Engineering Economics Overview

Engineering Economics Overview

• Engineering economy systematically evaluates the economic merits of proposed solutions to engineering problems.
• Proposed solutions must demonstrate a positive balance of long-term benefits over long-term costs to be considered economically acceptable.
• Engineering economy uses techniques to simplify comparisons of alternatives on an economic basis.
• An alternative is a stand-alone solution for a situation.

Principles of Engineering Economy

• Develop the Alternatives: Carefully define the problem, identify, and then define alternatives for analysis.
• Focus on the Differences: Only the differences in expected future outcomes among alternatives are relevant to comparisons.
• Use a Consistent Viewpoint: Develop prospective outcomes (economic & others) from a defined perspective.
• Use a Common Unit of Measure: Use a consistent unit to measure outcomes for easier analysis.
• Consider All Relevant Criteria: Decision making considers criteria that include monetary and non-monetary factors.
• Make Risk and Uncertainty Explicit: Recognize and analyze risk and uncertainty in estimating future outcomes.
• Revisit Your Decisions: Continuously improve decision-making by comparing projected outcomes to actual results.

Cash Flow

• Cash flow refers to estimated inflows (revenues) and outflows (costs) of money.

Alternative Selection

• Every situation has at least two alternatives: the formulated alternatives and the "do-nothing" (DN) alternative (the status quo).

Evaluation Criteria

• Financial units (dollars or currency) are the primary basis for evaluation.
• In situations with multiple alternatives, the optimal one is determined by the lowest overall cost or highest overall net income.

Intangible Factors

• Alternatives may have non-economic or intangible factors affecting the decision, such as goodwill, convenience, or morale.
• Intangible factors are critical when alternatives are difficult to distinguish economically.

Time Value of Money

• The change in the amount of money over time is an important concept in engineering economy.

Cost Terminology and Concepts

• Fixed Costs: Unchanged by activity level within operation range
  • Examples: Insurance, taxes, general management, salaries.
• Variable Costs: Vary with activity level.
  • Examples: Materials costs, labor costs, advertisement.
• Direct Costs: Costs easily allocated to a specific output (e.g., materials, labor for a product).
• Indirect Costs: Difficult to allocate (e.g., common tools, general supplies).
• Incremental Costs: Additional cost from increasing output.
• Standard Costs: Planned costs per unit of output.
• Cash Costs: Costs involving cash payment.
• Book Costs: Costs not involving direct cash payment.
• Sunk Costs: Irretrievable costs from past decisions, irrelevant in future analysis.
• Opportunity Costs: Lost potential gain from alternative use of resources.
• Life-Cycle Costs: All costs related to a product, structure, system, or service during its life.

Phases of the Life Cycle and Their Relative Cost

• Investment costs are capital required for acquisition-phase activities (e.g., equipment).
• Operation and maintenance (O&M) costs are recurring expenses during the operation phase (e.g., people, machinery, materials, energy, information).

Cost Terminology and Concepts (Disposal & Categorization)

• Disposal Costs: Non-recurring costs of shutting down operations and asset retirement.
• Consumer Goods/Services: Directly used by people to satisfy wants (e.g., food, clothing).
• Producer Goods/Services: Used to produce other goods/services (e.g., machine tools, farm machinery).

Relationship between Price and Demand

• As price increases, demand decreases; as price decreases, demand increases.
• This applies to various economic concepts.

Economic Competition

• Perfect Competition: Many vendors supply a product with no restrictions on entrants.
• Monopoly: A single supplier controls a product or service market and restricts entry of others.

Present Economy Studies

• When alternatives are compared over a short time period, economic benefits are analyzed with minimal time considerations.
•  Maximize overall profit given varying revenues among alternatives (Rule 1).
•  Minimize total cost per defect-free unit when revenues are constant across alternatives (Rule 2).