1 | Engineering Economics 1

UNIT 1: INTRODUCTION TO ENGINEERING

ECONOMICS

1.0. Intended Learning Outcomes

By the end of this unit, you should be able to:
 Define engineering economics
 Identify the steps in an engineering economy study
 Describe the role of engineering economics in decision making
 Explain different engineering economic terminology and symbols

1.1. Introduction
In the recent years, technological and social progress have changed rapidly.
Advancement in science and engineering revolutionized the practice of
medicine, transformed our transportation systems, reduced electronic circuits
so that a computer can be placed on a semiconductor chip and the list of such
achievements is almost countless.

However, all these achievements don’t occur without price. Therefore, as future
engineers, the need for basic economic knowledge is essential. Engineers are
not only enclosed to the design process of a technological model but they
should also answer the basic economic question of any design: Do its benefits
exceeds/outweigh its costs?

1.2 Pre-Assessment

Answer the following questions given below. If the answers will be sent through
online platform always send a CLEAR IMAGE of your answer and use
“CAMSCANNER” if possible. Always KEEP a BACK-UP FILE.

Evaluation Criteria:

Originality of the Answer 50%

Organization 15%
Cleanliness 15%
Timeliness 20%
100 %

1. What is economics in general? (10 pts.)

2. What are the important principles of Engineering Economics? Explain
each. (10 pts.)
 1 | Engineering Economics 2

1.3 Topics

1.3.1 Definitions
Engineering Economy involves the efficient evaluation of the economic
advantages of proposed solutions to engineering problems. It involves
collection of techniques that simplify comparisons of alternatives on an
economic basis.

To be economically acceptable (i.e., affordable), solutions to engineering

problems must:
 demonstrate a positive balance of long-term benefits over long-term
costs
 promote the well-being and survival of an organization
 embody creative and innovative technology and ideas
 permit identification and scrutiny of their estimated outcomes
 translate profitability to the “bottom line” through a valid and
acceptable measure of merit.

1.3.2 Principles of Engineering Economy

Like any other studies, all application begins with a set of principles. Thus,
before we apply engineering economics to our design, we must first discuss the
7 basic principles of engineering economy that would help us develop a step-
by-step process in establishing our economic analysis to our specific problem.

Once a problem or need has been clearly defined, the foundation of the
discipline can be discussed in terms of seven principles as follows:

Principle 1: Develop Alternatives

Principle 2: Focus on the differences

Principle 3: Hold a same viewpoint

Principle 4: Use common unit of measure

Principle 5: Consider all relevant criteria

Principle 6: Make risk and uncertainty explicit

Principle 7: Review/Revisit your Decision

 1 | Engineering Economics 3

Principle 1: Develop Alternatives

In this stage you must carefully define the problem and come up with feasible
solutions (alternatives) that address the problem.

After a problem or need has been carefully addressed, the identification and
development of alternatives follows since a decision involves making a choice
of two or more alternatives. Developing and defining the alternatives for
detailed evaluation is important because of the resulting impact on the quality
of a decision. Creativity and innovation are essential to this process.

Example:
You need to buy a car; your alternatives are the following:

©Autodeal Car Comparison, https://www.autodeal.com.ph/cars/compare/toyota+wigo+1-0-g-

at+vs+suzuki+celerio+cvt+vs+honda+brio+1-2-v-cvt

Principle 2: Focus on the Differences

Differences in expected future outcomes will drive the decision, since the
common attributes will be paid for, regardless of the choice. Thus, only the
differences in the future outcomes of the alternatives are important and should
be considered. Outcomes that are common to all alternatives can be
disregarded in the comparison and decision.

Example:

Specifications Toyota Wigo Suzuki Celerio Honda Brio

Price Php 658,000 Php 598,000 Php 658,000
Engine Size 1.0 L 1.0 L 1.2 L
 1 | Engineering Economics 4

Maximum Output 65 hp 67 hp 89 hp
Maximum Torque 89 Nm 90 Nm 110 Nm
Fuel Capacity 33 L 35 L 35 L
Resale Value after 2 Php
Php 360,000 Php 395,000
years
Transmission Automatic Automatic Automatic
Fuel Type Gasoline Gasoline Gasoline
Safety 2 air bags 2 air bags 2 air bags
©Autodeal Car Comparison, https://www.autodeal.com.ph/cars/compare/toyota+wigo+1-0-g
at+vs+suzuki+celerio+cvt+vs+honda+brio+1-2-v-cvt

Since fuel type, transmission, and safety of the three alternatives are the same,
it can be disregarded in the decision-making process.
Principle 3: Hold a Same Viewpoint
The viewpoint for a particular decision must be first defined then used
consistently in the description, analysis, and comparison of alternatives. The
perspective outcome of the alternatives must be consistently developed from a
same viewpoint, since one party’s cost is another party’s benefit.

Example: When buying a car, the perspective of the decision-maker, which is

the owner, should be used for all the alternatives not from the seller’s point of
view.

Principle 4: Use Common Unit of Measure

Using a common unit of measurement to analyze as many of the prospective
outcomes as possible will make it easier the analysis and comparison of
alternatives. Using more than one monetary unit for economic analysis will
complicate the project (e.g. using peso for spending and using dollars for
earning).
Example:

Specifications Toyota Wigo Suzuki Celerio Honda Brio

Price Php Php Php
Engine Size L L L
 1 | Engineering Economics 5

Maximum Output hp hp hp
Maximum Torque Nm Nm Nm
Fuel Capacity L L L
Resale Value after Php
Php Php
2 years
Transmission Automatic Automatic Automatic
Fuel Type Gasoline Gasoline Gasoline
Safety No. of air bags No. of air bags No. of air bags
©Autodeal Car Comparison, https://www.autodeal.com.ph/cars/compare/toyota+wigo+1-0-g
at+vs+suzuki+celerio+cvt+vs+honda+brio+1-2-v-cvt

Principle 5: Consider All Relevant Criteria

In engineering economic analysis, the primary criterion relates to long term
financial interest of the owner. There are also non-financial criteria in an
organizational objective that you would like to achieve with your decision and
this should be considered and given weight in the selection of an alternative.

Example:

Specifications Toyota Wigo Suzuki Celerio Honda Brio

Price Php 658,000 Php 598,000 Php 658,000
Engine Size 1.0 L 1.0 L 1.2 L

Maximum Output 65 hp 67 hp 89 hp
Maximum Torque 89 Nm 90 Nm 110 Nm
Fuel Capacity 33 L 35 L 35 L
Resale Value after 2 Php 398,000
Php 360,000 Php 395,000
years
Transmission Automatic Automatic Automatic
Fuel Type Gasoline Gasoline Gasoline
Safety 2 air bags 2 air bags 2 air bags
 1 | Engineering Economics 6

©Autodeal Car Comparison, https://www.autodeal.com.ph/cars/compare/toyota+wigo+1-0-g

at+vs+suzuki+celerio+cvt+vs+honda+brio+1-2-v-cvt

Principle 6: Make Risk and Uncertainty Explicit

The magnitude and impact of future outcomes of any course of action is
uncertain. Risk and uncertainty are unavoidable in estimating the future
outcomes of the alternatives and should be recognized.

Analysis of the alternatives involves projecting or estimating the future

consequences associated with each of them.

Example:

Specifications Toyota Wigo Suzuki Celerio Honda Brio

Spare Parts Easy
Easy Easy
Availability
Spare Parts Price Expensive Moderate Expensive

Principle 7: Review/Revisit Your Decision

In this stage you should compare the actual results to the projections made in
the study to improve the process for future analysis.

1.3.3 Engineering Economy and the Design Process

The seven-step procedure is also used to assist decision making within the
engineering design process, shown as the right-hand column in Table 1. In this
case, activities in the design process contribute information to related steps in
the economic analysis procedure.
 1 | Engineering Economics 7

Table 1: The General Relationship between the Engineering Economic

Analysis Procedure and the Engineering Design Process

Engineering Economic Analysis Engineering Design Process

Procedure
Steps Activity
1. Problem recognition, 1. Problem/need definition
definition, and evaluation. 2. Problem/need formulation
and evaluation

3. Synthesis of possible
solutions (alternatives).
2. Development of the feasible
alternatives.
3. Development of the outcomes
and cash flows for each
alternative. 4. Analysis, optimization, and
4. Selection of a criterion (or evaluation
criteria)
5. Analysis and comparison of
the alternatives
6. Selection of the preferred
5. Specification of preferred
alternative
alternative.
7. Performance monitoring and
6. Communication
post evaluation of results

1.3.4 Cost Concepts for Decision Making

1.3.4.1 Cost Terminology
Cost considerations and comparisons are fundamental aspects of
engineering practice. Before the study of various engineering economic
decisions problems, the concept of various costs must be understood. At
the level of plant operations, engineers must make decisions involving
materials, plant facilities and the in-house capabilities of company level.
 Fixed costs are those unaffected by changes in activity level over a
feasible range of operations for the capacity or capability available.
Examples are insurance and taxes on facilities, general management
and administrative salaries, license fees, and interest costs on borrowed
capital.
 1 | Engineering Economics 8

 Variable costs are those associated with an operation that vary in total
with the quantity of output or other measures of activity level.
Examples are the costs of material and labor used in a product or
service.
 Incremental cost is the additional cost (or revenue) that results from
increasing the output of the system by one or more units.
 Recurring costs are those that are repetitive and occur when an
organization produces similar goods or services on a continuing basis.
 Nonrecurring costs are those which are not repetitive even though the
total expenditure may become cumulative over a relatively short
period of time.
 Direct costs are costs that can be reasonably measured and allocated to
a specific output or work activity. Examples are labor and material
costs.
 Indirect costs are those that are difficult to attribute or allocate to a
specific output or work activity. Examples are the costs of common
tools, general supplies, and equipment maintenance.
 Overhead cost consists of plant operating costs that are not direct labor
or direct material costs. Examples are electricity, general repairs,
property taxes and supervision.
 Standard costs are representative costs per unit of output that are
established in advance of actual production or service delivery.
 Cash costs are that involves payment of cash.
 Noncash costs (book costs) are costs that does not involve a cash
payment, but rather represent the recovery of past expenditures over a
fixed period of time. Example is the depreciation charged. Sunk cost is
one that has occurred in the past and has no relevance to estimates of
future costs and revenues related to an alternative course of action.
 Sunk costs are cost that has occurred in the past and has no relevance
to estimates of future cost or revenues related to an alternative cost of
action.
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 Opportunity cost is incurred because of the use of limited resources

such that the opportunity to use those resources to monetary
advantage in an alternative use is foregone. It is the cost of the best
rejected opportunity.
 Life-cycle cost refers to a summation of all the costs, both recurring and
nonrecurring, related to product, structure system, or services during
its life span. Life cycle can be divided into two general periods:
Acquisition phase and operation phase.
 Investment cost is the capital required for most of the activities in the
acquisition phase.
 Working capital refers to the funds required for current assets that are
needed for the startup and support of operational activities.
 Operational and Maintenance cost includes many of the recurring
annual expense items associated with the operation phase of the life
cycle.
 Disposal cost includes those nonrecurring costs of shutting down the
operation and the retirement and disposal of assets at the end of the life
cycle. These costs will be offset in some instances by receipts from the
sale of assets with remaining value.
 Economic life coincides with the period of time extending from the
date of acquisition to the date of abandonment, demotion in use, or
replacement from the primary intended service.
 Ownership life is the period between the date of acquisition and the
date of disposal by a specific owner.
 Physical life is the period between original acquisition and final
disposal of an asset over the succession of owner.
 Useful life is the time period that an asset is kept in productive service
(either primary or backup). It is an estimate of how long an asset is
expected to be used in a trade or business to produce income.
 1 | Engineering Economics 10

1.3.4.2 The General Economic Environment

There are numerous general economic concepts that must be taken into
account in engineering studies.
 Consumer goods and services are those products or services that are
directly used by people to satisfy their wants. Examples are foods,
clothing, homes, cars, haircuts and medical services.
 Producer goods and services are used to produce consumer goods
and services and other producer goods. Examples are machine tools,
factory buildings, buses and farm machinery.
 Price of goods and services is defined to be the present amount of
money or its equivalent which is given in exchange for it.
 Demand is a quantity of certain commodity that is bought at a certain
price at a given place and time.
 Supply is a quantity of a certain commodity that is offered for sale at
a certain price at a given place and time.
 Total Revenue is the product of the selling price per unit and the
number of units sold.
 Total Cost is the sum of the fixed costs and the variable costs.
 Profit/ Loss is the difference between total revenue and the total
costs.

Competition
 Perfect competition occurs in a situation in which any given
product is supplied by a large number of vendors and there is
no restriction in additional suppliers entering the market.
 Perfect monopoly exists when a unique product or service is
available from a single supplier and that vendor can prevent the
entry of all others into the market.
 Oligopoly occurs when there are few suppliers and any action
taken by anyone of them will definitely after the course of
action of the others.
1 | Engineering Economics 11

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 will be purchased if money is available after the
required to support human life and activities that will be
purchased in somewhat the same quantity even though the
price varies considerably.

Demand
Demand 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 result
in a greater than proportionate increase in sales.
 Inelastic demand occurs when a decrease in selling price
produces a less than proportionate increase in sales.
 Unitary elasticity of demand occurs when the mathematical
product of volume and price is constant.

The Law of Supply and Demand

Supply is the quantity of a certain commodity that is offered for sale

at ascertain price at a given place and time.

The law of supply and demand may be stated as follows: “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”

Source: https://jackiekchantal.weebly.com/-a-page-defining-
the-differences-between-the-law-of-supply-and-the-law-of-
demand-and-how-price-relates-to-each.html
 1 | Engineering Economics 12

The relationship between the law of supply and demand is as demand

increases the price goes up, which attracts new suppliers who increase the
supply bringing the price back to normal.

If demand increases and supply remains unchanged, a shortage occurs.

If demand decreases and supply remains unchanged, a surplus occurs.
If demand remains unchanged and supply increases, a surplus occurs.
If demand remains unchanged and supply decreases, a shortage occurs.

The Law of Diminishing Returns

The law of diminishing returns states that in all productive processes,
adding more of one factor of production, while holding all others constant
("ceteris paribus"), will at some point yield lower incremental per-unit
returns.

1.3.5 Present Economy Studies

When alternatives for accomplishing a specific task are being compared over
one year or less and the influence of time on money can be ignored, engineering
economic analyses are referred to as present economy studies.

1.3.5.1 Rules in Present Economy Studies

Rule 1: When revenues and other economic benefits are present and vary
among alternatives, choose the alternative that maximizes overall profitability
based on the number of defect-free units of a product or service produced.

Rule 2: When revenues and other economic benefits are not present or are
constant among all alternatives, consider only the costs and select the
alternative that minimizes total cost per defect-free unit of product or service
output.
 1 | Engineering Economics 13

Present economy studies occur in the following situations:

1. Selection of material
2. Selection of methods to be used
3. Selection of design
4. Selection of site location for a project
5. Comparison of proficiency among workers
6. Economy of tool and equipment maintenance
7. Economy of number of workers