Scribd
Upload
115 views27 pages

Chapter 1 Making Economic Decisions

The document summarizes the key steps in the economic decision-making process: 1) Recognize the problem, define the goal, and assemble relevant data on costs and benefits. 2) Identify feasible alternatives, including the "do nothing" option. 3) Select criteria for determining the best alternative such as minimizing costs or maximizing profits. It also provides examples of applying these steps to problems involving choosing between suppliers or manufacturing methods.

Uploaded by

Shudipto Podder
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
115 views27 pages

Chapter 1 Making Economic Decisions

The document summarizes the key steps in the economic decision-making process: 1) Recognize the problem, define the goal, and assemble relevant data on costs and benefits. 2) Identify feasible alternatives, including the "do nothing" option. 3) Select criteria for determining the best alternative such as minimizing costs or maximizing profits. It also provides examples of applying these steps to problems involving choosing between suppliers or manufacturing methods.

Uploaded by

Shudipto Podder
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 27

Making Economic Decisions

Chapter 1
Supplemental Reading, Chapter 1
Newnan, D., Whittaker, J., Eschenbach, T., and Lavelle, J. (2018). Engineering Economic
Analysis (4th Canadian edition). Oxford University Press.

ENG 3000 – Engineering Economics


© Farhoud Delijani, 2022
Learning Objectives

• Distinguish between simple and complex problems


• Discuss role and purpose of engineering economic
analysis
• Describe nine steps of economic decision-making process
• Select appropriate economic criteria for different problem
types
• Solve simple engineering decision-making problems
Decision-Making Process

• This course is about ‘decision making’


• Specifically, economic decisions
• In order to make decisions, we will need to learn
‘how to make important decisions’
➢Simple problems
➢Intermediate problems
➢Complex problems
Decision-Making Process
➢ Simple (not much effort needed):
• If we use a machine three times a week, how many
should we buy at a time?
➢ Intermediate (primarily economic):
• Which machine should be purchased? Low-cost,
requiring three operators or high-cost, requiring only two
operators?
➢ Complex
• The annual budget of a corporation. All projects are
evaluated economically but may also include non-
economic factors such as political or national concerns,
individual concerns, and other corporation-wide impacts.
Decision-Making
Process
• There are 9 steps:
1. Recognize the Problem
• The starting point in rational
decision-making is
recognizing that a problem
exists.
• Problems can be
previously unrecognized
or only become apparent
directly as a result of a
new situation.
Decision-Making
Process
2. Define the Goal or
Objective
• A goal or objective can be
wide or narrow in scope:
• Wide scope:
• “Make the business
more profitable.”
• Narrow scope:
• “Determine the
most economical
machines to
purchase.”
Decision-Making
Process
3. Assemble Relevant Data
• Published information
• Individual’s knowledge and
experience
• Problem’s time horizon
• Accounting data
➢ Costs and Benefits
• Require the “true” differences
between alternatives (example 1)
• Financial consequences:
➢ Market and Extra-market
➢ Intangible
Decision-Making
Process
4. Identify Feasible
Alternatives
• “Do-nothing” can be an
alternative
• Determine ALL potential
alternatives:
• Brainstorming
• Conventional and
unconventional solutions
• Create a list:
• Only feasible alternatives
are used for the analysis
Example 1
• Problem
Assume a company with the following average monthly
costs for its three-person printing department:
Example 1
• Problem
The printing department charges the other departments for its
services to recover its $18,000 monthly cost. The charge to run 1,000
copies of an announcement is:

Another commercial printer prints the same 1,000 copies for $22.95. If
the shipping department (of the same company) needs about 30,000
copies printed a month, which printer should the department use?
Example 1
• Solution
Example 1
• Solution

• So, which one should we choose?


Decision-Making
Process
5. Select the Criterion
for Determining the Best
Alternative
•The standards by which we
determine the best
alternative.
• Monetary or other
factors
•Where the standard is to
“maximize profit,” there are
three types of problems:
Decision-Making Process

5. Select the criterion to determine the best alternative:

Category Economic Standard


Fixed input Must maximize benefits or other outputs
Fixed output Must minimize costs or other inputs
Neither input nor output fixed Must maximize value of outputs minus cost of inputs
Decision-Making
Process
6. Construct a Model
• This is an opportunity to
bring together the various
elements of a problem to
help form the solution.
• For example, a loan
consists of a mathematical
relationship between:
• Loan amount
• Interest rate
• Duration
• Payments
Decision-Making
Process
7. Predict the Outcomes for
Each Alternative
• In order to choose an alternative,
the alternatives must be evaluated
in a comparable way
• The consequences of alternatives
are evaluated in terms of monetary
(or other) consequences
• The most common error for longer-
term problems is the assumption
that the current situation will
continue well into the future
• or that the “do nothing”
alternative implies that nothing
else changes
Decision-Making
Process
8. Choose the Best Alternative
• Decisions can be made
through numerical methods.
• Intangibles may influence a
decision such that the most
economical (monetarily) may
not be chosen.
• Decision influences:
• Have all the factors been
considered?
• Who is responsible for
the decision?
Decision-Making
Process
9. Audit the Result
• An audit of the results
provides feedback into the
decision-making process.
• Audits help keep a project
on track.
• Audits help future
estimates and
assumptions.
• Audits provide an
incentive to give accurate
estimates.
Ethical Lapses
Decision-Making for Current Costs

➢Example: (Tile for plant floor: fixed output)


• 1000 m2
• Tile A costs:
➢Purchase: $52/m2
➢Installation: $37,000
• Tile B costs:
➢Purchase: $63/m2
➢Installation: $28,000

• Select Tile A to minimize cost for fixed output


Example 2

• Problem
A concrete aggregate mix must contain at least 31% sand by
volume for proper batching. Source ‘A’ has 25% sand and
75% coarse aggregate and sells for $3 per cubic metre (m3).

Source ‘B’ has 40% sand and 60% coarse aggregate and
sells for $4.40/ m3.

Which source or percentage of each source should be used


to minimize cost per cubic metre and meet the desirable
percentage sand volume of 31%?
Example 2
• Solution
Example 2
• Solution
Example 3
• Problem
A machine part is manufactured at a unit cost of 40¢ for
material and 15¢ for direct labour. An investment of $500,000 in
tooling is required for this method.

A new method of manufacture is being investigated. This new


method reduces unit costs to 34¢ for material and 10¢ for direct
labour. An investment of $600,000 in tooling would be required.

Both methods incur other costs that are 2.5 times the direct
labour costs.

Assume an order call for 1.5 million pieces. Which of these two
methods should be used?
Example 3
• Solution
Making Economic Decisions
Chapter 1
Supplemental Reading, Chapter 1
Newnan, D., Whittaker, J., Eschenbach, T., and Lavelle, J. (2018). Engineering Economic
Analysis (4th Canadian edition). Oxford University Press.

ENG 3000 – Engineering Economics


© Farhoud Delijani, 2020

You might also like