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INTRODUCTION TO
ENGINEERING ECONOMY
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WHAT IS ECONOMICS ?
The study of how limited
resources is used to
satisfy unlimited human
wants
WHAT IS ECONOMICS ?
The study of how individuals
and societies choose to use
scarce resources that nature
and previous generations
have provided.
Resources

• Land
• Labor
• Capital
Resources

• Land
• Labor
• Capital
 LAND
All gifts of nature, such as: water,
air, minerals, sunshine, plant and
tree growth, as well as the land
itself which is applied to the
production process.
 LABOR
The efforts, skills, and knowledge
of people which are applied to the
production process.
 CAPITAL
• Real Capital (Physical Capital )
– Tools, buildings, machinery --Dollar
things
Bills which
have been produced which are used in further
production
• Financial Capital
– Assets and money which are used in the
production process
• Human Capital
– Education and training applied to labor in
the production process
 What is Engineering Economy?
• Economic decision making for engineering systems is called
engineering economy. This definition may seem restricted to
engineering projects and systems only, engineering economy however
is also the study of industrial economics and the economic and
financial factors which influence industry.
• Engineers are the people who are familiar with all the technicalities of
machinery and production therefore they are the best judges of the
useful lives of an asset and they also have the technical knowledge to
calculate the number of units a proposed plant would produce when
operational.
• In today’s competitive world of business it has become essential that
engineers should practice financial project analysis for engineering
projects and make rational decisions.
• Engineering economy also includes the study of accounting practices
for manufacturing concerns. Unique features of accounting for
manufacturing concerns are process costing, batch costing, cost
allocation.
• Engineering economy deals with justification and selection of
projects. Many engineers work on projects which address a specified
activity or a problem. Any decision regarding the project must be
justified.
• In business environments, many if not all, decisions are justified using
monetary criteria such as “profit”. Such decisions are made at the
managerial level and many engineers become managers in
manufacturing environment.
• Therefore, all engineers, regardless of their employment, should know
methods and tools used in evaluation of projects.
• The purpose of engineering economy is to expose all engineering
students to the methods which are widely used for evaluation of
projects.
• Even though, engineering economy deals mostly with selection of
projects in business environment, the tools and methods can be and
are used by individuals and non-profit organizations such as
government, hospitals, and charitable entities, etc.

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 SOME EXAMPLES
Let us present few examples in different environments where engineering
economy can facilitate the decision making process.
• Business Environment: A small manufacturing company needs to buy
a forklift truck for material handling. Two different brands, say A and
B, are being considered. Which truck should be bought? The decision
will probably be based on minimization of cost.
• Non-profit Organizations: A project for widening a two lane highway to
four lanes is being considered by the county board. A four lane
highway may reduce the traffic accident rate but is expected to lower
property values in the immediate neighborhood of the highway.
Should the proposed highway be built? The county board must weigh
the relative benefit of lower accident rates against the possible loss in
value of homes as well as the construction cost.
• Individuals: A new college graduate needs a new car. Should this new
car be bought or leased? Methods from engineering economy can be
used for determining the best choice.
 Economic factors are as important as regard for the physical laws and
science that determine what can be accomplished with engineering.
The following figure shows how engineering is composed of physical
and economic components:
 Physical Environment: Engineers produce products and services
depending on physical laws. Physical efficiency takes the form:

System output(s)
Physical (efficiency) = -------------------------
System input(s)
 Economic Environment: Much less of a quantitative nature is known
about economic environments -- this is due to economics being
involved with the actions of people, and the structure of organizations.
 Satisfaction of the physical and economic environments is linked
through production and construction processes. Engineers need to
manipulate systems to achieve a balance in attributes in both the
physical and economic environments, and within the bounds of
limited resources.
• Following are some examples where engineering
economy plays a crucial role:
1. Choosing the best design for a high-efficiency gas furnace
2. Selecting the most suitable robot for a welding operation on an
automotive assembly line
3. Making a recommendation about whether jet airplanes for an
overnight delivery service should be purchased or leased
4. Considering the choice between reusable and disposable bottles
for high-demand beverages

• With items 1 and 2 in particular, note that

coursework in engineering should provide sufficient
means to determine a good design for a furnace, or a
suitable robot for an assembly line, but it is the
economic evaluation that allows the further
definition of a best design or the most suitable
robot.
PRINCIPLES OF ENGINEERING
ECONOMY
1. Develop the Alternatives;
2. Focus on the Differences;
3. Use a Consistent Viewpoint;
4. Use a Common Unit of Measure;
5. Consider All Relevant Criteria;
6. Make Uncertainty Explicit;
7. Revisit Your Decisions
DEVELOP THE ALTERNATIVES
The final choice (decision) is
among alternatives. The
alternatives need to be identified
and then defined for subsequent
analysis.
 Example
• Which Car to Lease?
Saturn vs. Honda

Defined the alternatives

Financial Data Required to Make an
Economic Decision
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.
USE A CONSISTENT VIEWPOINT
The prospective outcomes of the
alternatives, economic and other,
should be consistently developed from
a defined viewpoint (perspective).
 USE A COMMON UNIT OF
MEASURE
Using a common unit of measurement
to enumerate as many of the
prospective outcomes as possible will
make easier the analysis and
comparison of alternatives.
Financial Data Required to Make an
Economic Decision
 CONSIDER ALL RELEVANT
CRITERIA
Selection of a preferred alternative
(decision making) requires the use of
a criterion (or several criteria). The
decision process should consider the
outcomes enumerated in the monetary
unit and those expressed in some
other unit of measurement or made
explicit in a descriptive manner.
 CRITERIA
• Want mechanical security
• Want minimum total cash outlay
Financial Data Required to Make an
Economic Decision
MAKE UNCERTAINTY EXPLICIT
Uncertainty is inherent in projecting
(or estimating) the future outcomes of
the alternatives and should be
recognized in their analysis and
comparison.
 CRITERIA
• Mechanical security is uncertainty.
Probably need more research
 Which Car to Lease?
Saturn vs. Honda
•
1. Recognize a decision Need a car
problem
2. Define the goals or
objectives • Want mechanical
3. Collect all the relevant security
information • Gather technical as
4. Identify a set of feasible well as financial data
decision alternatives • Choose between
5. Select the decision Saturn and Honda
criterion to use • Want minimum total
6. Select the best cash outlay
alternative • Select Honda
 REVISIT YOUR DECISIONS
Improved 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
involves two or more alternatives and
normally includes other engineering
knowledge and input.
 ENGINEERING ECONOMIC ANALYSIS
PROCEDURE
1. Problem recognition, formulation, and
evaluation.
2. Development of the feasible alternatives.
3. Development of the cash flows for each
alternative.
4. Selection of a criterion ( or criteria).
5. Analysis and comparison of the
alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post-
evaluation results.
 ACCOUNTING AND ENGINEERING
ECONOMY STUDIES
Modern cost accounting may satisfy any or
all of the following objectives:
1. To determine the cost of products or
services
2. To provide a rational basis for pricing
goods or services
3. To provide a means for controlling
expenditures
4. To provide information on which operating
decisions may be based and the results
evaluated
 Engineering Economic
Decisions
Manufacturing Profit

Planning Investment

Marketing
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 Accounting Vs. E E
Evaluating past performance Evaluating and predicting future events

Accounting Engineering Economy

Past Future
Present