ENGINEERING ECONOMICS

LECTURE - 01

BY

DR. SYED MUHAMMAD ALI TIRMIZI, Ph.D.

Assistant Professor

Department of Management Sciences

Engineering Economic Analysis
9th Edition

Chapter 1

MAKING ECONOMIC DECISIONS

 Chapter Objectives
1. Distinguish between simple and complex problems.

2. Discuss the role and purpose of engineering economic analysis.

3. Describe and give examples of the nine steps in the economic

decision making process.

4. Select appropriate economic criteria for use with different type

of problems.

5. Solve simple problems associated with engineering decision

making.
 Introduction

 The subject of Engineering Economics

is about making decisions.
 Decision making is a broad topic, for it
is a major aspect of everyday human
existence.
 This subject develops the tools to
properly analyze and solve the
economic problems that are commonly
faced by engineers.
 Problems

1. Simple

2. Intermediate

3. Complex
 Simple Problems
On the lower end of our classification of problems
are simple situations.
Examples:
 Should I pay cash or use my credit card?
 Do I buy a semester parking pass or use the
parking meters?
 Shall we replace a burned-out motor?
 If we use three crates of an item a week, how
many crates should we buy at a time?
 Intermediate Problems
• Must be organized and analyzed
• Are sufficiently important to justify serious
thought and action
• Have significant economic aspects
• Are primarily economic
• Are the principal subject of this course
• Assume an economic situation in equilibrium
• Are generally adequately solved with single-
criteria decision making
 Intermediate Problems
Examples
• Shall I buy or lease my next car?
• Which equipment should be selected for a new
assembly line?
• Which materials should be used as roofing,
siding, and structural support for a new building?
• Shall I buy a 1 or 2 semester parking pass?
• Which printing press should be purchased?
• A low-cost press requiring three operators, or a
more expensive one needing only two operators?
 Complex Problems
• Such problems represent a mixture of 3 elements:
economic, political and humanistic.
• Complex problems are beyond the scope of this
course from a decision-making criteria point of
view, but the economic aspects of complex
problems will be discussed.
• E.g., The decision of Mercedes-Benz to build an
automobile assembly plant in Alabama, illustrates
a complex problem. Beside the economic
aspects, Mercedes- Benz had to consider
possible reactions in the American auto industry.
Role of Engineering Economic Analysis
• Assists in making decisions where:
 The decision is sufficiently important that
serious thought and effort is required.
 Careful analysis requires that the decision
variables be carefully organized and the
consequences be understood.
 ECONOMIC ISSUES are a significant
component of the analysis leading to a
decision.
Role of Engineering Economic Analysis
• When problems meet these three criteria,
engineering economic analysis is an appropriate
technique for seeking a solution.

• Since vast numbers of problems that one will

encounter in the business world (and in one's
personal life) meet these criteria, engineering
economic analysis is often required.
Examples of Eng. Economic Analysis
• In fact nearly everything that engineers design
calls for spending money in the design and
building stages, and after completion revenues
or benefits occur-usually for years.

• Thus, the economic analysis of costs,

benefits, and revenues occurring over time is
called engineering economic analysis.
Examples of Eng. Economic Analysis
• Engineering economic analysis is used to
answer many different questions.
 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 investment
decisions?
 The Decision Making Process
Rational decision making is a complex process that
contains nine essential elements/steps which are;
1. Recognize problem;
2. Define the goal or objective;
3. Assemble relevant data;
4. Identify feasible alternatives;
5. Select criterion to determine the best
alternative;
6. Construct a model;
7. Predict each alternative’s outcomes or
consequences;
8. Choose the best alternative; and
9. Audit the result.
 1. Recognize the Problem

• A problem exists when:

– A standard or expectation is not being met.
– A new standard or expectation is established
and needs to be achieved. (An opportunity.)

In the beginning the problems are

given. Later you might have to
analyze the information provided to
determine the real problem.
 2. Define the Goal or Objective

• A goal or objective is the standard or

expectation we wish to meet.
– A goal is a general statement about what we
expect.
• Pay all our bills on time.

– An objective is narrow and specific.

• Pay the auto loan on Tuesday morning at the
bank.
 3. Assemble Relevant Data
– Information may be Example 1-1
published or individual Economic analysis - Inside vs outside supplier
knowledge.
For: Large company
– Deciding which data is Comparison: Inside vs. outside printing of co
Requestor: Shipping department
relevant may be a Unit affected: Printing department
complex process. Supplier: Outside printer
Requirements 30,000 copies
– In engineering decision
making two important Printing department
Apparent cost
sources of data are the Cost per Cost per
organization’s Copies 1000 30,000
Direct labor $ 7.60 $ 228.00
accounting and Materials and supplies $ 9.80 $ 294.00
purchasing Overhead costs $ 9.05 $ 271.50
Total $ 26.45 $ 793.50
departments. Shipping department savings $ 111.00
4. Identify Feasible Alternatives

– The best alternative should be implemented.

Occasionally this is to maintain the existing
situation.

– Alternatives considered should include both

conventional and innovative approaches.

– Only feasible alternatives should be retained

for further analysis.
5. Select the Criterion to Determine
the Best Alternative
– A criterion, or a set of criteria, is used to
evaluate the alternatives to determine which
is best.

– Selecting criteria to use is not easy because

different groups often support different
criteria.

– The criteria most often used in economic

decision-making is to “use money in the
most efficient manner.”
 Economic Decision-Making
Problems Fall Into Three Categories
1. For fixed input situations, maximize the
benefits or other outputs.
2. For fixed output situations, minimize the
costs or other inputs.

3. Where inputs and outputs vary, maximize

(benefits – costs).
 6. Construct the Model

• Requires merging the various elements:

objective, relevant data, feasible alternatives
and selection criteria.

• In economic decision making the models are

usually mathematical.

• A model is a representation of reality.

– A model must represent the important parts of

the system at hand.

– Be adequate to solve the problem.

 7. Predicting the Outcomes
for Each Alternative
• To avoid complications, we assume that a
decision is based on a single criterion. If
necessary, multiple criteria are combined into a
single criterion.

• Usually the consequences or alternatives are

stated in the form of money, i.e., costs/benefits.

• Costs and benefits may occur over a short or

long time period.
8. Choosing the Best Alternative

– When choosing the best alternative both

economic and non-economic criteria must be
considered.
– During the prior steps in the decision making
process, only dominant alternatives may be
included based on either economic or non-
economic criteria.
– The elimination of feasible alternatives may
predetermine the outcome of the decision
making process.
 9. Audit the Results
• Compare the results of changes to the
predictions to assure that the chosen
alternative was implement as planned and
the results are as expected.
– Fix deviations from planned changes.
– Make sure prediction errors are not repeated.
– Identify added opportunities.

• Audits promote realistic economic analysis

and implementation.
 Problem 1.2
• A concrete aggregate mix is required to
contain at least 31% sand by volume for
proper batching. One source of material,
which has 25% sand and 75% coarse
aggregate, sells for $3 per cubic meter
(meter cube - m3). Another source, which
has 40% sand and 60% coarse aggregate,
sells for $4.40/m3.

• Determine the least cost per cubic meter

of blended aggregates.
Solution
 Problem 1.3
• A machine part is manufactured at a unit cost of 40 cents
for material and 15 cents for direct labor. An investment of
$500,000 in tooling is required. The order calls for 3 million
pieces. Halfway through the order, a new method of
manufacturing can be put into effect that will reduce the unit
costs to 34 cents for material and 10 cents for direct labor
but it will require $ 100,000 for additional tooling. This
tooling will not be useful for future orders. Other costs are
allocated at 2.5 times the direct labor cost. What if anything
should be done?
Solution
END OF LECTURE #: 01