CHAPTER 1

INTRODUCTION TO ENGINEERING ECONOMICS:

1.1 Define and Basic concept of the Engineering Economics.

What is Engineering Economics?

Engineering economics is Systematic evaluation of the economic merits of proposed

solutions to engineering problems.
Engineering economy, quite simply, is about determining the economic factors and the
economic criteria utilized when one or more alternatives are considered for selection

Example

Objective-Evaluation

How to compare the economic value of alternative design option?

Key issues- Time value of money, Cash flow occurring at different time , Designs with
different durations

What is Economy?

It is the management of household or private expenses. [From Greek]

It is the careful management of material resources. [Dictionary Definition]

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Definition of Engineering and Science

Engineering a profession in which knowledge of the mathematical and natural sciences

gained by study, experience and practice is applied with judgment to develop ways toUtilize
the material and forces economically and For the benefit of mankind.
Engineering is not a science but application of science
Nature of engineering: application
Role of scientist: Discover the universal laws of nature/ behavior
Role of engineer: Apply knowledge to particular situation to produce products and services

Engineering and Economics

Engineering activities are means of satisfying human rights and requirements

Concerns – material / forces and needs

Because of resource constraints, engineering is closely associated with economics

Its essential that an engineering proposal is evaluated in terms of economics [worth & cost]
before it is undertaken

Essential pre-requisite of successful engineering application is economic feasibility

To be economically acceptable [i.e., affordable], solutions to engineering problems must

demonstrate a positive balance of long-term benefits over long-term costs.\
The mission of EEs is to balance different types of costs and the performance [response
time, safety, reliability, etc.] in the most economical manner.
Engineering economy is a collection of mathematical / analytical techniques that
simplify economic comparison

Engineering economy: formulation, estimation and evaluation of the economic

outcomes out of various available alternatives to accomplish a defined purpose

Discipline that involves the systematic evaluation of the cost and benefit [economic
merits] of proposed technical projects

Basic Concept of Engineering Economics?

It is the branch of social science that deals with the production & distribution and
consumption of goods and services and their management.
It is the study of production and distribution of wealth.
It is the study of choice and decision-making in the world with limited resources.

It is the study of how individuals, businesses & governments use their limited resources and
satisfy unlimited wants. [Others]

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 Hence, the modern practice of engineering economics must include the ability to work in
different currencies, under varying rates of inflation and different tax regimes
Thus; in order to make these determination properly, the engineer need to understand the
mathematics governing relationship between time and money; to/and study subject
engineering economics.
Why Engineering Economy is Important?

There are lots of factors that are considered in making decisions

These factors are combinations of economic and non-economic ones
Engineers play a major role in investment by making decisions based on economic analysis
and design considerations
Thus, decisions often reflect the engineer’s choice of how to best invest funds by choosing
the proper alternative out of a set of alternatives
Role of Engineering Economics:

Selection of one design out of several competing designs

Selection of one construction methodology out of several construction methodologies
Replacement decisions
Investment decisions ? Risky investment with high returns vs safe investment with low
returns
Allocation of funds for few public projects out of several competing projects
Selection of a project out of several competing projects

1.2 Economy in Decision Making.

Engineering Decision making

Decision making represents passing judgment (taking action) on activities/issues. It

necessitates existence of decision problem.
Decision involves judgment on resources(physical or monetary) which requires
consideration of foregone alternatives.
Since engineering involves the idea of design and development, decision about the costs
are common.
The process of decision making (common steps in decision making):

Recognize the decision problem

Define the goals and objectives
Collect all the relevant information
Identify a set of feasible decision alternatives
Select the decision criterion to use
Select the best alternative

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What makes economic decisions d/t from engineering decisions?

Engineering decision is often time-invariant. i.e., it uses known physical resources, principles
of physics /chemistry, design correlates, & engineering judgment to arrive at workable &
optimal design. but, economic decisions are time dependent.
Factors to be considered for decision making may vary from time to time.
Investment decisions often require information about the uncertain future (w/c basically
depends on the degree of forecast& prediction).

Engineering Economic Decisions: refers to economic decisions related to engineering

projects. - capital expenditure decisions.
In general, engineers while making decisions must also:

- understand the business environment

- The company’s financial statement.

Types of engineering economic decisions:

Service or quality improvement: Investments in this category include any activities to

support the improvement of productivity. Quality, and customer satisfaction in the service
sector, such as in the financial, healthcare, and retail industries.
New products or product expansion: Investments in this category are those that increase
the revenues of a company if output is increased.
Equipment and process selection: this involves selecting the best course of action when
there are several ways to meet a project's requirements. Which of several proposed items of
equipment shall we purchase for a given purpose? In terms of the expected return & the
manufacturing process to use.
Cost reduction: this is about the purchase of equipments that can lower the company’s
operating costs.
Equipment replacement: This category of investment decisions involves considering the
expenditure necessary to replace worn-out or obsolete equipment.
In general, the factors of time and uncertainty are the defining aspects of any investment
project.All decisions, except perhaps the most routine and automatic ones or those that are
institutionalized in large organizations, are made, in the end, on the basis of belief as opposed to
logic.

Figure below is a useful illustration of how decisions are made.

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Generally in Engineering economy is an answer to following questions

Which engineering projects are worthwhile? [project worthiness]

Which engineering projects should have a higher priority? [priority for available alternatives]

How should the engineering project be designed? [economic design]

Role of Engineering Economy in Decision Making

Assist people in making decisions

Timeframe: future

Actual value may differ from estimated one

Sensitivity analysis: changes in decisions with varying estimates

Analysis of present and past situations based on observed data to predict the future

Rational Decision Making Process

Recognize a decision problem

roblem

Define the goals and/or objectives

Collect the relevant information

Identify a set of feasible decision alternatives

Select the decision criteria to use

Select the best alternatives

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Bi-Environmental Nature of Engineering

Physical environment is based on physical laws [formulas, maths, calculations],

therefore, it is certain

Economic environment is affected by the behavior of people, therefore, its not certain
and economic laws are not exact and certain

The function of engineering is to manipulate the physical environment to create value in

economic environment

Physical and Economic Efficiency

Physical efficiency = output / input

Physical efficiency is always less than unity or 100%

Economic efficiency = worth / cost

Economic efficiency can 100% or even more

Overall economic efficiency= economic/physical

= physical x worth / cost

1.3 Principle and Procedure of Engineering Economic

Principle 1: Develop the alternatives

The alternatives need to be identified and then defined for subsequent analysis.
Since the choice [decision] is among alternatives, developing and defining the
comprehensive list of alternatives for detailed evaluation is important.
Creativity and innovation are essential.
Principle 2: 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.
Outcomes that are common to all alternatives can be disregarded in the process of
comparison and decision
Principle 3: Use a consistent viewpoint

The prospective outcomes of the alternatives, selection of the criteria and other, should be
consistently developed from a defined viewpoint [perspective.
Usually, the viewpoint of the decision maker would be used.
For example, the perspective of the employees is used for the problem of designing the
employee benefit package.

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Principle 4: 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.
For economic outcomes, a monetary unit such as “birr/dollars” is the common unit of
measure.
If the outcomes cannot be quantified, describe these consequences explicitly so that the
information is useful to the decision maker in the comparison of the alternatives.
Principle 5: Consider all relevant criteria

Principle 6: Make uncertainty explicit

Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and
should be recognized in the analysis and comparison.

Principle 7: Revisit your decisions

Improved decision making results from an adaptive process. The initial projected outcomes of
the selected alternative should be subsequently compared with the actual results achieved.

Procedures of Engineering Economic Analysis

Problem recognition, formulation, and evaluation.

Development of the feasible alternatives. [Principle 1]
Development of the outcomes and cash flows for each alternative.
[Principles 2, 3 and 4]
Selection of a criterion [or criteria]. [Principles 3 and 5]
Analysis and comparison of the alternatives.[Principle 5]
Selection of the preferred alternative. [Principle 6]
Performance monitoring and post-evaluation of results. [Principle 7]

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