01 Handout 1 PDF - Introduction to Engineering Economics

IT2007 Introduction to Engineering Economics What is Engineering Economics? (Khan, Z., 2018) Engineering is the profession in which the knowledge gained in physics, chemistry, life sciences...

IT2007 Introduction to Engineering Economics What is Engineering Economics? (Khan, Z., 2018) Engineering is the profession in which the knowledge gained in physics, chemistry, life sciences, and mathematics is applied to make products on a large scale that increase the prosperity of man. (ABET - Accreditation for Engineering and Technology) Economics deals with the production, distribution, and consumption of goods and services. Engineering Economics is the discipline concerned with the economic aspects of engineering. It involves the systematic evaluation of the cost and benefits of proposed technical projects. (Eugene Grant) Principles of Engineering Economics (Sharma, K., 2015) Principle 1: Develop the Alternatives o The alternates can be developed using a brainstorming session. o The more creative and resourceful the team members are, the better the selection of alternates available for a go/no-go decision would be. Principle 2: Focus on the Difference o The future outcomes from the alternates are set as a higher priority. Based on differences among alternates, a future course of action is selected. o Analysis, projection, and comparison are used to differentiate alternates. Principle 3: Use a Consistent Viewpoint o The prospective outcomes of the alternatives should be consistently developed from a defined point of view. Goal-setting mode. o The perspective of the decision-maker, which is often that of the owners of the form, would be normally used. Principle 4: Use a Common Unit of Measure o Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will make easier the analysis and comparison of alternatives. o A common unit of measure (such as pesos versus units) totals costs or total profits that can be generated from the alternate considered. Principle 5: Consider All Relevant Criteria o The selection of a preferred alternative requires the use of a criterion or several criteria. o The decision process should consider the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner. Principle 6: Make Uncertainty Explicit o Risk and uncertainty are inherent in projecting (or estimating) the future outcomes of the alternatives and should be recognized with the firm’s analysis, comparison projection, and probability. Principle 7: Revisit Your Decisions o Learning from and adapting based on our experience are essential and are indicators of a good organization. o The initial projected outcomes of the selected alternate should be subsequently compared with the actual results achieved. 01 Handout 1 *Property of STI  [email protected] Page 1 of 5  IT2007 Economic Concepts (Khan, Z., 2018) Studying economics gives insights into the general environment of resource allocation decisions, opportunity costs, and project evaluation, which are crucial in many areas. Economics studies economic activities. Economics does not deal with all of them, but humans spend the maximum time on economic activities. Study of wants > efforts > wealth > satisfaction: Every human being has some wants, and these wants are unlimited. To fulfill these wants, a person does efforts, by doing efforts, he gets wealth, and with this earned wealth, he satisfies his wants. Study of human behavior with relation to ends and scarce means: As long as a person is alive, his wants go on increasing, but the person cannot fulfill all the wants. The reason is that the resources required to fulfill these wants are limited. Economics studies problem of choice: Scarcity and choice go together. If things were available in abundance, then there would have been no problem of choice; the point is that “problems of choice” arise because of scarcity. Basic Economic Activities (Khan, Z., 2018) An economic activity is a systematic endeavor to satisfy a material need. Material needs are the needs for goods and services. Production is a process of creation of utility or value in goods or services (or both). “Production may be defined as the creation of utilities.” (Anatol Murad) o Factors of Production: Factors of production are essential elements that cooperate in the process of production. ▪ Land: It is that factor of production which is available to humankind as a free gift of nature. ▪ Labor: It is the physical or mental effort of human beings in the process of production. Services of a doctor, lawyer, teacher, worker in the factory all constitute labor. ▪ Capital: Capital is a man-made material and is a source of production. It consists of the part of production which is used for further production. ▪ Entrepreneurship: Entrepreneurship refers to the skills of the entrepreneur: (a) to organize business (b) to undertake risks of business Consumption has a special meaning in economics; it means the use of or utility of goods and services for the direct satisfaction of individual and collective wants. o Individual Consumption: It is that consumption that leads to the final satisfaction of the wants of an individual. o Collective consumption: It is that consumption that leads to the final satisfaction of collective wants, for example, Uses of roads, dams, bridges, or parks. 01 Handout 1 *Property of STI  [email protected] Page 2 of 5  IT2007 Investment: “Investment is that part of production during a year which is not consumed but saved as a capital formation for further production.” Distribution refers to the way total output, income, or wealth is distributed among individuals or among the factors of production. o The excess of production over consumption in an accounting year is called capital formation or investment. The circular flow of production, income, and expenditure never stops. Supply and Demand Concepts (Yates, J., 2017 & Khan, Z., 2018) What is the Theory of Demand? In economics, demand is regarded as the lifeline of a business enterprise. The demand for a particular good is the amount that will be purchased at a given time and a given price. (Vera Anstey) Demand refers to the quantities of a commodity that the consumers are able and willing to buy at each possible price during a given period of time, other things being equal. (Charles Ferguson) Demand is the want of a person, which will become demand when he is ready to buy the goods at a given price and at a given point in time. What is the Law of Demand? The law of demand states that other things being equal, the demand for a good extends with a fall in price and contracts with a rise in price. There is an inverse relationship with a price, and the quantity demanded. The Law of Demand states that people will buy more at lower prices and buy less at higher prices, ceteris paribus, or the other things remaining the same. (Paul Samuelson) The Law of Demand states that the amount demanded increases with a fall in price and diminishes when price raises, other things being equal. (Alfred Marshall) What is the Theory of Supply? The theory of supply is as much necessary as the theory of demand for the analysis of prices. Supply means the amount offered for sale at a given price during a certain period of time. The supply of goods is the quantity offered for sale in a given market at a given time at various prices. (Thomas Robert Malthus) What is the Law of Supply? The law of supply expresses the relation between the price of a commodity and its supply. In other words, the law of supply states that “other things being equal, when the price rises, supply extends and when the price falls, supply contracts.” The law of supply states that other things being equal, the higher the price, the greater the quantity supplied or, the lower the price, the smaller the quantity supplied. (Peter Dooley) Necessities vs. Luxuries (Sharma, K., 2015) Necessity is a good that is vital to the function of the enterprise. o Example: Cash supply for the snack factory to pay its employees their wages. Luxury is an item that is in surplus of need. Luxury is an item that is not needed for the survival of the enterprise. o Example: Luxury tax. A fur coat is an example of luxury. 01 Handout 1 *Property of STI  [email protected] Page 3 of 5  IT2007 It has been observed that for most goods and services, there exists a relationship between the price that must be paid and the quantity that will be demanded or purchased. Consumer and Producer Goods and Services (Sharma, K., 2015) The goods and services that are produced and utilized may be categorized into two groups. Consumer goods and services are those products or services that are directly used by consumers to satisfy their desire. o Food, clothing, homes, air conditioners, fast-moving consumer goods, telephones, mobile phones, and banking services are examples of consumer goods and services. Producer goods and services are those products or services that are used to produce consumer goods and services or other producer goods. o Manufacturing infrastructure that includes building, machinery, instruments and control systems, locomotives, and land transport used for the transportation of manufactured goods are some examples. Cost Concepts (Sharma, K., 2015 & Khan, Z., 2018) The following are different types of cost that are involved in engineering and managerial problems: Fixed costs associated with a new or existing project are those costs that do not change over a wide range of activities of the project. These are the inevitable costs that must be paid regardless of the level of output and the resources used. o For example, interest on borrowed capital, the rental cost of a warehouse, administrative salaries, license fees, property insurance, and taxes are fixed costs. Variable costs are costs that vary to changes in the activity level of a new or existing project. o Examples of variable costs include raw material cost, direct labor cost, power cost, shipping charges, utility, etc. Incremental costs are additional costs that result from increasing the output by one or more units. o For example, if the cost of manufacturing 10 pieces is 2,000 and that of 11 pieces is 2,200, then the incremental cost is 200. Standard costs are the planned costs per unit of output, anticipated labor hours, materials, and overhead categories. Direct costs can be measured and attributed to a specific activity or output. Indirect costs cannot be attributed to a single activity. Cash Costs are transactions that involve payment of cash. Book Costs are a noncash cost such as depreciation on machinery, etc. Sunk cost refers to the cost that has occurred in the past and does not have any impact on the future course of action. o For example, a car enthusiast had made a down payment of 5,000 to an 80,000 secondhand vehicle. If the enthusiast decided not to buy the car, it would not give back the 5,000. The 5,000 is a sunk cost. Opportunity cost or implicit cost refers to the value of the resources owned and used by a firm in its own production activity. o Example: Investing capital in the most rewarding alternative use or renting its land and buildings to the highest bidder rather than using them itself. Investment cost, or first cost, refers to the capital required to start a project. It may be either a single lump sum or a series of cash inputs that must be made at the beginning of the project. 01 Handout 1 *Property of STI  [email protected] Page 4 of 5  IT2007 o For example, if we want to purchase a new car, then the investment cost for acquiring it is the sum of the down payment, taxes, and other charges involved in obtaining the ownership of the car. o For a capital-intensive project such as a construction project which takes several years to complete, the investment cost is usually spread over time in the form of progressive payments. Operation and Maintenance costs are costs that can be incurred by hiring people, purchasing machines, materials, information, and energy. Working Capital are funds required for the day-to-day operation of the enterprise. Salvage Value is the trade-in value of the equipment after its full use. Engineering Economics Environment (Khan, Z., 2018) The success of engineers depends upon their ability to manipulate goods and services by acquiring and applying physical laws. However, the worth of these goods and services lies in their utility, which is measured in economic terms. Thus, knowledge of both physical laws and economics is required for making appropriate decisions. References: Blank, L. & Tarquin A. (2018). Engineering economy (8th ed.). McGraw-Hill. Khan, Z., Siddiquee, A., Kumar, B., & Abidi, M. (2018). Principles of engineering economics with applications (2nd ed.). Cambridge University Press. Sharma, K.R. (2015). An introduction to engineering economics. Momentum Press Engineering. Yates, J.K. (2017). Engineering economics. CRC Press. 01 Handout 1 *Property of STI  [email protected] Page 5 of 5