ENGINEERING ECONOMICS
ECON 223
INTRODUCTION
Engineering economy involves the systematic evaluation of the economic
merits of proposed solutions to engineering problems. To be economically
acceptable (i.e., affordable), solutions to engineering problems must
demonstrate a positive balance of long-term benefits over long-term costs, and
they must also
• 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
INTRODUCTION
Traffic light meters converted from incandescent lights to
light-emitting diode (LED) lights
- Wattage reduced from 150W to 15W
- Lighting bill reduced from $440,000 annually to $44,000
annually
- Cost of installation: $150,000
INTRODUCTION
More situations in which engineering economy plays a crucial
role in the analysis of project alternative:
1. Choosing the best design for a high-efficiency gas furnace
2. Selecting the most suitable robot for a welding operation on
an automotive assembly line
3. Making a recommendation about whether jet airplanes for an
overnight delivery service should be purchased or leased
4. Determining the optimal staffing plan for a computer help
desk
THE PRINCIPLES OF ENGINEERING
ECONOMY
Principle 1. Develop the Alternatives
- After carefully defining the problem, make alternatives for your decision. The
alternatives need to be identified and defined for later analysis.
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.
Principle 3. Use a Consistent Viewpoint
- The prospective outcomes of the alternatives, economic and other, should be
consistently developed from a defined perspective.
THE PRINCIPLES OF ENGINEERING
ECONOMY
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
Principle 5. Consider All Relevant Criteria
- Selection of a preferred alternative requires the use of a criterion. The decision process
should consider both the outcomes enumerated in the monetary unit and those
expressed in some other unit of measurement or made explicit in a descriptive manner.
THE PRINCIPLES OF ENGINEERING
ECONOMY
Principle 6. Make Risk and Uncertainty Explicit
- Risk and uncertainty are inherent in estimating the future outcomes of the alternatives
and should be recognized in their analysis and comparison.
Principle 7. Revisit your Decisions
- Improved decision making results from an adaptive process; to the extent practical, the
initial projected outcomes of the selected alternative should be subsequently compared
with actual results achieved.
ENGINEERING ECONOMY & THE DESIGN
PROCESS
ENGINEERING ECONOMIC ANALYSIS
PROCEDURE
Step 1. Problem recognition, definition and evaluation
- A problem must be well understood and clearly stated before analysis. Recognition of
the problem is normally stimulated by internal or external organizational needs or
requirements.
- Once the problem is recognized, the boundary or extent of the situation needs to be
carefully defined. The elements of the problem and its scope should be established.
- Evaluation of the problem includes refinement of needs and requirements, and
information from the evaluation phase may change the original formulation of the
problem.
ENGINEERING ECONOMIC ANALYSIS
PROCEDURE
Step 2. Development of alternatives
- Searching for potential alternatives require creativity and resourcefulness
and these depend on the problem efficiency of an individual or group.
Several limitations may exist such as limited time and money,
preconceptions, and lack of knowledge.
- Potential alternatives are further screened to provide a smaller group of
feasible alternatives for detailed analysis. Each feasible alternative selected
will be judged to meet or exceed the requirements established for the
situation.
ENGINEERING ECONOMIC ANALYSIS
PROCEDURE
Step 3. Development of prospective outcomes
- Analyze the prospective outcomes of each alternative based on the
economic effects and nonmonetary factors. Economic effects can be
analyzed using the cash-flow approach. A cash flow represents the
economic effects of an alternative in terms of money spent and received.
- Nonmonetary factors often play a significant role in the final
recommendation. Examples may be meeting customer expectations, public
and employees’ safety, improving employee satisfaction, and maintaining
production flexibility to meet changing demands.
ENGINEERING ECONOMIC ANALYSIS
PROCEDURE
Step 4. Selecting criterion
- Selection of a preferred alternative requires the use of a criterion. it is wise
to select a that addresses all or most of the problems and will best serve the
long-term interest of the organization. It is also true that the economic
decision criterion should reflect a consistent and proper viewpoint to be
maintained throughout an engineering economy study.
ENGINEERING ECONOMIC ANALYSIS
PROCEDURE
Step 5. Analysis and comparison of alternatives
- Analysis of the economic aspects of an engineering problem is largely
based on cash-flow estimates for the feasible alternatives selected for
detailed study. Risks and uncertainties are also an essential part of an
engineering economy study. When cash flow and other required estimates
are eventually determined, alternatives can be compared based on their
differences.
Step 6. Selection of the preferred alternative
- The preferred alternative is a result of the total effort in performing the
first five steps of the engineering economic analysis procedure properly.
ENGINEERING ECONOMIC ANALYSIS
PROCEDURE
Step 7. Performance monitoring and post-evaluation of results
- Results achieved from the selected alternative are continuously monitored.
Monitoring project performance during its operational phase improves the
achievement of related goals and objectives and reduces the variability in
desired results. The aim is to learn how to do better analyses, and the
feedback from postimplementation evaluation is important to the
continuing improvement of operations in any organization.
COST CONCEPTS AND
DESIGN ECONOMICS
COST TERMINOLOGY
Fixed costs are those unaffected by changes in activity level over a feasible
range of operations for the capacity or capability available. Typical fixed
costs include insurance and taxes on facilities, general management and
administrative salaries, license fees, and interest costs on borrowed capital.
Variable costs are those associated with an operation that varies in total
with the quantity of output or other measures of activity level.
Incremental cost is the additional cost (or revenue) that results from
increasing the output of a system by one (or more) units. It is often
associated with “go-no go” decisions that involve a limited change in output
or activity level.
COST TERMINOLOGY
Direct costs are costs that can be reasonably measured and allocated to a
specific output or work activity. The labor and material costs directly
associated with a product, service, or construction activity are direct costs.
Indirect costs are costs that are difficult to allocate to a specific output or
work activity. For example, the cost of common tools, general supplies,
and equipment maintenance in a plant.
Standard costs are planned costs per unit of output that are established in
advance of actual production or service delivery. They are developed
from anticipated direct labor hours, materials, and overhead categories
(with their established costs per unit).
COST TERMINOLOGY
Cash cost is a cost that involve payment of cash.
Book cost, often referred as noncash cost, is a cost that does not involve
cash transaction but rather represent the recovery of past expenditures
over a fixed period of time.
Sunk cost is one that has occurred in the past and has no relevance to
estimates of future costs and revenues related to an alternative course of
action.
Opportunity Cost is cost incurred because of limited resources, such
that the opportunity to use those resources to monetary advantage in an
alternative use is gone.
COST TERMINOLOGY
Life-cycle refers to a summation of all the costs
related to a product, structure, system, or service
during its life span.
The cost elements of the life cycle that need to be
considered will vary with the situation.
1. Investment cost – the capital required for most
of the activities in the acquisition phase.
2. Operation & maintenance cost – includes
many of the recurring annual expense items
associated with the operation phase of the life
cycle.
3. Disposal cost – includes those nonrecurring
cost of shutting down the operation and the
retirement and disposal of assets at the end of
the life cycle.
PRESENT ECONOMY STUDIES
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 present economy
studies.
Rules for selecting Preferred Alternative:
1. When revenues and other economic benefits are present and vary
among alternatives, choose the alternative that provides maximum
profitability based on the number of feasible outputs.
2. When revenues and other economic benefits are not present and are
the same among the alternatives, consider the alternative that
provides the least cost to produce feasible outputs.
PRESENT ECONOMY STUDIES
TOTAL COST IN MATERIAL AND PROCESS SELECTION
In many cases, economic selection among materials cannot be based solely
on the costs of materials. Frequently, a change in materials will affect the
design and processing costs, and shipping costs may also be altered.
TRADE-OFFS IN ENERGY EFFICIENCY STUDIES
Energy efficiency affects the annual expense of operating an electrical
device such as pump or motor. Typically, a more energy-efficient device
requires a higher capital investment than does a less energy-efficient
device, but the extra capital investment usually produces annual savings in
electrical power expenses relative to a second pump or motor that is less
energy efficient.
GENERAL ECONOMIC ENVIRONMENT
GENERAL ECONOMIC ENVIRONMENT
GENERAL ECONOMIC ENVIRONMENT
THE ECONOMIC ENVIRONMENT
CONSUMER AND PRODUCER GOODS AND SERVICES
- Consumer goods and services are those products or services that are directly used by
people to satisfy their wants
- Producer goods and services are used to produce consumer goods and services or other
producer goods
NECESSITIES AND LUXURIES
- Necessities are those products or services that consumers will buy regardless of the
changes in their income levels.
- Luxuries are those products or services that are not essential but are highly desired and
associated with wealthy and affluent people.
THE ECONOMIC ENVIRONMENT
DEMAND
- Demand is the quantity of a certain commodity that is bought at a certain price at a
given place and time.
- Elastic demand occurs when a decrease in selling price result in a greater than
proportionate increase in sales.
- Inelastic demand occurs when a decrease in selling price produces a less than
proportionate increase in sales.
- Unitary elasticity of demand occurs when the mathematical product of volume and
price is constant
THE ECONOMIC ENVIRONMENT
DEMAND
THE ECONOMIC ENVIRONMENT
COMPETITION, MONOPOLY AND OLIGOPOLY
- Perfect competition occurs in a situation where a commodity or service is supplied by
a number of vendors and there is nothing to prevent additional vendors entering the
market.
- Monopoly is the opposite of perfect competition. A perfect monopoly exists when a
unique product or service available from a single vendor and that vendor can prevent
the entry of all others into the market.
- Oligopoly exists when there are so few suppliers of a product or service that action by
one will almost inevitably result in similar action by the others.
THE ECONOMIC ENVIRONMENT
THE LAW OF SUPPLY AND DEMAND
“Under conditions of perfect competition the price at which a given product will be
supplied and purchased is the price that will result in the supply and the demand being
equal”
