LESSON 1.

2: DEFINITIONS, TERMINOLOGIES, AND CONCEPTS

1.2.1 ENGINEERING
• It is the profession in which knowledge of the mathematical and natural sciences gained by study,
experience and practice is applied with judgment to develop ways to utilize economically the
material and forces of nature for the benefit of mankind.

1.2.2 ECONOMICS
• It is the science that deals with the production and consumption of goods and services and the
distribution and rendering of these for human welfare.
• A high level of employment, price stability, efficiency, an equitable distribution of income, and
growth are the economic goals.

1.2.3 ECONOMICS VERSUS ECONOMY

Table 1.2: Comparison Chart for Economics and Economy

BASIS FOR
ECONOMICS ECONOMY
COMPARISON
Economics is the science and art of When a country or a geographical region
decision making, regarding the use of is defined in the context of its economic
Meaning
scarce resources, under the conditions of activities, it is known as economy or
scarcity, to attain maximum satisfaction. economic system.
What is it? Theory and Principle Practical Application of Economics
How human beings make decisions when How are resources allocated among
Determines
there is scarcity of resources? different members of society?
The way in which economic agents
The way in which country’s economic
Focuses on behave and interact and the way in
affairs are organized and conducted.
which economies work.

1.2.4 ENGINEERING ECONOMICS

• It deals with the methods that enable one to take economic decisions towards minimizing costs
and/or maximizing benefits to business organizations.
• In the simplest of terms, it is a collection of techniques that simplify comparisons of alternatives
on an economic basis.
• It is not a method or process for determining what the alternatives are. On the contrary, it begins
only after the alternatives have been identified.
• It is applied in an extremely wide variety of situations. Samples are:
o Equipment purchases and leases, sales, and marketing projects
o Cyber security, and safety systems
o Construction projects, and transportation systems
o Airport design and operations
o Product design, chemical and manufacturing processes, and quality assurance
o Wireless and remote communication and control
o Hospital and health care operations
o Government services for residents and businesses

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1.2.5 ALTERNATIVE
• It is a stand-alone solution for a given situation.
• Words, pictures, graphs, equipment and service descriptions, simulations, etc. define each
alternative.

1.2.6 CASH FLOW

• The estimated inflows (revenues) and outflows (costs) of money is called cash flows.

1.2.7 ALTERNATIVE SELECTION

• Every situation has at least two alternatives.
• In addition to the one or more formulated alternatives, there is always the alternative of inaction,
called the do-nothing (DN) alternative.
• This is the as-is or status quo condition.
• In any situation, when one consciously or subconsciously does not take any action, he or she is
actually selecting the DN alternative.
• If this was selected out of all the alternatives, it shall be the most favorable economic outcome at
the time of evaluation.

1.2.8 EVALUATION CRITERIA

• It is the use of criteria to choose between alternatives.
• For example, you are having your examination and you decide to “impress” your instructor. But
how you define “impress”? Was impressing your instruction means to finish the exam as fast as
possible, follow the instructions carefully, get a perfect score, check for erroneous questions or
what? This depends on which criterion or combination of criteria is used and a different way to
impress your instructor might be selected each time.

1.2.9 TANGIBLE FACTORS

• In economic analysis, financial units (currency) are generally used as the tangible basis for
evaluation and considered as an economic factor.

1.2.10 INTANGIBLE FACTORS

• When alternatives under consideration are hard to distinguish economically or difficult to
quantify, intangible factors may tilt the decision in the direction of one of the alternatives.
• A few examples of noneconomic factors are goodwill, convenience, and friendship.

1.2.11 TIME VALUE OF MONEY

• The change in the amount of money over a given time period is called the time value of money.
• It is the most important concept in engineering economics.

1.2.12 PRESENT ECONOMIC STUDY

• 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
a present economy study.
• The use of present economy studies in engineering decision making can provide satisfactory
results and save considerable analysis effort by considering the various monetary consequences
that occur in short time period.

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LESSON 1.3: PRINCIPLES OF ENGINEERING ECONOMICS

The development, study, and application of any discipline must begin with a basic foundation. The
foundation for engineering economy is a set of principles that provide a comprehensive doctrine for
developing the methodology. Once a problem or need has been clearly defined, the foundation of the
discipline can be discussed in terms of seven principles.

PRINCIPLE 1: Develop the Alternatives

• Carefully identify and define the problem then the choice (decision) is among alternatives.
• The alternatives need to be identified and then defined for subsequent alternatives.
• Engineers and managers should place a high priority on this responsibility.
• Creativity and innovation are essential to the process.

PRINCIPLE 2: Focus on the Differences

• Only the differences in the future outcomes of the alternatives are important.
• Outcomes that are common to all alternatives can be disregarded in the comparison and decision.

PRINCIPLE 3: Use a Consistent Viewpoint

• The prospective outcomes of the alternatives, economic and other should be consistently
developed from a defined viewpoint.
• The viewpoint for the particular decision be first defined and then used consistently in the
description, analysis, and comparison of the alternatives.

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 measuring the economic consequences, a monetary unit (e.g., peso) is the common measure.
• Try to translate other outcomes (which do not initially appear to be economic) into monetary unit.
• Using more than one monetary unit will complicate the overall economic analysis of a project.

PRINCIPLE 5: 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 both the outcomes in monetary unit and descriptive
manner.
• In engineering economic analysis, the primary criterion relates to the long-term financial interest.
• Decision making based on several criteria.
• There are other organizational objectives to achieve with the decision and these should be
considered and given weight in the selection of an alternative.

PRINCIPLE 6: Make Risk and Uncertainty Explicit

• Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should
be recognized, identify, define, allocate and mitigate.
• The analysis of the alternatives involves projecting or estimating the future consequences
associated with each of them.

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PRINCIPLE 7: Revisit Your Decisions
• A good decision-making process can result in a decision that has an undesirable outcome.
• Other decisions, even though relatively successful, will have results significantly different from
the initial estimates of the consequences.
• The initial projected outcomes of the selected alternatives should be subsequently compared
with actual result achieved.

EXAMPLE 1.3.1:
While studying for the Engineering Economics final exam, you and two friends find yourselves craving
for a fresh pizza. You can’t spare the time to pick up the pizza and must have it delivered. “Pizza Hub”
offers a 1” thick (including toppings), 20” square pizza with your choice of two toppings for ₱750.00
plus 5% sales tax and a ₱75.00 delivery charge (no sales tax on delivery charge). “Crusty Pie” offers the
round, deep-dish Sasquatch which is 20 inches in diameter. It is 1-3/4” thick, which includes two
toppings, and costs ₱900.00 plus 5% sales tax and free delivery.
a. What is the problem in this situation? Please state it in a lucid manner.
b. Systematically apply the seven principles of engineering economy to the problem you have
defined in part (a).
c. Assuming that your common unit of measure is ₱ (i.e., cost), what is the better value for getting
a pizza based on the criterion of minimizing cost per unit of volume?
d. What other criteria might be used to select which pizza to purchase?

➢ SOLUTION:
a. One problem involves how to satisfy the hunger of three students – assume a piping hot,
delicious pizza will satisfy this need. (Another problem is to learn enough about Engineering
Economics to pass – or better yet earn a “1.00” – on the final examination and ace the course.
Maybe a pizza will help solve this problem too?) Let’s use “hunger satisfaction with a pizza” as
the problem/need definition.

b. Principle 1 - Develop the Alternatives

(i) Alternative A is to order a pizza from “Pizza Hub.”
(ii) Alternative B is to order a pizza from “Crusty Pie.”
Other options probably exist but we’ll stick to these two alternatives.

Principle 2 - Focus on the Differences

Difference in delivery time could be an issue. A perceived difference in the quality of the
ingredients used to make the pizza could be another factor to consider. We’ll concentrate our
attention on cost differences in part (c) to follow.

Principle 3 - Use a Consistent Viewpoint

Consider your problem from the perspective of three customers wanting to get a good deal.
Does it make sense to buy a pizza having a crust that your dog enjoys, or ordering a pizza from
a shop that employs only college students? Use the customers’ point of view in this situation
rather than that of the owner of the pizza shop or the driver of the delivery vehicle.

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Principle 4 - Use a Common Unit of Measure

Most people use “pesos” as one of the most important measures for examining differences
between alternatives. In deciding which pizza to order, we’ll use a cost based metric in part
(c).

Principle 5 - Consider All Relevant Criteria

Factors other than cost may affect the decision about which pizza to order. For example,
variety and quality of toppings and delivery time may be extremely important to your choice.
Dynamics of group decision making may also introduce various “political” considerations into
the final selection.

Principle 6 - Make Uncertainty Explicit

The variability in quality of the pizza, its delivery time and even its price should be carefully
examined in making your selection. (Advertised prices are often valid under special conditions
– call first to check on this!)

Principle 7 - Revisit Your Decision

After you’ve consumed your pizza and returned to studying for the final exam, were you
pleased with the taste of the toppings? On the downside, was the crust like cardboard? You’ll
keep these sorts of things in mind (good and bad) when you order your next pizza!

c. Assumptions:
(i) weight is directly proportional to volume (to avoid a “meringue” pizza with lots of fluff but
meager substance),
(ii) you and your study companions will eat the entire pizza (avoids variable amounts of
discarded left-overs and hence difficult to predict cost of cubic inch consumed), and
(iii) data provided in the Example Problem are accurate (the numbers have been confirmed by
phone calls).
Analysis is shown in Table 1.3. Therefore, order the pizza from “Crusty Pie” to minimize total
cost per cubic inch.

Table 1.3: Comparison of Alternatives in Cost per Unit Volume

ALTERNATIVES A = “PIZZA HUB” B = “CRUSTY PIE”
3
Volume (20”)(20”)(1”) = 400 𝑖𝑛 𝜋 (10”)2 (1.75”) = 550 𝑖𝑛3
Total Cost ₱750.00(1.05) + ₱75.00 = ₱862.50 ₱900.00(1.05) = ₱945.00
Cost per cubic inch ₱862.50/400 𝑖𝑛3 = ₱2.16 ₱945.00/550 𝑖𝑛3 = ₱1.72

d. Typical other criteria you and your friends could consider are:
(i) cost per square inch of pizza (select “Pizza Hub”),
(ii) minimize total cost regardless of area or volume (select “Pizza Hub”), and
(iii) “Crusty Pie” can deliver in 30 minutes but “Pizza Hub” cannot deliver for one hour because
one of their ovens is not working properly (select “Crusty Pie”).

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LESSON 1.4: ANALYSIS PROCEDURE AND DESIGN PROCESS

• Engineering economics involves the systematic

evaluation of the economic benefits of proposed
solutions to engineering problems.
• Engineering economics involves technical
analyzing with emphasis on the economic aspects
and has the objective of assisting decisions.
• Engineering economics is closely aligned with
conventional micro-economics. It is devoted to
problem solving and decision making at the
operational level.
• Thus, “Engineering Economics refers to those
aspects of economics and its tools of analysis
most relevant to the Engineer’s decision making
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 somehow other
engineering knowledge and input.
• Figure 1.1 is the flow chart representation of the
steps in an engineering economic study while
Table 1.4 shows the engineering design process
which has a possible activity for each steps.

Figure 1.1: Steps in an Engineering Economic Study

Table 1.4: The General Relationship between the Engineering Economic Analysis Procedure and the
Engineering Design Process
ENGINEERING ECONOMIC ANALYSIS PROCEDURE ENGINEERING DESIGN PROCESS
STEPS: ACTIVITY:
1. Problem recognition, definition, and
1. Problem / need definition.
evaluation.
2. Problem / need formulation and evaluation.
2. Development of the feasible alternatives. 3. Synthesis of possible solutions.
3. Development of the outcomes and cash flows
for each alternative.
4. Analysis, optimization, and evaluation.
4. Selection of a criterion.
5. Analysis and comparison of the alternatives.
6. Selection of the preferred alternatives. 5. Specification of preferred alternative.
7. Performance monitoring and post monitoring
6. Communication.
results.

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ENGINEERING ECONOMIC ANALYSIS PROCEDURE
1. Problem recognition, definition, and evaluation.
Problem must be well understood and stated in an explicit form before the project team proceeds
with the rest of the analysis. Evaluation of the problem includes refinement of needs and
requirements, and information from the evaluation phase may change the original formulation of
the problem.

2. Development of the feasible alternatives.

It incorporates the Principle 1 of Engineering Economics, development of potential alternatives.
Searching for potential alternatives (creativity and resourcefulness), screening them to select a
smaller group of feasible alternatives for detailed analysis.

3. Development of the outcomes and cash flows for each alternative.

It incorporates the Principles 2, 3, and 4 of Engineering Economics. Cash flow approach (revenue
and payments), nonmonetary factors e.g. meeting or exceeding customer expectations, safety to
employees, employee satisfaction, etc.

4. Selection of a criterion.
It incorporates Principle 5 of Engineering Economics, considering all relevant criteria. Long-term
interest of the client and the organization, environmental concerns, etc. will be normally selected
by the decision maker. The economic decision criterion should reflect a consistent and proper
viewpoint (Principle 3) to be maintained throughout an engineering economy study.

5. Analysis and comparison of the alternatives.

It incorporates Principle 6 of Engineering Economics. An essential part of an engineering economy
study is the consideration of future uncertainties. It is based on cash flows, exchange rate,
inflation, regulatory, and etc. When cash flow and other required estimates are eventually
determined, alternatives can be compare based on their differences which is Principle 2 of
Engineering Economics (Focus on Differences).

6. Selection of the preferred alternatives.

A result of the total effort of the above mentioned 5 steps. It is the technical-economic modelling.

7. Performance monitoring and post monitoring results.

It implements the Principle 5 of Engineering Economics, revisiting your decision. Accomplished
during and after the time that the result achieved. The aim of post evaluation is to learn how to
do better the job. It is also the follow-up step to a previous analysis, comparing actual results
achieved with the previously estimated outcomes.

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