Economics (HS-402)

BS (Electrical Engineering) Program

Lecture# 02
Principles of Engineering
Economy

1
 Engineering Economy

Engineering economy involves the systematic

evaluation of the economic merits of proposed
solution to engineering problems.

Economically acceptable is positive balance of

long term benefits over long term costs.

2
 Decision Making

Decision Making
The process of choosing a solution from
available alternatives.

Rational Decision Making

A systematic process of defining problems,
evaluating alternatives and choosing optimal
solutions.
3
 Rational Decision Making Process

▪ Recognize the decision

problem
▪ Collect all needed (relevant)
information
▪ Identify the set of feasible
decision alternatives
▪ Define the key objectives
and constraints
▪ Select the best possible and
implementable decision
alternative
4
 Class Exercise

Follow the rational decision making process

for leasing a car.

5
 Car to lease

▪ Recognize the decision • Need to lease a car

problem
▪ Collect all needed • Gather technical and
(relevant) information financial data
▪ Identify the set of feasible • Select cars to consider
decision alternatives
▪ Define the key objectives • Wanted: small cash outlay,
and constraints safety, good performance,
aesthetics,…
▪ Select the best possible
• Choice between Corolla and
and implementable Honda (or others)
decision alternative
• Select Honda 6
 Economic Decisions

Profit!
Manufacturing

Design

Financial Investment
planning and loan Marketing

7
What makes the engineering economic
decisions difficult?

8
 Predicting the Future

• Estimating the required

investments
• Estimating product
manufacturing costs
• Forecasting the demand for
a brand new product
• Estimating a “good” selling
price
• Estimating product life and
the profitability of
continuing production

9
 Role of Economics in Engineering

Create & Design

Projects

Analyze Estimate Evaluate

• Production Methods • Expected • Impact on Financial

• Engineering Safety Profitability Statements
• Environmental Impacts • Timing of • Firm’s Market Value
• Market Assessment Cash Flows • Stock Price
• Degree of
Financial Risk

10
 Reading Assignment

Read about role of engineers in Business

Environment.

11
 Key Factors to Consider

• Objectives
• Available resources
• Time
• Uncertainty

12
 Large Scale Engineering Projects

These typically
• require a large sum of investment
• can be very risky
• take a long time to see the financial
outcomes
• lead to revenue and cost streams that are
difficult to predict

13
Types of Strategic Economic Decisions in
Manufacturing Sector

14
 Service Improvement

From data to denim

Making customized jeans, a
new computerized system
being installed at some
Original Levi’s Stores allow
customers to order
customized jeans

• How many more jeans

would Levi’s need to sell to
justify the cost of
additional robotics tailors?

15
 Equipment and Process Selection

• How do you choose between using alternative (the

Plastic SMC and steel sheet stock for an auto body
panel) materials?

• The choice of material will dictate the

manufacturing process and the associated
manufacturing costs.

• Hint: Compare material cost, machinery investment,

tooling investment and cycle time

16
 Equipment Replacement Problem

Key question:
When is the right time to replace an old
machine or equipment?

17
 New Product and Product Expansion

• Shall we build or
acquire a new
facility to meet
the increased
(increasing
forecasted)
demand?

• Is it worth
spending money
to market a new
product?

18
 Reading Assignment

Read about Ansoff’s Product-Market

Expansion Grid.

19
 Cost Reduction

• Should a company
buy new equipment
to perform an
operation that is now
done manually?

• Should spend money

now in order to save
more money later?

20
 Fundamental Principles of Engineering
Economics
1: An instant dollar is worth more than a distant
dollar.

2: Only the relative (pair-wise) difference among the

considered alternatives counts.

3: Marginal revenue must exceed marginal cost, in

order to carry out a profitable increase of operations

4: Additional risk is not taken without an expected

additional return of suitable magnitude

21
 Principle 1
An instant dollar is worth more than a distant dollar

• Money has a time

value associated
with it Today

• It is better to
receive money 6 Months Later

earlier than later

22
 Principle 2
Only the cost (resource) difference among alternatives
counts

The data shown in the green fields are irrelevant items for decision making, since
their financial impact is identical in both cases
23
 Principle 3
Marginal (unit) revenue has to exceed marginal cost, in
order to increase production

Marginal revenue means the additional revenue made

possible by increasing the activity by one unit.

Cost of Goods sold $2/unit Marginal

cost

Gross Revenue $4/unit Marginal

revenue

Each decisions alternative must be justified on its own

economic merits before being compared to other alternatives

24
 Principle 4
Additional risk is not taken without a suitable expected
additional return

• Investors demand a minimum return that must be

greater than the anticipated rate of inflation or any
perceived risk.

• Expected return
from bonds and
stock are normally
higher than the
expected return
from savings
Note that all investments imply some risk
account.
25
Other Principles of Engineering Economy

I- Develop the Alternatives

II-Focus on Differences
III-Use a consistent viewpoint
IV-Use a common unit of measurement
V-Consider all relevant criteria
VI-Make uncertainty explicit
VII-Revisit your decisions

26
 Engineering Economy & the Design Process
Engineering Economic Analysis Engineering Design Process
(Steps) (Activities)
1 Problem recognition, definition and Problem/need definition
evaluation
2 Development of the feasible Problem/need formulation and
alternatives evaluation
3 Development of the cash flows for Synthesis of possible solutions
each alternatives (alternatives)
4 Selection of criterion (criteria) Analysis, optimization and evaluation
5 Analysis and comparison of the Specification of preferred alternative
alternatives
6 Selection of the preferred alternative communication
7 Performance monitoring and post
evaluation of results

27
 Class Exercise
While studying, you and two friends find yourselves craving a fresh pizza.
You can’t spare the time to pick up the pizza and must have it delivered. “A”
offers a 1-1/4” thick (incl. toppings), 20” square pizza with your choice of
two toppings for $15 plus 5% sales tax and a $1.50 delivery charge (no
sales tax on delivery charge).
“B” offers the round deep dish Sasquatch which is 20” in diameter. It is 1-
3/4” thick, which includes two toppings, and costs $17.25 plus 5% sales
tax and free delivery.

a. What is the problem here?

b. Apply the seven step process to define the problem.
c. Assume that your common unit of measurement is $ (i-e. cost), what
is the better value for getting a pizza based on the criterion of
minimum cost?

28