ENGINEERING ECONOMICS
ECO - 130
ENGINEERING ECONOMICS
WHAT IS ECONOMICS?
WHAT IS ENGINEERING?
of Study of how individuals & societies
machines, structures & processes using choose to use scarce resources (or factors
“Designing,
testing
&
building
mathematics & science”
“Application of science, mathematics,
natural sciences & judgment gained by
of production i.e. Land, Labor, Capital,
Entrepreneurial Capability) that nature &
previous
generations
have
provided
(Economies: Maximize limited resources)
study, experience & practice”
WHAT IS ENGINEERING ECONOMICS?
“Collection of mathematical techniques that simplify economic comparisons”
“Formulating, estimating, & evaluating the economic outcomes when alternatives, to
accomplish a defined purpose, are available”
THE FOUNDATION OF ECONOMICS
SOCIETY HAS VIRTUALLY UNLIMITED WANTS...
BUT LIMITED OR SCARCE PRODUCTIVE
RESOURCES!
INSATIABLE WANTS + FINITE RESOURCES = THE NEED TO
ECONOMISE
TYPES OF PROBLEMS?
SIMPLE PROBLEMS?
COMPLEX PROBLEMS?
• Do not require much time/ effort to find a • Represents a mixture of economic,
solution.
political, and humanistic elements.
• Can generally be worked in one’s head • Beyond the scope of this course from a
without extensive analysis
decision-making point of view, but the
“Should I pay cash for an item or use
economic aspects of complex problems
will be discussed
my credit card”?
INTERMEDIATE PROBLEMS? Primarily economic that:- “Shall I buy or lease my next car”?
• Must be organized and analyzed
“Which materials should be
• Are sufficiently important to justify serious thought &
used as roofing, siding, &
action
structural support for a new
• Are the principal subject of this course
building”?
Difference bewteen Economics & Finance?
Economics
Finance
• It involves the study of production, • It focuses on how money flows through
consumption and distribution of goods
the
market,
including
business,
and services.
personal and institutional finances.
Fundamental Principles in Engineering
Economics
Principle 1
An earlier dollar is worth more
than a later dollar – it is better to
receive money earlier than later.
Principle 2
All that counts is the differences
among alternatives
Principle 3
Marginal revenue must exceed
marginal cost (any increased
economic activity must be justified
by this principle)
Principle 4
Additional risk is not taken without
expected additional return.
ROLE OF ENGINEERING ECONOMIC ANALYSIS
• Assists in making decisions where:
• Decision is sufficiently important that serious thought and effort is required
• Careful analysis requires that decision variables be carefully organized &
consequences be understood (the decision cannot be worked in one’s head)
• ECONOMIC ISSUES are a significant component of the analysis leading to a
decision
Which engineering projects are
worthwhile?
Which engineering projects should have
a higher priority?
How should the engineering project be
designed?
How to achieve long-term financial
goals?
How to compare different ways to
finance purchases?
How to make short and long term
decisions
RATIONAL DECISION MAKING
Decision
Making
Situation
At least 2 x
Alternatives
exist
Rational
Decision
Making
1. Recognize a Decision Problem
Employee turnover increase by 5%
2. Define the goal or objective
Increase retention
3. Assemble relevant data
Gather all possible information
4. Identify feasible alternatives
Increase benefits, wages or
change hiring standards
5. Select the criterion to determine the best alternative
Improved retention rate with min
financial burden on company
6. Construct a model
Mathematical equations
7. Predict each alternative’s outcomes
Use the equations to calculate
8. Choose the best alternative
Based on step 7
9. Audit the result
Monitor the new policy
ETHICAL DILEMMA'S IN DECISION MAKING
Ethical issues can arise at every stage of integrated process for engineering decision making
Example Ethical Lapses by Decision Process Step
Decision Process Step
Example Ethical Lapses
Recognize the problem
“Looking the other way,” (not recognizing the problem- due to
bribes/ fear of retribution for being a “Whistle-blower”)
Define the goal or objective
Favoring one group by focusing on their objective for a project
Assemble relevant data
Using faulty or inaccurate data
Identify feasible alternatives
Leaving legitimate alternatives out of consideration
Select the criterion to determine Considering only monetary consequences when there are other
the best alternative
significant consequences
Construct a model
Using a possibility that favors one alternative over another
Predict each alternative’s
outcomes
Using optimistic estimates for one alternative & pessimistic for
others
Choose the best alternative
Choosing an inferior alternative, one that is unsafe, adds
unnecessary cost for the end user, harms environment, etc.
Audit the result
Hiding past mistakes
RATIONAL DECISION MAKING
A concrete aggregate mix must contain at least 31% sand by volume for proper
batching. One source of material, which has 25% sand and 75% coarse aggregate,
sells for Rs 3000/m3. Another source, which has 40% sand and 60% coarse
aggregate, sells for Rs 4400/m3. Determine the least cost per cubic meter of blended
aggregates.
Least cost of blended aggregate will results from maximum use of the lower cost material &
small amount from high cost material
Let x = Portion of blended aggregates from Rs 3000/m3 source
1-x = Portion of blended aggregates from Rs 4400/m3 source
Sand balance 
x(0.25) + (1-x)(40) = 0.31  x =0.6
The 60-40% blended aggregate will cost  0.6(3000)+0.4(4400) = Rs 3560/m3
RATIONAL DECISION MAKING
A machine part is manufactured at a unit cost of Rs 400 for material and 150 for direct
labor. An investment of 500 Million in tooling is required. The order calls for 3 million
pieces. Halfway through the order, managers learn that a new method of
manufacture can be put into effect that will reduce the unit costs to 340 for material
and 100 for direct labor—but it will require 100 Million for additional tooling. Other
costs are allocated at 2.5 times the direct labor cost. What, if anything, should be
done?
Continue with Present Method
New Method
Material Cost 15,00,000 pieces x 400 Additional tooling cost = 100 Million
= 600 Million
Material Cost :15,00,000 pieces x 340 = 510 Mn
Direct Labor Cost 15,00,000 pieces x Direct Labor Cost: 15,00,000 pieces x 100 =
150 = 225 Million
150 Mn
Other Costs 2.5 x direct labour cost Other Costs 2.5 x direct labour cost =
= 562.5 Million
375 Mn
Cost for remaining 1500000 Pieces Cost for remaining 1.5 Million Pieces=1135Mn
= 1387.5 Million
Half the order is already complete so excluding it from calculations
RATIONAL DECISION MAKING
Two different liquid filter systems are being studied to clarify a liquid stream. A
traditional filter will operate for one 8-hour shift before being replaced. A special
pleated design can last one full week, operating 24 hours a day (3 shifts), 5 days per
week. Labor cost to change a filter is Rs 1000/- for each filter change because a
mechanic would work overtime to change the filter. The traditional filters cost Rs 3500;
the special pleated filters cost Rs 9000. Which filter should be chosen?
Material Cost
Traditional: 3500/Filter Change x 3 Filter changes / Day x 5 Days / Week = 52500/Week
Special: 9000/Filter change x 1 Filter change / Week = Rs 9000/Week
Labor Cost
Traditional: 1000/Filter Change x 3 Filter changes / Day x 5 Days / Week = 15000/Week
Special: 1000/Filter change x 1 Filter change / Week = Rs 1000/Week
Total Cost
Traditional: 52500 + 15000= 67500/Week
Special: 9000+1000= Rs 10000/Week
The special pleated filter offers a lower total cost alternative
RATIONAL DECISION MAKING
Car A initially costs Rs 500 Thousand more than Car B, but it consumes 0.04 litres/km
versus 0.05 litres/km for B. Both last 8 years and B’s salvage value is 100 thousand
smaller than A’s. Fuel costs 250 per litre. Other things being equal, beyond how many
kms of use per year (X) does A become preferable to B?
?
RATIONAL DECISION MAKING
Car A initially costs 500 Thousand more than Car B, but it consumes 0.04 litres/km
versus 0.05 litres/km for B. Both last 8 years and B’s salvage value is 100 thousand
smaller than A’s. Fuel costs 250 per litre. Other things being equal, beyond how many
kms of use per year (X) does A become preferable to B?
Difference (A & B)
A
B
Price
A
B
500,000
Fuel Consumption/Km in Rs
0.04 x 250 0.05 x 250
2.5/km
Value after 8 Years
100,000
0
100,000
Kms/yr beyond which A preferred over B
X
X
Total yrs
8
8
So, Car A will become preferable over B beyond 20,000kms/yr of use for 8 x years
(500,000−100,000) = (X×0.05×250×8)- (X×0.04×250×8)
X = 20,000kms/yr
What Makes Economic Decisions Different
from Other Design Decisions?
In a design situation
The engineer uses known
 Physical properties
 Principles of chemistry and physics
 Engineering design correlations
 Engineering judgment
to arrive at a workable and optimal design
In considering economic decisions
the measurement of investment
attractiveness is relatively straight
forward.
However, information required in such
evaluations
always
involves
predicting, or forecasting, product
sales, product selling price. and
various costs over some future time
frame - 5 years, 10 years, even 25
years.
?
Any Questions