SIMPLE INTEREST It is computed on the basis of exact number of days
In this module, we will study a simple interest. in a year, 365 days for an ordinary year, and 366
days for leap year.
Time value of money
One (1) interest period = 365 days or 366 days
It is defined as the time-dependent value of money
stemming both from changes in the purchasing
power of money (inflation or deflation) and from the
 ▪ To illustrate the
above principles
please refer to
the sample
problem below.
▪

Sample Problem no. 5

A loan of P100 at a simple interest of 10% will
become P150 after 5 years.
Solution

Compound Interest
It is the interest for an interest period is
calculated on the principal plus total amount of
interest accumulated in previous periods.
1.3. Cash-flow Diagram
It also means the interest on top of interest.
▶ CASH-FLOW DIAGRAM

In this module, we will study the cash-flow diagram

and compound interest.
Cash-flow Diagram

It is the graphical presentation of each flows drawn on a

time scale.

▪ ↑receipt (positive
cash flow or cash
inflow)
▪ ↓disbursement
(negative cash
flow or cash
outflow)
 Sample Problem no. 6
Find the nominal rate which if converted
quarterly could be used instead of 12%
compounded monthly. What is the
corresponding effective rate?

Rates of Interest Solution

a). Nominal rate of interest Let r = the unknown nominal rate

The nominal rate of interest specifies the rate ***For two or more nominal rate rates to be
of interest and a number of interest periods in equivalent, their corresponding effective rates
one year. must be equal

where
i = rate of interest per interest period
r = nominal rate of interest
m = no. of compounding periods per year (shall
be multiplied by the number of years)
If the nominal rate of interest is 10%,

Sample Problem no. 7

A P2,000 loan was originally made at 8% simple
interest for 4 years. At the end of this period,
the loan was extended for 3 years, without the
interest being paid, but the new interest rate
was made 10% compounded semi-annually.
How much should the borrower pay at the end of
7 years?
Solution

b). Effective rate of interest

It is the actual or exact rate of interest on the
principal during one year.
If P1.00 is invested at a nominal rate of 15%
compounded quarterly, after one year this will
become,
1.4. Equation of Values In continuous compounding, it is assumed that cash
payments occur once per year but the compounding
▶ EQUATION OF VALUES is continuous throughout the year.
In this module, we will study the equation values.

Equation of Values

An equation of value is obtained by setting the sum

of the values on a certain comparison or focal date
of one set of obligations equal to the sum of the
values on the same date of another set of
obligations.

In relation to this module, let's watch this video

below.

https://youtu.be/lUhjTL5jvj0

To illustrate the principles above please refer to the

sample problem below.

Sample Problem no. 8

A man bought a lot worth P1,000,000 if paid in

cash. On the installment basis, he paid a down
payment of P200,000, P300,000 at the end of one
year, P400,000 at the end of three years, and a final
payment at the end of five years. What was the
final payment if interest was 20%.

Solution

Let F = be the final payment

Using today as focal date

Amount paid in cash = Amount paid on an Sample Problem no. 9

installment basis
1,000,000 = 200,000 + 300,000 (P/F, 20%, 1) +
400,000 (P/F, 20%, 3) + F(P/F, 20%, 5)
1,000,000 = 200,000 + 300,000 (1 + 0.20) -1 +
400,000 (1 + 0.20)-3 + F(1 + 0.20)-5
F = P792,576.00
Compare the accumulated amounts after 5
years of P1,000 invested at a rate of 10% per
year compounded (a) annually, (b) semi-
annually, (c) quarterly, (d) monthly, (e) daily, and
(f) continuously.
Solution

Continuous Compounding and Discrete Payments

In discrete compounding, the interest is compounded

at the end of each finite-length period, such as a
month, a quarter, or a year.
1.5. Discount and Inflation
▶ DISCOUNT
In this module, we will study Discount and Inflation.
Discount
Discount on a negotiable paper is the difference
between the present worth (the amount received for
the paper in cash) and the worth of the paper at some
time in the future(the face value of the paper or
principal).
It is the interest paid in advance.
Discount = Future Worth - Present Worth
The rate of discount is the discount on one unit of
principal for one unit of time.
To illustrate the above principle please refer to
the sample problem below.
Sample problem no. 9
Mr. J Dela Cruz borrowed money from the bank. He
received from the bank P1,342 and promised to
repay P1,500 at the end of 9 months. Determine
the interest rate and the corresponding discount
rate or often referred to as the "Banker's Discount".
Solution
Inflation
It is the increase in the prices for goods and services
from one year to another, thus decreasing the
purchasing power of money.
FC = PC (1+f)n
where
PC = present cost of commodity
FC = future cost of the same commodity
f = annual inflation rate
n = no. of years
To illustrate the above principle please refer to the
sample problem below.
Sample problem no. 10
A bag of cement cost P220 at present. What will be
the cost after 5 years if the rate of inflation is 8%
per year?
Solution
In an inflammatory economy, the buying power of
money decreases as costs increase. Thus,

where
F = future worth of money
P = present amount of money
If interest is compounded,

Sample problem no. 11

What is the future amount of P1,000 after 5
years if the rate of inflation is 8%?
Solution