Module 1: Introduction

SI-4151 Ekonomi Teknik

Rani G. K. Pradoto, Ph.D .

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 1

 Outline Module 1

• What is Economics?
• What is Engineering Economy?
• The Role of Engineering in Shaping the Economic
Environment
• Economics Aspects on Civil Engineering
• Project Life Cycle
• Some Concepts, Definitions and Terminologies
• Time Value of Money
• Interest and Interest Rate
• Cash Flow
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 What is Economics?
• The study of how limited resources are used to satisfy
unlimited human wants.
• The study of how individual and societies choose to use
and utilize scarce resources
• It’s the social science that deals with the production, distribution,
and consumption of goods and services

• Resources:
– LAND → all gifts of nature that can be applied to the
process (production)
– LABOR → efforts, skills, expertise, knowledge of people
which can be applied to the process
– CAPITAL → human, tools/machineries, financial
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 Engineering is not just knowing how to
design something.

“ An engineer is one who could make

something for one dollar what
others can make for two…

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 What is Engineering
Economy?
• Engineering and the Economy
– Any endeavor, including engineering, will always have consequences
– It deals with the method that enables one to take economic decision towards
minimizing cost and maximizing benefits to business organization
– It quantifies the benefits and costs associating with engineering projects to
determine if they save enough money to warrant their capital investments
– Engineering endeavor
• Add value → betterment of effectiveness, efficiency, changing conditions
• Add economic value → the most common comparable measurement
• Example:
– Economic decisions
• A piece of equipment has been used for 10 years as part of important process. Current
condition indicates that service level is slightly decrease, often breaks down. On the other
hand the demand for product is in constant increase, at least for the next 5 years.
• Alternatives:
– Replaced with a new one or to be repaired
– Current and future technology (?)
– Future demand (?)

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 1-5

 Engineering Economy
• Deals with the concepts and techniques of analysis useful
for evaluating the worth of goods, services, system in
relation to cost
• For engineers, it is used to answer questions such as:
– Which engineering projects are worthwhile?
– Which engineering projects should have higher
priority?
– How should an engineering project be designed?
• The answers based on the concepts of:
– Cash flows (cash in and cash out)
– Interest rate and time value of money
– Equivalent techniques

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 The Role of Engineering in
Shaping the Economic
Environment
• Engineering Options
– There are many (engineering) alternative solution for any
problem or challenge
– What solution is best to satisfy? For now or anytime in the
future
– How do we compare one to another?
• Engineering Steps
1. Determine objectives
2. Identification of strategic factors
3. Determine means → engineering proposals
4. Evaluation of engineering proposals → cash flow of
alternatives
5. Decision making → economic evaluation
Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 1-7
 Economics aspect on Civil
Engineering

▪ A Civil Engineer designs and constructs structures that the people

demands which makes people's lives easier, convenient and safer
▪ It costs money to design, supervise, construct & maintain structures
that engineers build & the only way to be effective at doing this
whole cycle is to have proper knowledge of economics
▪ An Engineer that designs something that the world doesn't need or
doesn't want, then that engineer wouldn't sell his design, that’s why
having a knowledge of demand and supply is necessary
▪ Projects that are technically feasible but economically infeasible are
discarded
▪ To ensure minimum waste & maximum usage of resources knowledge
of economics is a must

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 8

 CLASSIFICATION

MACRO
ECONOMICS

ECO ENGINEERING
NOMICS ECONOMICS

MICRO
ECONOMICS

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 9

 ENGINEERING ECONOMICS

IT IS DEFINED AS A
"guide for the economic selection among technically
feasible alternatives for the purpose of a rational
allocation of scarce resources."

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 10

 ECONOMICS IN ENGINEERING

INDUSTRIAL
ENGINEERING
In Civil Engineering, Industrial
Engineering or any types of
CIVIL production based engineering, we
ENGINEERING must study the basics of micro
economics, more specifically
Engineering Economics.
OTHER
TYPES OF
PRODUCTION BASED
ENGINEERING

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 11

 USES OF ECONOMIC THEORIES

The Economics theories are As the design and

construction
used to take decisions related
to uncertain and changing 1 2 process become
business environment. more complex, the
Economics theories deal MAKING BUILDING
with the principles of
Civil Engineer is
demand, pricing, cost, DECISION STRUCTURES making decisions
production and national that involve
income and so on. money and
economics more
than ever before.

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 Project Life Cycle
Concept &
Definition
Phase Next Cycle
Design Phase

Construction Phase

Level of Change Operation & Maintenance Phase

scope cost

Time
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 Time Value of Money
• Purchasing or earning power of money
– Funds borrowed for the prospects of gain are commonly
exchanged for goods, services or instruments of production, that
ultimately leads to increase earning
• Time value of money
– What you could buy with Rp. 1 million a year ago will not be the
same with the ones you buy today.
– Rp. 1 million you invested in a bank a year ago will yield more
when you draw today.
– Rp 1 million today is worth more than a year later.
– Concept of equivalence → different sums of money at different
time can be equal in economic value.

Rp. 1 Mill P F Rp. 1 Mill

+ interest

0 1 2 3 n-1 n
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 Interest and Interest Rate
• Interest is defined as a rental amount charged by financial institution of
the use of money
• Interest rate (also known as rate of capital growth) is defined as the
rate gain received from an investment → measured in %
• Interest rate is determined mutual agreement between the borrower
and the lender, or by market forces involving supply and demand →
market value.
• From lender’s point of view:
– Involves risk of default
– Compensate for not taking other alternative (including for own use)
– Cost of investigating borrower and other administrative expenses
– To make up for inflation
• From borrower’s point of view:
– Based in one’s utility, for personal use
– Based on expected return, for financing operation or investment

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 1-15

 Basic Calculation of Interest
Rp. 1 Mill P F Rp. 1 Mill
+ interest

0 1 2 3 n-1 n

• Original investment → present value (P)

• Total accumulated amount → future value (F)
• Interest , I = F – P
• Interest rate, i = (interest accrued per unit time) /
(original amount)

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 Simple Interest
 Simple interest = (principal)(number of periods)(interest rate), I = P.n.i
 Accumulated amount, F = P + I = P(1+ni)

i=12%
End of Amount Owed at Interest Charged Amount Owed at End of Amount Paid at End
Period Beginning of Period (C) = (B) x i Period of Period
(A) (B) (D) = (B) + (C)
1 Rp. 1.000.000,- Rp. 120.000,- Rp. 1.120.000,- Rp. 0

2 Rp. 1.120. 000,- Rp. 120.000,- Rp. 1.240.000,- Rp. 0

3 Rp. 1.240.000,- Rp. 120.000,- Rp. 1.360.000,- Rp. 0

4 Rp. 1.360.000,- Rp. 120.000,- Rp. 1.480.000,- Rp. 1.480.000,-

EXCEL

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 1-17

 Compound Interest
 Compound interest → interest will be charged for all unpaid amount
 Accumulated amount, F = P(1+i)n
End of Amount Owed at Interest Charged Amount Owed at Amount Paid at
Period Beginning of Period (C) = (B) x i End of Period End of Period
(A) (B) = (C)n-1 (D) = (B) + (C) (E)
1 Rp. 1.000.000,- Rp. 120.000,- Rp. 1.120.000,- Rp. 0,-
2 Rp. 1.120. 000,- Rp. 134.400,- Rp. 1.254.400,- Rp. 0,-
3 Rp. 1.254.400,- Rp. 150.528,- Rp. 1.404,928- Rp. 0,-
4 Rp. 1.404.928,- Rp. 168.592,- Rp. 1.573.519,- Rp. 1.573.519,-

End of Amount Owed at Interest Amount Owed at End of Period

Period Beginning of Period Charged
1 P Pi P + Pi = P (1+i)1
2 P(1+i) P(1+i) i P(1+i) 1 + P(1+i)i = P (1+i) 2
3 P(1+i) 2 P(1+i) 2i P(1+i) 2 + P(1+i) 2.i = P (1+i) 3
n P(1+i) n-1 P(1+i) n-1i P(1+i) n-1 + P(1+I) n-1i = P(1+i) n EXCEL

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 Exercise for Concept of
Equivalence
• Loan: $ 5,000, i = 8%, n = 5
• Repayment plans:
– Plan 1: Simple interest, pay all at end.
– Plan 2: Compound interest, pay all at end.
– Plan 3: Simple interest paid annually, principal
repaid at end.
– Plan 4: Compound interest and portion of
principal repaid annually.
– Plan 5: Equal payments of compound interest and
principal made annually. EXCEL

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 19

 Cash Flows

• Any undertaking and/or business endeavor (including

engineering projects) generally have economic consequences
that occur over an extended period of time.
• Each project is described as cash received (inflow – cash in)
or disbursement or expenses (outflow – cash out) at
different point in time.
• Cash Flow Diagram (CFD) summarizes the costs and benefits
of engineering project over time. CFD illustrates the size, sign
and timing of individual cash flows and form as the basis for
engineering economic analysis

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 Cash Flows Diagram

• In a CFD the end of period t is the same as the

beginning of next period t+1
• The choice of time 0 is arbitrary. It can be when the
project is analyzed, when funding is approved or
when the construction begins

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 1-21

 Homework #1
1. What will be the accumulated amount of Rp 1.750.000,-
compounded annually for three years at the rate of 15% p.a?
2. How much do you have to save now if you’d like to have
Rp. 12.500.000,- to start a new company 3 years from now at the
interest rate of 12% per year?
3. What is the rate of return of an initial investment worth Rp. 30
millions that yield Rp. 45.000.000,- after 3 years?
4. An initial investment of Rp. 50 millions is being considered.
The revenues from this investment are Rp 20 millions at the end of
first year, Rp 25 millions and Rp 15 millions at the end of second and
third years. If the alternative will give a revenue of Rp 57,5 millions
at the end of the third year, which investment would you
recommend? The interest rate is set at 10% annually.

Rani G. K. Pradoto Ph.D. SI-4151 Ekonomi Teknik 1-22

 Thank You!

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