Module 1 - Introduction To Engineering Economics 1 PDF

Chapter 1.
INTRODUCTION TO
ENGINEERING
ECONOMICS
©2017 Batangas State University
1
Introduction
The technological and social environments in which we live continue to
change at a rapid rate. In recent decades, advances in science and engineering
have transformed our transportation systems, revolutionized the practice of
medicine, and miniaturized electronic circuits so that a computer can be placed
on a semiconductor chip. The list of such achievements seems almost endless. In
your science and engineering courses, you will learn about some of the physical
laws that underlie these accomplishments.
In this Chapter, we able to determine basic principles about engineering

economics, how does it affects our decision-making. Thinking solutions to a
certain problem in an economic way.
2 ©2017 Batangas State University

Learning Objectives
Define what engineering economy is.
Understand the principles of

engineering economics.
Discuss the general economic environment

and the different cost terminologies.
.

Definition and Basic Principles
Engineering
The Accreditation Board for Engineering and Technology
states that engineering “is the profession in which a
knowledge of the mathematical and natural sciences
gained by study, experience, and practical is applied with
judgment to develop ways to utilize, economically, the
materials and forces of nature for the benefit of mankind.”

Engineering
 Emphasized the economic aspects of engineering
 The physical aspects
 It is essential that the economic part of engineering
practice be accomplished well.
 Engineers use knowledge to find new ways of doing
things economically.

Engineering Economy...
 Involves the systematic evaluation of the economic merits
of proposed solutions to engineering problems.
 To be economically acceptable (i.e., affordable), solutions
to engineering problems must demonstrate a positive
balance of long-term benefits over long term costs.
 An analysis and evaluation of the factors that will affect
the economic success of engineering projects to the end
that a recomendation can be made which will insure the
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best use of capital.
Solutions to Engineering Problems must:
 promote the well-being and survival of an organization,
 embody creative and innovative technology and ideas
 permit identification and scrunity of their estimated
outcomes , and
 translate profitability to the “bottom line” through a valid
and acceptable measure of merit.

Engineering economics analysis can play a role in
many types of situations.
 Choosing the best design for a high-efficiency gas furnace
 Selecting the most suitable robot for a welding operation
on an automotive assembly line.
 Making a recommendation about whether jet airplanes for
an overnight delivery service should be purchased or
leased.
 Determining the optimal staffing plan for a computer hel
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desk.
Engineering economy......
 includes significant technical considerations
 involves technical analysis, with emphasis on the
economic aspects
 has the objective of assisting decisions.
 An engineer who is unprepared to excel at engineering

economy is not properly equipped for his or her job.

Fundamental Principles of Engineering Economy.
1. Develop the alternatives.

 Carefully define the problem !
 Then the choice (decision) is among alternatives
 The alternatives need to be identified and then efined
for subsequent analysis.

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.

1.1 Definition and Basic Principles
1. Develop the alternatives.
2. Focus on the differences.
3. Use a consistent view point.
4. Use a common unit of measure.
5. Consider all relevant criteria.
6. Make risk and uncertainty explicit.
7. Revisit your decisions.

3. Use a consistent viewpoint.

 The prospective outcomes of the alternatives, economic
and other, should be consistently developed from a
defined viewpoint (perspective).

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.

5. Consider all relevant criteria.

 Selection of 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.
6. 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.

7. Revisit your decisions.

 Improve 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.

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 normally includes other engineering knowledge and
input.

Engineering Economic Analysis Procedure
1. Problem Definition
2. Development of Alternatives
3. Development of prospective outcomes
4. Selection of a decision criterion
5. Analysis and comparison of alternatives.
6. Selection of the preferred alternative
7. Performance monitoring and post evaluation of results.

 A problem must be well understood and stated in an
explicit form before the project team proceeds with
the rest of the analysis.
 Recognition of the problem is normally stimulated
by internal or external organizational needs or
requirements.
 Once the problemis recognized, its formulation
21
should be viewed from a systems perspective.
 Evaluation of the problem includes refinement of
needs and requirements, and information from the
evaluation phase may change the original
formulation of the problem.
 Redifining the problem until a consensus is reached
may be the most important part of the problem-
solving process !
2. Development of Alternatives
 Searching for Superior Alternatives
The difference between good and great alternatives
depends largely on an individual's or group's
problem-solving efficiency. Such efficiency can be
increased in the following ways:
1. Concentrate on redifining one problem at a time.
2. Develop many redefinitions for the problem.
 Searching for Superior Alternatives
3. Avoid making judgments as new problem
definitions are created.
4. Attempt to redefine a problem in terms that are
dramatically different from the original
problem definition.
5. Make sure that the true problem is well
researched and understood.
Example: Defining the Problem and Developing Alternatives

 Developing investment alternatives

(1) Classical Brainstorming
(2) Nominal Group Technique

3. Development of Prospective Outcomes

A cash flow occurs when money is transferred fne
organization or individual to another. Thus, a cash
flow represents the economic effects of an alternative
in terms of money spent and received.


In addition to the economic aspects of decision
making, nonmonetary factors (attributes) often play a
significant role in the final recommendation.
Examples of objectives other than profit maximization
or cost minimization that can be important to an
organization include the following:
1. Meeting or exceeding customer expectations
2. Safety to employees and to the public
3. Improving employee satisfaction
4. Maintaining production flexibility to meet changing
demands
5. Meeting or exceeding all environmental requirements
6. Achieving good public relations or being an exemplary
member of the community
4. Selection of a Decision Criterion
The decision maker will normally select the alternative
that will best serve the long-term interests of the
owners of the organization. It is also true that the
economic decision criterion should reflect a consistent
and proper viewpoint to be maintained throughout an
engineering economy study.

5. Analysis and Comparison of Alternatives

Analysis of the economic aspects of an engineering
problem is largely based on cash-flow estimates for the
feasible alternatives selected for detailed study.

6. Selection of the Preferred Alternative

The soundness of the technical-economic modeling
and analysis techniques dictates the quality of the
results obtained and the recommended course of
action.

7. Performance Monitoring and Postevaluation Results
Monitoring project performance during its operational
phase improves the achievement of related goals and
objectives and reduces the variability in desired results.
The aim is to learn how to do better analysis, and the
feedback from post implementation evaluation is
important to continuing improvement of operations in
any organization.
Application of the Engineering Economic Analysis Procedure




General Economic Environment
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 and services or other producer goods

Necessities and Luxuries
Necessities are those products or services that are required to

support human life and activities, that will 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
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 the 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.

Competition, Monopoly and Oligopoly
Perfect competition occurs in a situation where a commodity or
service is supplied by a number of vendors and there is nothing to
prevent additional vendors entering the market.
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.
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.
The 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.
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.


The Law of Diminishing Returns
“When the use of one of the factors of production is limited, either

in increasing cost or by absolute quantity, a point will be reached
beyong which an increase in the variable factors will result in a less
than proportionate increase in output.”


The effect of the law of diminishing returns on the performance of

an electric motor is illustrated in Fig. 1-5. For the early increase in
input through input of 4.0 kw, the actual increase in output os
greater than proportional; beyond this point the output is less than
proportional. In this case, the fixed input factor is the electric motor.

Cost Terminology
There are variety of costs to be considered in an engineering

economic analysis. These costs differ in their frequency of
occurrence, relative magnitude, and degree of impact on the study.
Fixed, Variable and Incremental Costs

Fixed costs are those unaffected by changes in activity level over a
feasible range of operations for the capacity or capability available.

Cost Terminology

Fixed costs include insurance and taxes on facilities, general
management and administrative salaries, license fees, and interest
costs on borrowed capital.
Variable costs are those associated with an operation that varies in
total with the quantity of output or other measures of activity level.
Examples are the costs of material and labor used in product or
service because they vary in total with the number of output units,
even though the costs per unit stay the same.
Cost Terminology
Incremental Costs or incremental revenue is the additional costs that

results from increasing an output of a system by one (or more) units.

Cost Terminology
Direct, Indirect and Standard Costs
Direct costs are costs that can be resasonably measured and

allocated to a specific outputor work activity. The labor and material
costs directly associated with a product, service or construction
activity are direct costs. For example, the ,materials needed to make
a pair of scissors would be a direct cost.

Cost Terminology
Indirect costs are costs that are difficult to allocate to a specific

output or work activity. Normally, they are costs allocated through a
selected formula to the outputs or work activities. For example, the
costs of common tools, general supplies, and equipment
maintenance in a plant are treated as indirect costs.

Cost Terminology
Overhead costs consists of plant operating costs that are not direct
labor or direct material costs.
Standard costs are planned costs per unit of output that are
established in advanced of actual production or service delivery.

Cost Terminology
Cash Cost versus Book Cost
Cash costs involves payment of cash. Are estimated from the

perspective established for the analysis and are the future expenses
incurred for the alternatives being analyzed.
Book costs are costs that do not involve cash payments but rather
represent the recovery of past expenditures over a fixed period of
time. Example: depreciation charged for the used assets

Cost Terminology
Sunk Cost
Sunk costs is one that has occured in the past and has no relevance to
estimates of future costs and revenues related to an alternative
course of action.

Cost Terminology
Opportunity Cost
Opportunity costs 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 and is often hidden or implied.

Cost Terminology
Life Cycle Cost
Life cycle costs refers to a summation of all the costs related to a

product, structure, system, or service during its life span.

Chapter Test
Problem 1: During your first month as an employee at Greenfield
Industries (a large drill-bit manufacturer), you are asked to evaluate
alternatives for producing a newly designed drill bit on a turning machine.
Your boss' memorandum to you has practically no information about what
the alternatives are and what criteria should be used. The same task was
posed to a previous employee who could not finish the analysis, but she has
given you the following information:
An old turning machine valued at $350,000 exists (in the warehouse)
that can be modified for the new drill bit. The in-house

Chapter Test
technicians have given an estimate of $40,000 to modify this machi, and

they assure you that they will have the machine ready before the projected
start date (although they have never done any modifications of this type). It
is hoped that the old turning machine will be able to meet production
requirements at full capacity. An outside company, McDonald Inc., made
the machine seven years ago and can easily do the same modifications for
$60,000. The cooling system used for this machine is not environmentally
safe and would require some disposal costs. McDonald Inc. has offered to
build a new turning machine with more environmental safeguards

Chapter Test
and higher capacity for a price of $450,000. McDonald Inc. has promised
this machine before the startup date and is willing to pay any late costs.
Your company has $100,000 set aside for the start-up of the new product
line of drill bits. For this situation,
a. Define the problem
b. List key assumptions
c. List alternatives facing Greenfield Industries
d. Select a criterion for evaluation of alternatives
e. Introduce risk into this situation
f. Discuss how non-monetary considerations may impact the selection.
g. Describe how a post-audit could be performed.

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Chapter 1.

In this Chapter, we able to determine basic principles about engineering

2 ©2017 Batangas State University

Define what engineering economy is.

Understand the principles of

Discuss the general economic environment

3 ©2017 Batangas State University

4 ©2017 Batangas State University

5 ©2017 Batangas State University

7 ©2017 Batangas State University

 An engineer who is unprepared to excel at engineering

9 ©2017 Batangas State University

1. Develop the alternatives.

10 ©2017 Batangas State University

2. Focus on the differences.

11 ©2017 Batangas State University

12 ©2017 Batangas State University

3. Use a consistent viewpoint.

13 ©2017 Batangas State University

4. Use a common unit of measure.

14 ©2017 Batangas State University

5. Consider all relevant criteria.

6. Make risk and uncertainty explicit.

16 ©2017 Batangas State University

7. Revisit your decisions.

17 ©2017 Batangas State University

 An engineering economy study is accomplished using a

18 ©2017 Batangas State University

20 ©2017 Batangas State University

25 ©2017 Batangas State University

 Developing investment alternatives

26 ©2017 Batangas State University

3. Development of Prospective Outcomes

27 ©2017 Batangas State University

3. Development of Prospective Outcomes

30 ©2017 Batangas State University

5. Analysis and Comparison of Alternatives

31 ©2017 Batangas State University

6. Selection of the Preferred Alternative

32 ©2017 Batangas State University

34 ©2017 Batangas State University

35 ©2017 Batangas State University

36 ©2017 Batangas State University

37 ©2017 Batangas State University

Consumer goods and services are those products or services

Producer goods and services are used to produce consumer

38 ©2017 Batangas State University

Necessities are those products or services that are required to

Elastic demand occurs when a decrease in selling price result in

41 ©2017 Batangas State University

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

43 ©2017 Batangas State University

44 ©2017 Batangas State University

The Law of Diminishing Returns

“When the use of one of the factors of production is limited, either

45 ©2017 Batangas State University

46 ©2017 Batangas State University

The effect of the law of diminishing returns on the performance of

47 ©2017 Batangas State University

There are variety of costs to be considered in an engineering

Fixed, Variable and Incremental Costs

48 ©2017 Batangas State University

Fixed, Variable and Incremental Costs