GET 521

ENGINEERING ECONOMICS
LECTURE NOTE

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 MODULE 1

INTRODUTION TO ENGINEERING ECONOMICS

Engineering Economics, previously known as engineering economy, is a subset of economics

concerned with the use and application of economic principles in the analysis of engineering
decisions. As a discipline, it is focused on the branch of economics known as
microeconomics in that it studies the behavior of individuals and firms in making decisions
regarding the allocation of limited resources. Thus, it focuses on the decision making process,
its context and environment. It is pragmatic by nature, integrating economic theory with
engineering practice.

But, it is also a simplified application of microeconomic theory in that it avoids a number of

microeconomic concepts such as price determination, competition and demand/supply. As a
discipline though, it is closely related to others such as statistics, mathematics and cost
accounting.

Engineers seek solutions to problems, and the economic viability of each potential solution is
normally considered along with the technical aspects. Fundamentally, engineering economics
involves formulating, estimating, and evaluating the economic outcomes when alternatives to
accomplish a defined purpose are available.

Considering the time value of money is central to most engineering economic analyses. Cash
flows are discounted using an interest rate. For each problem, there are usually many possible
alternatives. The opportunity cost of making one choice over another must also be
considered.

Costs as well as revenues are considered, for each alternative, for an analysis period that is
either a fixed number of years or the estimated life of the project. The salvage value is often
important, and is either the net cost or revenue for decommissioning the project.

Some other topics that may be addressed in engineering economics are inflation, uncertainty,
replacements, depreciation, resource depletion, taxes, accounting, cost estimations, amd
capital budgeting. All these topics are primary skills and knowledge areas in the field of cost
engineering.

Since engineering is an important part of the manufacturing sector of the economy,

engineering economics is an important part of industrial or business economics.

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1.1 Microeconomics

Microeconomics is a branch of economics that studies the behavior of individuals and firms
in making decisions regarding the allocation of scarce resources and the interactions among
these individuals and firms.

One goal of microeconomics is to analyze the market mechanisms that establish relative
prices among goods and services and allocate limited resources among alternative uses.
Microeconomics shows conditions under which free markets lead to desirable allocations. It
also analyzes market failure, where markets fail to produce efficient results. Macroeconomics
involves the sum total of economic activity, dealing with the issues of growth, inflation, and
unemployment and with national policies relating to these issues.

1.2 Inflation

In economics, inflation is a sustained increase in the price level of goods and services in an
economy over a period of time. When the price level rises, each unit of currency buys fewer
goods and services; consequently, inflation reflects a reduction in the purchasing power per
unit of money – a loss of real value in the medium of exchange and unit of account within the
economy. A chief measure of price inflation is the inflation rate, the annualized percentage
change in a general price index, usually the consumer price index, over time. The opposite of
inflation is deflation.

The negative effects of inflation include an increase in the opportunity cost of holding
money, uncertainty over future inflation which may discourage investment and savings, and
if inflation continue on the increase, it could lead to shortages of goods as consumers begin
hoarding because of concern that prices will increase in the future.

Economists generally believe that the high rates of inflation and hyperinflation are caused by
an excessive growth of the money supply. Views on which factors determine low to moderate
rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations
in real demand for goods and services, or changes in available supplies such as during
scarcities. However, the consensus view is that a long sustained period of inflation is caused
by money supply growing faster than the rate of economic growth.

The task of keeping the rate of inflation low and stable is usually given to monetary
authorities. Generally, these monetary authorities are the central banks that control monetary
policy through the setting of interest rates, open market operations, and the setting of banking
reserve requirements.

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1.3 Depreciation

In accountancy, depreciation refers to the decrease in value of assets. Depreciation is a

method of reallocating the cost of a tangible asset over its useful life span of it being in
motion. Businesses depreciate long-term assets for both accounting and tax purposes. The
former affects the balance sheet of a business or entity, and the latter affects the net income
that they report. Generally, the cost is allocated, as depreciation expense, among the periods
in which the asset is expected to be used. Methods of computing depreciation, and the periods
over which assets are depreciated, may vary between asset types within the same business
and may vary for tax purposes. These may be specified by law or accounting standards,
which may vary by country. There are several standard methods of computing depreciation
expense, including fixed percentage, straight line, and declining balance methods.
Depreciation expense generally begins when the asset is placed in service. Some causes of
depreciation are the natural wear and tear of the asset.

1.4 Tax

A tax is a mandatory financial charge or some other type of levy imposed upon a taxpayer (an
individual or other legal entity) by a governmental organization in order to fund various
public expenditures. Failure to pay, along with evasion of or resistance to taxation, is
punishable by law. Taxes consist of direct or indirect taxes and may be paid in money or as
its labour equivalent.

Most countries have a tax system in place to pay for public/common/agreed national needs
and government functions: some levy a flat percentage rate of taxation on personal annual
income, some on a scale based on annual income amounts, and some countries impose a very
low tax rate for a certain area of taxation. Some countries charge a tax both on corporate
income and dividends; this is often referred to as double taxation as the individual
shareholder(s) receiving this payment from the company will also be levied some tax on that
personal income.

1.5 Accounting

Accounting or accountancy is the measurement, processing, and communication of financial

information about economic entities. Accounting, which has been called the "language of
business", measures the results of an organization's economic activities and conveys this
information to a variety of users, including investors, creditors, management, and regulators.
Practitioners of accounting are known as accountants. Accounting can be divided into several

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fields including financial accounting, management accounting, external auditing, tax
accounting and cost accounting. Accounting information systems are designed to support
accounting functions and related activities. Financial accounting focuses on the reporting of
an organization's financial information, including the preparation of financial statements, to
the external users of the information, such as investors, regulators and suppliers; and
management accounting focuses on the measurement, analysis and reporting of information
for internal use by management. The recording of financial transactions, so that summaries of
the finance may be presented in financial reports, is known as bookkeeping, of which double-
entry bookkeeping is the most common system.

1.6 Capital (economics)

According to Adam Smith, capital as that part of men's stock which he expects to afford him
revenue. In Marxian definition, capital is money used to buy something only in order to sell it
again to realize a financial profit. For Marx, capital only exists within the process of
economic exchange—it is wealth that grows out of the process of circulation itself, and for
Marx it formed the basis of the economic system of capitalism. This form of capital is
generally referred to as financial capital and is distinguished from capital goods.

Capital goods, real capital, or capital assets are already-produced, durable goods or any non-
financial asset that is used in production of goods or services.

Capital goods are durable goods (one that does not quickly wear out) that are used in the
production of goods or services. Capital goods are one of the three types of producer goods,
the other two being land and labour, which are also known collectively as primary factors of
production. This classification originated during the classical economics period and has
remained the dominant method for classification.

A society acquires capital goods by saving wealth that can be invested in the means of
production. In terms of economics, capital goods are tangible property. People use them to
produce other goods or services within a certain period. Machinery, tools, buildings,
computers, or other kinds of equipment that are involved in production of other things for
sale, are capital goods.

Capital is distinct from land (or non-renewable resources) in that capital can be increased by
human labor. At any given moment in time, total physical capital may be referred to as the
capital stock. Capital is an input in the production function. Homes and personal autos are not

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usually defined as capital but as durable goods because they are not used in a production of
saleable goods and services.

1.7 Factors of production

In economics, factors of production are resources or inputs used in the production process to
produce output—that is, finished goods and services. There are three basic/primary resources
or factors of production: land, labour and capital. The factors are also frequently labelled
"producer goods or services" to distinguish them from the goods or services purchased by
consumers, which are frequently labeled "consumer goods". All three of these are required in
combination at a time to produce a commodity.

There are two types of factors of production: primary and secondary. The primary factors are
land, labour (the ability to work), and capital. Materials and energy are considered secondary
factors in classical economics because they are obtained from land, labor and capital. The
primary factors facilitate production but neither become part of the product (as with raw
materials) nor become significantly transformed by the production process (as with fuel used
to power machinery).

1.8 Cost engineering

Cost engineering is the engineering practice devoted to the management of project cost,
involving such activities as estimating, cost control, cost forecasting, investment appraisal
and risk analysis. Cost Engineers budget, plan and monitor investment projects. They seek
the optimum balance between cost, quality and time requirements. In otherword, a cost
engineer is an engineer whose judgment and experience are utilized in the application of
scientific principles and techniques to problems of estimation; cost control; business planning
and management science; profitability analysis; project management; planning and
scheduling.

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 MODULE 2

TIME VALUE OF MONEY

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EXERCISE 1

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EXERCISE 2

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EXERCISE 3

EXERCISE 4

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EXERCISE 5

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 MODULE 3

SIMPLE INTEREST AND COMPOUND INTEREST

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 MODULE 4

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KINDS OF CAPITAL BUDGETING DECISION

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the standard acceptable limit will be considered.

EXERCISE 6

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EXERCISE 7

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UNEVEN CASH FLOW

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 MODULE 5

ANALYSIS OF PROJECT

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 MODULE 6

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 MODULE 7

BREAK EVEN ANALYSIS- ALGBRAIC METHOD

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 MODULE 8

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