ENGINEERING ECONOMICS
1. Introduction to Economics
Definition and Concept
Economics is the study of how individuals and societies allocate scarce resources to satisfy their
unlimited wants. It involves analyzing decision making processes, market behaviour, and the impacts
of various policies and external factors.
Engineering economics is a branch of engineering that applies economic principles to analyze
engineering decisions and projects. It's concerned with evaluating the costs and benefits of
engineering projects to determine if they're worth the investment.
2. Importance of Economics for Engineers
1. Project Feasibility and Viability
Cost Benefit Analysis: Helps in evaluating whether the benefits of a project outweigh its costs,
ensuring that resources are allocated efficiently.
Budgeting: Essential for managing and controlling project expenses, ensuring projects stay within
financial limits.
2. Resource Optimization
Efficient Allocation: Economic principles guide engineers in the optimal use of limited resources
(materials, labour, time) to achieve the best outcomes.
Cost Reduction: Identifies opportunities for cost saving measures without compromising quality or
performance.
3. Decision Making and Risk Management
Informed Decisions: Economic analysis provides data driven insights that support better decision-
making processes.
Risk Assessment: Helps in evaluating financial risks and uncertainties, leading to more resilient
project planning.
4. Project Evaluation and Performance
Profitability Analysis: Assessing the financial return on investment (ROI) of engineering projects to
determine their profitability.
Performance Metrics: Using economic indicators to measure and enhance the efficiency and
effectiveness of engineering solutions.
5. Market and Demand Understanding
Demand Forecasting: Anticipating market demand for products or services to align engineering
designs and production capacities accordingly.
Market Trends: Staying informed about economic trends and consumer preferences that impact
engineering practices and product development.
6. Sustainable Development
Economic Sustainability: Balancing economic growth with environmental and social considerations
to ensure long-term viability.
Cost Benefit of Sustainability Measures: Evaluating the economic impact of adopting sustainable
practices and technologies.
7. Regulatory and Policy Compliance
Economic Policies: Understanding the impact of economic policies and regulations on engineering
projects, including taxes, subsidies, and environmental regulations.
Compliance Costs: Assessing and managing the costs associated with adhering to industry standards
and regulations.
8. Innovation and Competitive Advantage
Economic Incentives: Leveraging financial incentives for innovation and research to drive
technological advancements.
Competitive Edge: Using economic insights to develop cost effective and high value engineering
solutions that provide a competitive advantage.
9. Project Funding and Investment
Funding Strategies: Identifying and securing funding sources, including grants, loans, and
investments, for engineering projects.
Investment Appraisal: Evaluating the financial viability of investment opportunities in new
technologies or infrastructure projects.
10. Communication with Stakeholders
Financial Reporting: Clearly presenting economic data and financial projections to stakeholders,
including investors, clients, and regulatory bodies.
Value Proposition: Articulating the economic value and benefits of engineering solutions to gain
stakeholder support and buy in.
3. Key Economic Concepts
A. Wealth
Definition: The total value of assets owned by an individual or society.
Importance: Indicates the economic wellbeing and potential for future growth.
B. Goods
Definition: Tangible products that satisfy human wants and needs (e.g., machinery, tools).
Types: Consumer goods (direct use) and capital goods (used in production).
C. Value and Price
Price:
• The amount of money required to purchase a good or service. It is a quantitative measure set
in the market and typically determined by factors such as supply and demand, production
costs, and market competition.
Value:
• The worth or importance of a good or service as perceived by an individual or society. It is a
qualitative measure and can vary significantly based on personal preferences, needs, and
perceptions.
Example: Basic Necessities (e.g., Bread)
• Price: The price of a loaf of bread might be $3. This price is determined by factors such as
production costs, supply chain expenses, and local market conditions.
• Value: For someone who is hungry and needs sustenance, the value of the bread is much
higher than its price because it fulfils an essential need. In contrast, someone who is not
hungry may not place high value on the bread, despite its low price.
D. Capital
Definition: Physical assets used in the production of other goods and services (e.g., machinery,
buildings).
Types: Fixed capital (long term assets) and working capital (short term assets).
E. Money
Definition: A medium of exchange used to facilitate transactions.
Functions: Medium of exchange, unit of account, store of value, and standard of deferred payment.
F. Income
Definition: The flow of money received over a period (e.g., wages, salaries, investments).
Types: Earned income (from labour) and unearned income (from investments).
G. Margins
Definition: The difference between the cost of production and the selling price of a good or service.
Importance: Indicates profitability and efficiency of operations.
H. Utility
Definition: The satisfaction or benefit derived from consuming a good or service.
Marginal Utility: The additional satisfaction gained from consuming one more unit of a good.
Example: A Cold Drink on a Hot Day
• Situation: Imagine you're outside on a scorching summer day, feeling parched and overheated.
You purchase a cold drink, such as lemonade or iced tea.
• Utility: The cold drink provides high utility in this scenario because it quenches your thirst,
cools you down, and provides comfort. The satisfaction or benefit you get from consuming the
drink is significant due to the immediate relief it provides from the heat.
4. Demand and Supply
Demand
Definition: The quantity of a good or service that consumers are willing and able to buy at various
prices.
Supply
Definition: The quantity of a good or service that producers are willing and able to sell at various
prices.
Law of Demand
Definition: The Law of Demand states that, all else being equal, as the price of a good or service
decreases, the quantity demanded for that good or service increases. Conversely, as the price
increases, the quantity demanded decreases. This relationship is generally inverse and is reflected in a
downward-sloping demand curve.
Explanation:
• Substitution Effect: When the price of a good falls, it becomes cheaper relative to other goods,
leading consumers to substitute it for more expensive alternatives.
• Income Effect: When the price of a good decreases, consumers’ purchasing power effectively
increases, allowing them to buy more of the good.
Example:
• Situation: Consider the market for coffee.
o Price Decrease: Suppose the price of a cup of coffee falls from $5 to $3.
o Effect on Quantity Demanded: At the lower price, consumers may decide to buy more
coffee because it is now more affordable. This increase in quantity demanded is a
direct result of the price decrease.
o Demand Curve: If you plot this on a graph, with price on the vertical axis and quantity
demanded on the horizontal axis, the demand curve will slope downward from left to
right, reflecting the inverse relationship.
Law of Supply
Definition: The Law of Supply states that, all else being equal, as the price of a good or service
increases, the quantity supplied for that good or service increases. Conversely, as the price decreases,
the quantity supplied decreases. This relationship is generally direct and is reflected in an upward-
sloping supply curve.
Explanation:
• Profit Motive: Higher prices provide an incentive for producers to increase production because
they can earn more revenue and potentially higher profits.
• Cost of Production: As prices rise, producers are willing to supply more of the good, as the
higher prices help cover the increasing costs of production.
Example:
• Situation: Consider the market for wheat.
o Price Increase: Suppose the price of wheat rises from $4 to $6 per bushel.
o Effect on Quantity Supplied: Farmers might respond by planting more wheat or
increasing the amount they harvest to take advantage of the higher prices. This
increase in quantity supplied is a result of the price increase.
o Supply Curve: If you plot this on a graph, with price on the vertical axis and quantity
supplied on the horizontal axis, the supply curve will slope upward from left to right,
reflecting the direct relationship.
Equilibrium
Definition: The point where the quantity demanded equals the quantity supplied.
Importance: Determines the market price and quantity of goods.
Interaction of Supply and Demand
The interaction between supply and demand determines the equilibrium price and quantity in a
market. At equilibrium, the quantity demanded equals the quantity supplied.
Example of Equilibrium:
• Situation: Let’s use the coffee market again.
o Initial Equilibrium: Suppose initially, the price of a cup of coffee is $4, and at this price,
the quantity demanded by consumers matches the quantity supplied by coffee shops.
o Change in Demand: If a new study reveals that coffee has health benefits, demand for
coffee increases. The demand curve shifts to the right, leading to a higher equilibrium
price and quantity, assuming supply remains constant.
o Change in Supply: Conversely, if coffee shops improve their efficiency and reduce
costs, the supply of coffee increases. The supply curve shifts to the right, leading to a
lower equilibrium price and a higher quantity of coffee sold, assuming demand
remains constant.
5. Microeconomics and Macroeconomics
Microeconomics
Definition: Microeconomics is the branch of economics that studies individual units within the
economy, such as consumers, businesses, and industries. It focuses on how these entities make
decisions and interact in specific markets.
Key Points:
1. Focus:
o Examines the behaviour of individual consumers and firms.
o Analyzes supply and demand in specific markets.
o Studies pricing, competition, and consumer choices.
2. Scope:
o
Deals with the allocation of resources, production, and pricing at a small scale.
o
Looks at how individuals and companies respond to changes in prices and policies.
3. Examples:
o Consumer Choice: How a consumer decides between buying a laptop or a tablet based
on their budget and preferences.
o Firm Production: How a company determines the optimal number of workers to hire
to maximize profits while minimizing costs.
o Market Pricing: How the price of a particular good, like coffee, is determined by the
interaction of supply and demand in the coffee market.
Macroeconomics
Definition: Macroeconomics is the branch of economics that studies the economy as a whole. It
focuses on large-scale economic factors and aggregates, such as national income, inflation, and
unemployment.
Key Points:
1. Focus:
o Examines the performance and behaviour of the entire economy.
o Analyzes broad economic indicators and their impact on overall economic health.
o Studies economic growth, inflation, and unemployment rates.
2. Scope:
o
Deals with aggregate economic phenomena and national economic policies.
o
Looks at how various sectors and economies interact on a larger scale.
3. Examples:
o Economic Growth: Measuring a country’s GDP (Gross Domestic Product) to assess its
economic growth over time.
o Inflation: Analyzing the rate at which prices for goods and services are rising across
the entire economy.
o Unemployment: Studying the overall unemployment rate and its impact on the
national economy.
Comparison Table
Aspect Microeconomics Macroeconomics
Entire economy and economic
Scope Individual markets and agents
aggregates
Specific industries, consumers, and National income, inflation, and
Focus
firms unemployment
Price of coffee, individual business
Examples National GDP, overall inflation rate
decisions
Questions How do price changes affect individual How does inflation impact national
Addressed choices? growth?
Policy Implications Pricing strategies, market competition Monetary policy, fiscal policy
6. Application of Economics in Engineering
• Project evaluation
• Cost benefit analysis, risk assessment, and budgeting.
• Resource management
• Optimal allocation of materials, labour, and time.
• Decision making
• Trade-offs between cost and quality, and analyzing the impact of economic conditions on
project success.
