Engineering Economy PDF

ENGINEERING ECONOMY Instructor: Engr. Winnie Rossette Bae Flores  Basic Economic Principles Reasons for Studying 01 Introduction 02 Engineering Economics Important Applications of Engineering Economy 03 Engineering 04 Technique...

ENGINEERING ECONOMY Instructor: Engr. Winnie Rossette Bae Flores  Basic Economic Principles Reasons for Studying 01 Introduction 02 Engineering Economics Important Applications of Engineering Economy 03 Engineering 04 Technique Economy  1-01 INTRODUCTION INTRODUCTION Economics is one of the social sciences which consists of that body of knowledge dealing with people and their assets or resources. Economics has also defined as the sum total of knowledge which treats of the creation and utilization of goods and services for the satisfaction of human wants. INTRODUCTION Engineering economy is defined as that branch of economics which involves the application of definite laws of economics, theories of investment and business practices to engineering problems involving cost. INTRODUCTION Engineering economy may also be considered to mean the study of economic problems with the concept of obtaining the maximum benefit at the least cost. Engineering economy also involves the study of cost features and other financial data and their applications in the field of engineering as bases for decision.  1-02 REASONS FOR STUDYING ENGINEERING ECONOMY REASONS FOR STUDYING ENGINEERING ECONOMY (1) Engineers, as a group, (2) In the professional life have wrought immense changes in of engineers, it is readily observed improving the economic well- that the most successful ones are being of mankind through their those who gradually divorce inventions and their applications of themselves from the technical scientific principles to the varied aspects of engineering related to problems of industry. engineering work.  1-03 IMPORTANT APPLICATIONS OF ENGINEERING ECONOMY IMPORTANT APPLICATIONS OF ENGINEERING ECONOMY (1) Seeking of new (2) Discovery of (3) Analysis of objectives for the factors limiting possible applications of the success of a investment of engineering. venture or capital. enterprise. IMPORTANT APPLICATIONS OF ENGINEERING ECONOMY (4) Comparison of (5) Determination alternatives as a of bases for basis for decision. decision.  1-04 ENGINEERING ECONOMY TECHNIQUE ENGINEERING ECONOMY TECHNIQUE The complete analysis of a proposed project involves three basic steps according to Bullinger, as follows: (1) the (2) the (3) the economy financial intangible analysis analysis analysis ENGINEERING ECONOMY TECHNIQUE The economy analysis considers all factors affecting the economy of the project which can be reduced to specific monetary values. It determines the initial cost of the project, the costs for operation and maintenance, the needed working capital, the probable income the project will generate when operational, the rate of return on the investment, and all other cost factors. ENGINEERING ECONOMY TECHNIQUE The primary purpose of the financial analysis is the determination of the methods and resources of financing the project, either through equity capital or borrowed capital, or a combination of both. ENGINEERING ECONOMY TECHNIQUE It tries to discover the best methods of financing the project to the extent of the amount obtained in the economy analysis. The financial analysis follows the economic analysis since it is dependent upon the latter for necessary data. ENGINEERING ECONOMY TECHNIQUE The intangible analysis determines all aspects of the project which cannot be produced to monetary values and considers the uncertainty and the risk inherent in the project. Its scope includes the so-called judgment factor whose analysis since it is dependent upon the latter for necessary data. Basic Terms and Principles of Economics Tangible and 05 Intangible Factors 06 Competition 07 Monopoly 08 Oligopoly Price and Local and National 09 Production 10 Market Basic Terms and Principles of Economics Consumer and 11 Producer Goods 12 Demand 13 Law of Demand 14 Elasticity of Demand Utility and Law of Diminishing 15 Demand 16 Utility Basic Terms and Principles of Economics 17 Marginal Utility 18 Supply Law of Supply and 19 Law of Supply 20 Demand Law of Diminishing Marginal Revenue 21 Returns 22 and Marginal Cost Basic Terms and Principles of Economics Compromise Physical and 23 Economic Efficiency 24 between Perfection and Economy  1-05 TANGIBLE AND INTANGIBLE FACTORS TANGIBLE AND INTANGIBLE FACTORS Tangible factors are those which can be expressed in terms of monetary values, while intangible factors are those which are difficult or impossible to express definitely in terms of monetary values. Intangible factors are also called irreducible factors.  1-06 COMPETITION COMPETITION Most economic laws are premised and stated for situations in which free or perfect competition exists. Perfect competition occurs when a certain product is offered for sale by many vendors or suppliers, and there is no restriction against other vendors or suppliers from entering the market. Buyers are free to buy from any vendor, and the vendors, like wise, are free to sell to anyone.  1-07 MONOPOLY MONOPOLY Monopoly is the opposite of perfect competition. A perfect monopoly occurs when a unique product or service is available only from a single supplier and entry of all other possible suppliers is prevented. Under conditions of perfect monopoly, the single vendor can control the supply and the price of the product or service.  1-08 OLIGOPOLY OLIGOPOLY Oligopoly occurs when there are few suppliers and any action taken by anyone of them will definitely affect the course of action of the others.  1-09 PRICE AND PRODUCTION PRICE AND PRODUCTION The price of a good or commodity is defined to be the amount of money or its equivalent which is given in exchange for it. In a capitalistic system, industry is based on profit, and profit is in based on price. Goods that are in great demand and are scarce command a high price relative to cost of production and therefore will yield a high profit. PRICE AND PRODUCTION Price therefore regulates production. If prices go up, production will increase. If prices decrease, production will also decrease or cease.  1-10 LOCAL AND NATIONAL MARKET LOCAL AND NATIONAL MARKET A market defined to be a place where sellers and buyers come together. A limited locality where certain goods such as those which are perishable are sold, is said to be a local market. Certain goods sold all over the country are said to be have a national market. Goods that are exported to other countries are said to have a world market.  1-11 CONSUMER AND PRODUCER GOODS CONSUMER AND PRODUCER GOODS Consumer goods are those that are consumed or used directly by people, or are things and services which serve to satisfy human needs. CONSUMER AND PRODUCER GOODS Producer goods are those which produce goods and services for human consumption. These are instrumental in producing something or furnishing service for people.  1-12 DEMAND DEMAND Demand is the quantity of a certain commodity that is bought at a certain price at a given place and time. It should not be confused with the quantity of the commodity which a person desires to purchase. Desire without actual purchase of the commodity does not constitute demand.  1-13 LAW OF DEMAND LAW OF DEMAND The law of demand may be stated as: The demand for a commodity varies inversely as the price of the commodity, though not proportionately. LAW OF DEMAND The price-demand relationship is illustrated in Fig. 1-01. Fig 1-01. Price-Demand Relationship for Necessities and Luxuries LAW OF DEMAND It will be noted from Fig. 1-01 that when the price of a commodity is low, the demand is great, for then more people will be able to afford the price the commodity. However, as the price increases, the demand decreases.  1-14 ELASTICITY OF DEMAND ELASTICITY OF DEMAND Elastic demand occurs when a decrease in selling price will cause a greater than proportionate increase in the volume of sales. ELASTICITY OF DEMAND Inelastic demand occurs when a decrease in selling price will cause a less than proportionate increase in sales. ELASTICITY OF DEMAND Unitary elasticity of demand occurs when the mathematical product of price and volume of sales remains constant regardless of any change in price. 𝑃𝑉 = 𝐶 where, 𝑃 = price of the product, 𝑉 = volume of sales, and 𝐶 = a constant.  1-15 UTILITY AND DEMAND UTILITY AND DEMAND Utility is defined to be the capacity of a commodity to satisfy human. If the utility of a certain good to a certain individual is great, his demand for that good will be great. UTILITY AND DEMAND However, if a certain good has very small utility the demand will likewise be small. Hence, the demand for a certain good varies directly as the utility.  1-16 LAW OF DIMINISHING UTILITY LAW OF DIMINISHING UTILITY An increase in the quantity of any good consumed or acquired by any individual will decrease the amount of satisfaction derived from that good. LAW OF DIMINISHING UTILITY The utility of a commodity decreases with an increase in the quantity available. To increase the utility of any commodity, it should be different from other similar commodities. Thus, manufacturers of the similar goods vary the style, size, and the use of the goods they manufacture.  1-17 MARGINAL UTILITY MARGINAL UTILITY The marginal utility of a commodity is the utility of the last unit of the same commodity which is consumed or acquired. The last unit of similar commodities consumed or acquired is marginal unit. 1-18 SUPPLY SUPPLY Supply is the quantity of a certain commodity that is offered for sale at a certain price at a given place and time.  1-19 LAW OF SUPPLY LAW OF SUPPLY The supply of a commodity varies directly as the price of the commodity, though not proportionately. As the price increases, the supply also increases. Likewise, as the price decreases, the supply will also decrease. This is graphically shown in Figs. 1-02 and 1-03. LAW OF SUPPLY Fig. 1-02. Price-Supply Relationship with Supply as abscissa Fig. 1-03. Price-Supply Relationship with Price as abscissa  1-20 LAW OF SUPPLY AND DEMAND LAW OF SUPPLY AND DEMAND The law may be stated as follows: When free competition exists, the price of a product will be that value where supply is equal to the demand. LAW OF SUPPLY AND DEMAND Actually this is a combination of the laws of demand and supply. No sale exists if the buyers and the sellers do not agree on a common price for the commodity. The price is determined only when the demand is equal to the supply and sale occurs. LAW OF SUPPLY AND DEMAND This is pictured graphically in Fig. 1-04. Fig. 1-04. Price-Supply-Demand Relationship  1-21 LAW OF DIMINISHING RETURNS LAW OF DIMINISHING RETURNS This law was originally applied to agriculture, correlating the input of men, fertilizers, and other variable factors to the output in crops or harvest. LAW OF DIMINISHING RETURNS The law may be stated thus: When one of the factors of production is fixed in quantity or is difficult to increase, increasing the other factors of production will result in a less than proportionate increase in output.  1-22 MARGINAL REVENUE AND MARGINAL COST MARGINAL REVENUE AND MARGINAL COST Marginal revenue is that amount received from the sale of an additional unit of a product. Marginal cost is the additional cost of producing one more unit. MARGINAL REVENUE AND MARGINAL COST When free competition exists, the number of units produced that will give the maximum profit is that for which the marginal revenue and marginal cost are equal.  1-23 PHYSICAL AND ECONOMIC EFFICIENCY PHYSICAL AND ECONOMIC EFFICIENCY The effectiveness of the utilization is measured by the well-known equation: 𝑂𝑢𝑡𝑝𝑢𝑡 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 = 𝐼𝑛𝑝𝑢𝑡 PHYSICAL AND ECONOMIC EFFICIENCY Where physical units are involved, efficiency is measured by: 𝑂𝑢𝑡𝑝𝑢𝑡 𝑖𝑛 𝑃ℎ𝑦𝑠𝑖𝑐𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 𝑃ℎ𝑦𝑠𝑖𝑐𝑎𝑙 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 = 𝐼𝑛𝑝𝑢𝑡 𝑖𝑛 𝑃ℎ𝑦𝑠𝑖𝑐𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 This kind of efficiency can never exceed 100%. PHYSICAL AND ECONOMIC EFFICIENCY However, when money is they material, effective utilization is measured by: 𝐼𝑛𝑐𝑜𝑚𝑒 𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 = 𝐶𝑜𝑠𝑡 Unless the economic or financial efficiency exceeds 100%, the investment of capital, from a strictly financial viewpoint is not recommended. PHYSICAL AND ECONOMIC EFFICIENCY A common measure of financial efficiency is the so-called rate of return given by the formula: 𝐴𝑛𝑛𝑢𝑎𝑙 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 This is the most universally accepted measure of financial effectiveness. PHYSICAL AND ECONOMIC EFFICIENCY Another measure of economic efficiency is the payout period: 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑃𝑎𝑦𝑜𝑢𝑡 = 𝑁𝑒𝑡 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 This ratio determines the number of years necessary to recover the amount of invested capital from the earnings of the investment.  1-24 COMPROMISE BETWEEN PERFECTION AND ECONOMY COMPROMISE BETWEEN PERFECTION AND ECONOMY Complete quality control of all the units produced by a factory is to desired, but it will definitely increase the cost of manufacturing, such that the goods are priced out of the market. It is desired that a machine function properly as an economic unit.