INTRODUCTION TO ENGINEERING ECONOMICS

Engineering economy is a branch of economics that deals with applying established economic
principles, theories of investment, and business practices to cost-related engineering
challenges.

It is also described as the study of economic theories and how they apply to engineering
challenges with the idea of making decisions based on maximizing benefit at the lowest possible
cost. In order to make decisions, it also requires studying cost characteristics and other financial
information and applying them to the field of engineering.

Engineering economics is often connected with economic viability and practicality. In order to
come up with the most useful design and development, it is also necessary to seek for the
recognition of alternatives, which are then contrasted and evaluated.

Engineering economy is the methodical assessment of the financial viability of suggested

solutions to engineering issues.

IMPORTANT USES OF ENGINEERING ECONOMY

1. Seeking new objectives for the application of engineering – An important use of

engineering economy is to seek new objectives for engineering application. Engineers are
constantly seeking new and wider application of their technical knowledge for the benefit of
mankind and in line with this, engineering economy provides basic principles and laws.

2. Discovery of factors limiting the success of a venture or enterprise – upon knowing the
objectives, next is to determine ways and means to attain such objectives. With Engineering
Economy, the so-called limiting factors which may hinder the success of a project are being
discovered.

3. Comparison of alternatives as a basis for decision – The principles of engineering

economy helps to point out the analysis of choosing the best alternatives on a quantitative
basis.
4. Analysis of possible investment of capital – Engineering economy enables engineers to
consider all aspects of investment from both the technical and financial viewpoints. It provides
several patterns of analysis to determine rate of return, annual costs and pay out periods, which
all serves as bases for decision.

5. Determination of bases for decision – Engineers main ‟ concern is on future actions, that is
on what to do and not on what has been accomplished. Decisions on future actions are more
valid and accurate if the principles of engineering economy are correctly applied.

PRINCIPLES OF ENGINEERING ECONOMY

Principle 1. Develop the alternatives. The choice is among alternatives. It is necessary to

determine the options. a selection entails making a decision between options, defining and
creating options depend on the imagination and invention of the engineer.

Principle 2. Focus on the differences. Only the difference in expected outcomes is considered.
If the potential results of all reasonable options were the same. Obviously, the only distinctions
between the options' future results that matter. Results that apply to all alternatives might be
ignored when comparing and choosing. For instance, if two apartments had the same purchase
price or rental price, the decision of which option to choose would depend on additional factors
such location and yearly operating and maintenance costs.

Principle 3. Use a consistent viewpoint. Prospective outcomes of the alternatives, economic,

etc. should be considered. Owner's point of view is frequently the decision maker's perspective.
The standpoint for the engineering projects' success can be viewed from the multiple
viewpoints, such as those of the beneficiary group, the financier, and the giver. But the analysis
must have a consistent point of view.

Principle 4. Use a common unit of measure. Using a common unit of measurement of the
possible outcomes in comparing alternatives. For economic consequences, a monetary unit
such as dollars or rupees is the common measure.

Principle 5. Consider all relevant criteria. Consider both monetary and other unit of measure
in measurement of outcomes. The decision-making process should take into account both the
outcomes listed in the monetary unit as well as those expressed in another unit of measurement
or explicitly stated in a descriptive way. In addition to the owner's long-term financial interests,
stakeholders' requirements should be taken into account.

Principle 6. Make uncertainty explicit. Uncertainty is inherent in projecting future outcomes

and should considered in their analysis and comparison. Any course of action's future
magnitude and influence are unclear, and its likelihood of happening differs from what was
originally anticipated. As a result, managing uncertainty is a key component of engineering
economic analysis.

Principle 7. Revisit your decisions. Projected results and decisions should be compared with
actual results to improve the decision process. If results significantly different from the initial
estimates, appropriate feedback to the decision-making process should occur.

ENGINEERING ECONOMICS AND THE DESIGN PROCESS

If you take a moment to observe your surroundings, you will see examples of technological
creativity. The physical objects you see, whether they are telephones, automobiles, bicycles, or
electric appliances, all came into being through the creative application of technology. These
everyday inventions did not miraculously appear but originated in the minds of human beings
and took time to develop. Engineering is the creative process of turning abstract ideas into
physical representations (products or systems). What distinguishes engineers from painters,
poets, or sculptors is that engineers apply their creative energies to producing products or
systems that meet human needs. This creative act is called design.

ENGINEERING DESIGN

Most engineering designs can be classified as inventions-devices or systems that are created
by human effort and did not exist before or are improvements over existing devices or systems.
Inventions, or designs, do not suddenly appear from nowhere. They are the result of bringing
together technologies to meet human needs or to solve problems. Sometimes a design is the
result of someone trying to do a task more quickly or efficiently. Design activity occurs over a
period of time and requires a step-by-step methodology.
We described engineers primarily as problem solvers. What distinguishes design from other
types of problem solving is the nature of both the problem and the solution. Design problems
are open ended in nature, which means they have more than one correct solution. The result or
solution to a design problem is a system that possesses specified properties.

Design problems are usually more vaguely defined than analysis problems. Suppose that you
are asked to determine the maximum height of a snowball given an initial velocity and release
height. This is an analysis problem because it has only one answer. If you change the problem
statement to read, "Design a device to launch a 1 -pound snowball to a height of at least 160
feet," this analysis problem becomes a design problem. The solution to the design problem is a
system having specified properties (able to launch a snowball 160 feet), whereas the solution to
the analysis problem consisted of the properties of a given system (the height of the snowball).
The solution to a design problem is therefore open ended, since there are many possible
devices that can launch a snowball to a given height. The original problem had a single solution:
the maximum height of the snowball, determined from the specified initial conditions.

Solving design problems is often an iterative process: As the solution to a design problem
evolves, you find yourself continually refining the design. While implementing the solution to a
design problem, you may discover that the solution you've developed is unsafe, too expensive,
or will not work. You then "go back to the drawing board" and modify the solution until it meets
your requirements. For example, the Wright brothers' airplane did not fly perfectly the first time.
They began a program for building an airplane by first conducting tests with kites and then
gliders. Before attempting powered flight, they solved the essential problems of controlling a
plane's motion in rising, descending, and turning. They didn't construct a powered plane until
after making more than 700 successful glider flights. Design activity is therefore cyclic or
iterative in nature, whereas analysis problem solving is primarily sequential.

The solution to a design problem does not suddenly appear in a vacuum. A good solution
requires a methodology or process. There are probably as many processes of design as there
are engineers. Therefore, this lesson does not present a rigid "cookbook" approach to design
but presents a general application of the five-step problem-solving methodology associated with
the design process. The process described here is general, and you can adapt it to the
particular problem you are trying to solve.
THE DESIGN PROCESS

The basic five -step process usually used in a problem-solving works for design problems as
well. Since design problems are usually defined more vaguely and have a multitude of correct
answers, the process may require backtracking and iteration. Solving a design problem is a
contingent process and the solution is subject to unforeseen complications and changes as it
develops. Until the Wright brothers actually built and tested their early gliders, they did not know
the problems and difficulties they would face controlling a powered plane.

1.Define the problem

2. Gather pertinent information

3. Generate multiple solutions

4. Analyze and select a solution

5. Test and implement the solution

The first step in the design process is the problem definition. This definition usually contains a
listing of the product or customer requirements and specially information about product
functions and features among other things. In the next step, relevant information for the design
of the product and its functional specifications is obtained. A survey regarding the availability of
similar products in the market should be performed at this stage. Once the details of the design
are clearly identified, the design team with inputs from test, manufacturing, and marketing teams
generates multiple alternatives to achieve the goals and the requirements of the design.
Considering cost, safety, and other criteria for selection, the more promising alternatives are
selected for further analysis. Detail design and analysis step enables a complete study of the
solutions and result in identification of the final design that best fits the product requirements.
Following this step, a prototype of the design is constructed and functional tests are performed
to verify and possibly modify the design.

When solving a design problem, you may find at any point in the process that you need to go
back to a previous step. The solution you chose may prove unworkable for any number of
reasons and may require redefining the problem, collecting more information, or generating
different solutions.

Define the Problem

You need to begin the solution to a design problem with a clear, unambiguous definition of the
problem. Unlike an analysis problem, a design problem often begins as a vague, abstract idea
in the mind of the designer. Creating a clear definition of a design problem is more difficult than,
defining an analysis problem. The definition of a design problem may evolve through a series of
steps or processes as you develop a more complete understanding of the problem.

a. Identify and Establish the Needs

b. Develop and Problem Statement

c. Establish Criteria for Success

The following is a list of preliminary criteria for a better mousetrap design. This list would be
included in the problem definition statement.

 The design must be low cost.

 The design should be safe, particularly with small children.
 The design should not be detrimental to the environment.
 The design should be aesthetically pleasing.
 The design should be simple to operate, with minimum human effort.
 The design must be disposable (you don't reuse the trap).
 The design should not cause undue pain and suffering for the mouse.

Gather Pertinent Information

  Is the problem real and its statement accurate?
 Is there really a need for a new solution or has the problem already been solved?
 What are the existing solutions to the problem?
 What is wrong with the way the problem is currently being solved?
 What is right about the way the problem is currently being solved?
 What companies manufacture the existing solution to the problem?
 What are the economic factors governing the solution?
 How much will people pay for a solution to the problem?
 What other factors are important to the problem solution (such as safety, aesthetics and
environmental issues)?

Generate Multiple Solution

 Curiosity and tolerance of the unknown. Creative people have a positive curiosity of the
unknown. They are not afraid of what they don't understand.
 Openness to new experiences. Creative people have a healthy and positive attitude
toward new experiences.
 Willingness to take risks. Creative people are not afraid to take risks and try new
experiences or ideas, knowing that they may be misunderstood and criticized by others.
They are self-confident and not afraid to fail.
 Ability to observe details and see the "whole picture." Creative people notice and
observe details relating to the problem, but they also can step back and see the bigger
picture.
 No fear of problems. Creative people are not afraid to tackle complex problems, and
they even search for problems to solve. They seek solutions to problems with their own
abilities and experience if possible. They have the attitude of "if you want something
done, you'd better do it yourself."
 Ability to concentrate and focus on the problem until it's solved. Creative people can set
goals and stick to them until they're reached. They focus on a problem and do not give
up until the problem is solved. They have persistence and tenacity.
Analyze and Select a Solution

 Functional analysis
 Industrial design/Ergonomics
 Mechanical/Strength analysis
 Electrical/Electromagnetic
 Manufacturability/Testability
 Product safety and liability
 Economic and market analysis
 Regulatory and Compliance

Test and Implement the Solution

 Protyping
 Concurrent Engineering
 Documentation
 Applying for Patents
 Testing and Verification

COST CONCEPTS FOR DECISION MAKING

Fixed / Variable Costs – If costs change appreciably with fluctuations in business activity, they
are “variable.” Otherwise, they are “fixed.”

A widely used cost model is:

Total Costs = Fixed Costs + Variable Costs
Top 9 Cost Concepts used in Decision Making
a) Marginal Cost
Marginal cost is the total of variable costs, i.e., prime cost plus variable overheads. It is based
on the distinction between fixed and variable costs. Fixed costs are ignored and only variable
costs are taken into consideration for determining the cost of products and value of work-in-
progress and finished goods.
b) Out of Pocket Costs
This is that portion of the costs which involves payment to outsiders, i.e., gives rise to cash
expenditure as opposed to such costs as depreciation, which do not involve any cash
expenditure. Such costs are relevant for price fixation during recession or when make or buy
decision is to be made.
c) Differential Costs
The change in costs due to change in the level of activity or pattern or technology or process or
method of production is known as differential costs. If any change is proposed in the existing
level or in the existing methods of production, the increase or decrease in total cost as a result
of this decision is known as differential cost. If the change increases the cost, it will be called
incremental cost. If there is decrease in cost resulting from decrease in output, the difference is
known as decremental cost.
d) Sunk Costs
A sunk cost is an irrecoverable cost and is caused by complete abandonment of a plant. It is the
written down value of the abandoned plant less its salvage value. Such costs are historical
which are incurred in the past and are not relevant for decision-making and are not affected by
increase or decrease in volume. Thus, expenditure which has taken place and is irrecoverable
in a situation is treated as sunk cost. For taking managerial decisions with future implications, a
sunk cost is an irrelevant cost. If a decision has to be made for replacing the existing plant, the
book value of the plant less salvage value (if any) will be a sunk cost and will be irrelevant cost
for taking decision of the replacement of the existing plant. Sunk costs are not affected by
increase or decrease of volume. Examples of such costs include depreciated fixed assets,
development cost already incurred etc.
e) Opportunity Cost
It is the maximum possible alternative earning that might have been earned if the productive
capacity or services had been put to some alternative use. In simple words, it is the advantage,
in measurable terms, which has been foregone due to not using the facility in the manner
originally planned. It refers to the value of sacrifice made or benefit of opportunity foregone in
accepting an alternative course of action. For example, if an owned building is proposed to be
used for a project, the likely rent of the building is the opportunity cost which should be taken
into consideration while evaluating the profitability of the project.
f) Imputed Costs
Notional costs or imputed costs are those costs which are notional in character and do not
involve any cash outlay, e.g., notional rent charged on business premises owned by the
proprietor, interest on capital for which no interest has been paid. When alternative capital
investment projects are being evaluated it is necessary to consider the imputed interest on
capital before a decision is arrived as to which is the most profitable project.
g) Replacement Cost
It is the cost at which there could be purchase of an asset or material identical to that which is
being replaced or revalued. It is the cost of replacement at current market price.
h) Avoidable Cost and Unavoidable
Cost Avoidable costs are those which can be eliminated if a particular product or department,
with which they are directly related, is discontinued. For example, salary of the clerks employed
in a particular department can be eliminated, if the department is discontinued.
i) Relevant Cost and Irrelevant Cost
A cost that is relevant to a decision is called relevant cost. Past costs are not generally relevant
costs because they are sunk costs or costs already incurred. Thus, the book value of an asset
or depreciation charged in accounts in respect of an asset is not relevant cost. On the other
hand, the fall in the resale value of an asset as a result of using it, as also the running expenses
incurred to make use of the asset are relevant costs.