ENGINEERING

ECONOMY

Eng Econ
Objectives:

– To present, define some engineering economy

terminologies
– To present and discuss the Principles of
Engineering Economy.
 INTRODUCTION
Engineering Economy is one of the most important and useful
subjects in the engineering curricula, so much so that it is a
subject common to all engineering discipline. The purpose of this
subject is to give the students a sound understanding of its basic
concepts and some insights into approaches that can be used for
making sound economic decisions. The aim of the subject is to
prepare and equip them with skills in engineering economy so as
to better face the challenges of their professions.
 INTRODUCTION
 The technological and social environments in which we live continue
to change at a rapid rate. In recent decades, advances in science and
eng’g have made space travel possible, transformed our
transportation systems, revolutionized the practice of medicine, and
miniaturized electronic circuits so that a computer can be placed on
a semiconductor chip. The list of such achievements seems almost
endless. In your science and eng’g courses, you will learn about some
of the physical laws that underlie these accomplishments.
The utilization of scientific and eng’g knowledge for our benefit
is achieved through the design of things we use, such as
machines, structures, products, and services. However, these
achievements don’t occur without a price, monetary or
otherwise. Therefore, the purpose of which is then is to develop
and illustrate the principles and methodology required to
answer the basic economic question of any design.
 What is Engineering?

 It is the profession in which a knowledge of mathematical and natural

sciences gained by study, experience, and practice is applied with
judgment to develop ways to utilize, economically, the materials and
forces of nature for the benefit of mankind.

 *the definition emphasizes the economic aspects of eng’g as well as

physical aspects. It is then essential that the economic part of eng’g
practice be accomplished well. Thus, engr’s use knowledge to find new
ways of doing things economically.
 What is Economics?

It is the science that deals with the production,

distribution, development, and consumption of goods
and services.
Economics is the study of how resources are
allocated and used.
 What is Economy?

It is the careful or thrifty use or management of

resources as of income, materials or labor. A system for
the management and development of resources.
Economy is the system that organizes those
resources.
 What is Engineering Economy?

It involves the systematic evaluation of the economic merits of

proposed solutions to eng’g problems.
It is a discipline concerned with the systematic evaluation of the costs
and benefits of proposed technical and business projects and
ventures.
 Engineering economics is a field that addresses the dynamic
environment of economic calculations and principles through
the prism of engineering. It is a fundamental skill that all
successful engineering firms employ in order to retain
competitive advantage and market share.
 What is Engineering
Economy?


Engineering economy is the analysis and
evaluation of the factors that will affect the
economic success of engineering projects to
the end that a recommendation can be made
which will ensure the best use of capital.
*To be economically acceptable (ex. Affordable), solutions to eng’g
problems must
 demonstrate a positive balance of long-term benefits over long-
term costs
 Promote the well-being and survival of an organization.
 Embody creative and innovative technology and ideas.
 Permit identification and scrutiny of their estimated outcomes, and
 Translate profitability to the “bottom line” through a valid and
acceptable measure of merit.
 What are the Principles of
Engineering Economy?

The dev’t, study, and application of any discipline must

begin with a basic foundation. The foundation for eng’g
economy defined to be a set of principles that provide a
comprehensive doctrine for developing the
methodology.
 Principle 1: Develop the Alternatives

 The choice (decision) is among alternatives. The alternatives need to be

defined and then defined for subsequent analysis.

 A decision situation involves making a choice among two or more

alternatives. Developing and defining the alternatives for detailed
evaluation is important because of the resulting impact on the quality of
the decision. Eng’rs 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 expected future outcomes among the alternatives

are relevant to their comparison and should be considered in the
decision.

 If all prospective outcomes of the feasible alternatives were exactly the

same, there would be no basis or need for comparison. We would be
indifferent among the alternatives and could make a decision using a
random selection.
 Obviously, 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. For example, if your feasible
housing alternatives were two residences with the same purchase (or
rental) price, price would be inconsequential to your final choice. Instead,
the decision would depend on other factors, such as location and annual
operating and maintenance expenses. This example illustrates, in a simple
way, Principle 2, which emphasizes the basic purpose of an eng’g economic
analysis: to recommend a future course of action based on the differences
among feasible alternatives.
 Principle 3: Use a Consistent Viewpoint
 The prospective outcomes of the alternatives, economic and other, shld be
consistently developed from a defined viewpoint (perspective).

 The perspective of the decision maker, which is often that the owners of the
firm, would normally be used. However, it is important that the viewpoint
for the particular decision be first defined and then used consistently in the
description, analysis, and comparison of the alternatives.
As an example, consider a public organization operating for the
purpose of developing a river basin, including the generation and
wholesale distribution of electricity from dams on the river
system. A program is being planned to upgrade and increase the
capacity of the power generators at two sites. What perspective
should be used in defining the technical alternatives for the
program? The “owners of the firm” in this example means the
segment of the public that will pay the cost of the program and
their viewpoint should be adopted in this situation.
Now let us look at an example where the viewpoint may not be that
of the owners of the firm. Suppose that the company in this
example is a private firm and that the problem deals with providing
a flexible benefits package for the employees. Also, assume that the
feasible alternatives for operating the plan all have the same future
costs to the company. The alternatives, however, have differences
from the perspective of the employees, and their satisfaction is an
important decision criterion. The viewpoint for this analysis should
be that of the employees of the company as a group, and the
feasible alternatives should be defined from their perspective.
 Principle 4: Use a Common Unit of
Measurement

 Using a common unit of measurement to enumerate as many of the prospective outcomes as

possible will simplify the analysis of the alternatives.

 It is desirable to make as many prospective outcomes as possible commensurable (directly

comparable). For economic consequences, a monetary unit such us dollars is the common
measure. You should also try to translate other outcomes (which do not initially appear to be
economic) into the monetary unit. This translation, of course, will not be feasible with some of
the outcomes, but the additional effort toward this goal will enhance commensurability and
make the subsequent analysis of alternatives easier.
What should you do with the outcomes that are not economic
(ex. The expected consequences that cannot be translated and
estimated) using the monetary unit? First, if possible, quantify the
expected future results using an appropriate unit of measurement
for each outcome. If this is not feasible for one or more outcomes,
describe this consequences explicitly so that the information is
useful to the decision maker in the comparison of the
alternatives.
 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
shld consider both the outcomes enumerated in the monetary
unit and those expressed in some other unit of measurement or
made explicitly in a descriptive manner.
 The decision maker will normally select the alternative that will best serve
the long-term interests of the owners of the organization. In eng’g
economic analysis, the primary criterion relates to the long-term financial
interests of the owners. This is based on the assumption that available
capital will be allocated to provide maximum monetary return to the
owners. Often, though, there are other organizational objectives you would
like to achieve with your decision, and these should be considered and
given weight in the selection of an alternative. These nonmonetary
attributes and multiple objectives become the basis for additional criteria
in the decision making process.
 Principle 6: 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.

 The analysis of the alternatives involves projecting or estimating the future

consequences associated with each of them. The magnitude and the impact of the
future outcomes of any course of action are uncertain. Even if the alternative involves
no change from current operations, the probability is high that today’s estimate of, for
example, future cash receipts and expenses will not be what eventually occurs. Thus,
dealing with uncertainty is an important aspect of engineering economic analysis.
 Principle 7: Revisit your Decisions

 Improved decision making results from adaptive process; to the extent

practicable, the initial projected outcomes of the selected alternative shld
be subsequently compared with actual results achieved.

 A good decision-making process can result in a decision that has

undesirable outcome. Other decisions, even though relatively successful,
will have results significantly different from the initial estimates of the
consequences. Learning from and adapting based on our experience are
essential and are indicators of a good organization.
 The evaluation of the results versus the initial estimate of outcomes for the
selected alternative is often considered impracticable or not worth the
effort. Too often, no feed back to the decision-making process occurs.
Organizational discipline is needed to ensure that implemented decisions
are routinely post evaluated and that the results are used to improve
future analyses and the quality of decision making. For example, a
common mistake made in the comparison of alternatives is the failure to
examine adequately the impact of uncertainty in the estimates of selected
factors on the decision. Only post evaluations will highlight this type of
weakness in the eng’g economy studies being done in an organization.