CE 203
Chapter 1
Economics in
Engineering
Decisions
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The Significance of Numbers
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23 - 3
9/11
911
Personal Finance
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How much to save each month for an
annual trip
Is graduate school a good investment in
my future? Will the loss in income be
regained by additional earnings?
Is a higher salary better than stock
options?
Can you believe an ad for a car of 15y old
and having done only 500 miles?
Photo of car in front of the house
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Decisions: Classifying by Complexity
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Simple
– Should I buy a new mechanical pencil?
– Should I buy cash or use credit card?
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Intermediate
– Which backhoe make/model should we buy?
– Shall sub out the concrete work?
– Shall we do our own wastewater treatment?
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Complex (social, political, economic elements)
– Shall we build a new lock and dam at…?
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Could the World Trade Center
have withstood the 9/11 attacks?
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Towers did not collapse immediately
Fires brought them down
Better fire prevention measures?
Sturdier fireproofing adds weight and
cost
How much should be spend on new
high-rise buildings to prevent this?
Decisions: Classifying by Type
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Technical
– What strength steel is required?
– How large a settling tank is required?
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Economic
– Which backhoe make/model should we buy?
– What type of foundation is most costeffective?
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Societal
– Is the wetland in the public’s best interest?
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Problems emphasized in CE 203
Intermediate complexity, primarily
economic
– Important enough to require analysis
– Difficult enough to require organized,
rational approach
– Decided largely or entirely on the basis of
costs versus benefits (the single criterion
of economics)
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Problems beyond CE 203
Complex, a mixture of economic,
social, and political elements
– Economic aspects of such problems will
be discussed in CE 203
– Classic economic theory assumes that the
whole economy is in equilibrium (steady
state)
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Rational Decision Making (9 steps)
(1) Recognize the problem (State A)
– Is there a problem that is solvable?
– How can the problem be defined?
(2) Define the goal or objective (State B)
– What do we want (or want to know)?
– What change do we desire?
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Rational Decision Making (9 steps)
(3) Identify/develop alternatives
– Use/modify existing solutions
– Brainstorm (and other techniques) to
expand solution space
– Do nothing (does not imply no change)
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Rational Decision Making (9 steps)
(4) Assemble data –
in 203, primarily economic
– Costs
» Materials and supplies
» Direct labor
» Overhead (facilities, support labor, utilities, etc.)
» Extra-market (e.g., employee injuries)
– Benefits
» Sales (of products/services)
» Extra-market (social, psychological, …)
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Rational Decision Making (9 steps)
(5) “Real life” definitions for costs and
benefits may get complicated
– Initial cost per unit?
– “Life cycle cost” per unit?
– Total cost of satisfying
mission requirements?
– “Spread the work around” cost
(DOD work by congress)?
– “Accomplish mission regardless” cost?
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Rational Decision Making (9 steps)
(6) Construct the model(s)
– Physical (various kinds)
– Virtual (3-D computer model)
– Mathematical (typical for economic and
many other types of problems)
(7) Analyze the alternatives
– Data processed using model
– Results stated in comparable way
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Rational Decision Making (9 steps)
(8) Select the best alternative
– Select highest B:C alternative for
economic problems
– Include extra-market and “intangible”
consequences at this point
– Present at least two “well-engineered”
solutions for complex problems
– Be careful in eliminating alternatives
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Rational Decision Making (9 steps)
(9) Audit the process and the results
– Were assumptions reasonable?
– Were projections accurate?
– Are changes in process called for?
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CE 203
Chapter 2 EEA
Engineering Costs
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Costs: what to keep in mind
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Actual costs may not be known
– may mean they must be estimated
Estimating may be difficult but is often critical
– good analysis with bad data is worthless
if not disastrous
Costs tend to be underestimated
(60% low to 30% high)
Benefits tend to be overestimated
(50% high to 20% low)
Costs: some definitions
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Fixed cost
– Constant, unaffected by volume: rent,
insurance, property taxes, interest on
borrowed capital, variety of overhead costs
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Variable cost
– Changes as a function of output: direct
utilities, direct labor, materials, sales
commissions, shipping costs, etc.
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Costs: some definitions (cont’d)
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Average cost
– Per unit cost =
(Total cost) / (number of units)
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Marginal cost
– Variable cost for one more unit
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Costs: some definitions (cont’d)
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Sunk cost
– Already spent due to past decision
– Immaterial to future decisions (though
sometimes this is hard to accept)
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(Lost) Opportunity cost
– Benefit foregone because resources
(time, money, equipment, etc.)
are
being used for something else
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Costs: some definitions (cont’d)
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Recurring cost
– Known, occurring at regular intervals (and
therefore easy to plan for); e.g., rent, utility
bill, full-time labor, etc.
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Non-recurring cost
– One-of-a-kind, irregular, often unanticipated
(and then difficult to plan for); e.g., start-up
costs, unfavorable court verdict, damage
due to natural disaster, etc.
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Costs: some definitions (cont’d)
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Incremental cost
– Differences between the costs of two
alternatives --- these differences should be
the focus of the comparison of the two
alternatives
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Costs: some definitions (cont’d)
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Cash cost
– Actual transfer of money (“out-of-pocket”)
– Basis for engineering economic analysis
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Book cost
– No transfer of money (usually)
– Common example is asset depreciation
(“written off” by the accounting
department)
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Costs: some definitions (cont’d)
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Life-cycle cost
– Sum of all costs associated with the lifecycle of a product or service
conception, design, production, testing and
quality assurance, maintenance, effects on the
environment, disposal, etc.)
– Two concepts:
» The later the design change, the higher the cost
» The earlier the design decision, the more later
costs are “locked in.”
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Cash Flow Diagram (CFD)
Graphic tool showing size, sign, and timing
of cash flows – helpful for engineering
economic analysis (very important initially)
– Horizontal line indicating uniform units of
time (days or months or years or …)
– Each cash flow “in” (revenue or benefit) is
shown as an arrow up (positive) from time line
– Each cash flow “out” (cost) is shown as an
arrow down (negative) from time line
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Cash Flow Diagram (CFD) sample
$3000
$2000 $2000
Money in
0 1
(+)
Money out
(-)
2
$1500 $1500
3
4
Time “0” or
Today (usually)
$3000
$4000
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5
6
End of period 3 is
also beginning of
period 4
Some Cash Flow Categories
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First Cost
– Costs of “getting started”
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Operations and Maintenance (O&M)
– Annual expense (though not necessarily
constant) for fuel, labor, minor repair, etc.)
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Salvage value
– Revenue received for sale or transfer of
property at end of “project” or useful life
Some Cash Flow Categories
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Revenue
– “Sale” price of goods/services
Overhaul
– Major repair or refurbishing
during life of asset
In-class example (CFD)
Company A purchased a backhoe for $33,500. The
company paid $12,000 immediately and agreed to pay
four additional payments of $6,000 each at the end of
one, two, three, and four years. Maintenance for the
backhoe is expected to be $500 at the end of the first
year and $1,000 at the end of each subsequent year.
They expect to sell the backhoe for $16,000 at the end
of the fifth year (after paying for the needed
maintenance).
Draw the cash flow diagram
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