ENGINEERING ECONOMICS

SPRING / 2024

1
 INTRODUCTION TO
ENGINEERING ECONOMICS

Economics is defined as the study of allocation of scarce resources among

unlimited ends (or wants).
Our wants are unlimited or at least increasing ever and to satisfy all these
wants, we need unlimited supply of productive resources which could
provide necessary goods and services to the community. However,
resources are scarce i.e. limited in supply and obtained at some cost. In
other words, resources are scarce in relation to its needs Therefore, scarce
resources should be used wisely judiciously and more effectively at
optimum level, minimizing the cost and maximizing profit and benefit
without compromising the quality of product or service.
All engineering decisions involve number of feasible alternatives or options.
These feasible alternatives must be properly evaluated before
implementing them. If there is no alternative, there is no need of economic
study.
Mission of engineers is to transform the resources of nature for the benefit
of the human race. Engineers translate an idea into reality. However an
idea may be technically excellent incorporating sound design, latest
technology but if it does not convert into real product or service that is
affordable and fit for purposes satisfying needs and requirements of its end
users, clients, target group, beneficiary group, then it is not worthwhile to
invest in such ventures. The products or services generated should use
optimized utilization of various resources so that cost of production is not
2
high, affordable to users and compete with similar product and services of
competitors in the market.
Engineering economy involves the systematic evaluation of the economic
merits of proposed solutions to engineering problems. To be economically
acceptable (i.e. affordable), solutions to engineering problems must be
demonstrate a positive balance of long-term benefits over long-term
costs,…

ROLE OF ENGINEERS ON ECONOMIC DECISION

Engineering is involved in every detail of a product's production, from the
conceptual design to the shipping. Engineering decisions accounts majority
of (say 85%) of product cost. Engineers must consider the effective use of
capital assets such buildings, plants and workshops, machine and
equipments.. One of the engineer's primary task is to plan for acquisition of
equipment (capital expenditure decision).With the acquisition of any fixed
capital, we need to estimate or predict the cash flows and profits that asset
will generate during its service period and make decision whether the
investment would be justified.
Engineers play a role in effective utilization of assets. They utilize same
technique for engineering economic decision. Judicious, effective and wise
of poor predication or estimation or projection of performance of investment
into future is a challenging and risky job which can be rewarding or
disastrous.
Engineers are called upon to translate an idea into reality. Constant flow of
innovative and creative ideas for generating new products as per ever

3
changing needs of its clients in dynamic environment and market
conditions affect growth and development of firm, also make competitive.
Based on past experience, and research and development, investments
decisions are made to make existing product better or produce them at a
competitive price. Engineers must understand how their investment
decisions affect overall position of the company and its future growth and
prospectus.
The steps/procedure in the engineering economic decision making are:
 Identification of problem and prospects
 Develop feasible & relevant alternatives
 Determine appropriate selection criteria.
 Analysis, comparison of various alternatives
 Evaluate & recommend the alternative
 Select the best alternative
 Implementation of the selected alternative
 Monitoring and controlling

What are the course topics about?

 About decision making process
 Providing you with the tools to properly solve and analyze various DM
problems
 It is needed to understand the decision making process and use
proper tools to compare between alternatives
 Final goal is to make better decisions

4
 ORGANIZATION

Organization
Organization is defined as ‘’two or more people who work together in a
structured way to achieve a specific goals’’.

A university, sport team, musical or theatrical group; religious or civic

association, a branch of armed forces, or a business is examples of
organizations. The organizations generally incorporate either a formal or
informal structure. However regardless of how they differ, all organizations
have several basic things in common. The most obvious common element
is a goal or purpose.

MANAGEMENT

Definition
I. Directing the actions of a group to achieve a goal in most efficient
manner.
II. Getting things done through other people.
III. Process of achieving organizational goals by working with and
through people and organizational resources.

5
Levels of Management
I. Top-level: President, Executive vice president
II. Middle-level: Chief engineer, Division head, etc.
III. First-line: Foreman, Supervisor, Section chief

Functions of Managers
I. Planning: Selecting objectives and methodology by good
decision making process.
II. Organizing: Establishing the structure for the objective.
III. Directing: Influencing people to achieve the objective.
IV. Controlling: Measuring the progress towards goals, observing
any deviations, and defining corrective action.

6
 ENGINEERING ECONOMICS

ENGINEERING
Engineering is profession in which knowledge of the mathematical and
natural science gained by study; experience and practice is applied with
judgment to develop ways to utilize economically the materials and forces
of nature for the benefit of mankind.

ECONOMICS
Economics is the science that deals with the production and
consumption of goods and services and the distribution and rendering of
these for human welfare.

The following are the economic goals.

 A high level of employment
 Price stability
 Efficiency
 An equitable distribution of income
 Growth

Some of the above goals are interdependent. The economic goals are
not always complementary; in many cases they are in conflict. For
example, any move to have a significant reduction in unemployment will
lead to an increase in inflation.

7
Flow in an Economy
The flow of goods, services, resources and money payments in a
simple economy are shown in Fig. 1.1. Households and businesses
are the two major entities in a simple economy. Business
organizations use various economic resources like land, labour and
capital which are provided by households to produce consumer
goods and services which will be used by them. Business
organizations make payment of money to the households for
receiving various resources. The households in turn make payment of
money to business organizations for receiving consumer goods and
services. This cycle shows the interdependence between the two
major entities in a simple economy.

8
Law of Supply and Demand
An interesting aspect of the economy is that the demand and supply
of a product are interdependent and they are sensitive with respect to
the price of that product. The interrelationships between them are
shown in Fig. 1.2.

From Fig. 1.2 it is clear that when there is a decrease in the price of a
product, the demand for the product increases and its supply
decreases. Also, the product is more in demand and hence the
demand of the product increases. At the same time, lowering of the
price of the product makes the producers restrain from releasing
more quantities of the product in the market. Hence, the supply of the
product is decreased. The point of intersection of the supply curve
and the demand curve is known as the equilibrium point. At the

9
price corresponding to this point, the quantity of supply is equal to the
quantity of demand. Hence, this point is called the equilibrium point.

Factors influencing demand

The shape of the demand curve is influenced by the following factors:

1. Income of the people

2. Prices of related goods
3. Tastes of consumers

If the income level of the people increases significantly, then their

purchasing power will naturally improve. This would definitely shift the
demand curve to the north-east direction of Fig. 1.2. A converse
situation will shift the demand curve to the south-west direction.

If, for instance, the price of television sets is lowered drastically its
demand would naturally go up. As a result, the demand for its
associated product namely VCDs would also increase. Hence, the
prices of related goods influences the demand of a product. Over a
period of time, the preference of the people for a particular product
may increase, which in turn, will affect its demand. For instance,
diabetic people prefer to have sugar-free products. If the incidence of
diabetes rises naturally there will be increased demand for sugar-free
products.

10
Factors influencing supply
The shape of the supply curve is affected by the following factors:
1. Cost of the inputs
2. Technology
3. Weather
4. Prices of related goods

If the cost of inputs increases, then naturally, the cost of the product will go
up. In such a situation, at the prevailing price of the product the profit
margin per unit will be less. The producers will then reduce the production
quantity, which in turn will affect the supply of the product. For instance, if
the prices of fertilizers and cost of labour are increased significantly, in
agriculture, the profit margin per bag of paddy will be reduced. So, the
farmers will reduce the area of cultivation, and hence the quantity of supply
of paddy will be reduced at the prevailing prices of the paddy.
If there is an advancement in technology used in the manufacture of the
product in the long run, there will be a reduction in the production cost per
unit. This will enable the manufacturer to have a greater profit margin per
unit at the prevailing price of the product. Hence, the producer will be
tempted to supply more quantity to the market.
Weather also has a direct bearing on the supply of products. For example,
demand for woolen products will increase during winter. This means the
prices of woolen goods will be increased in winter. So, naturally,
manufacturers will supply more volume of woolen goods during winter.

11
CONCEPT OF ENGINEERING ECONOMICS
Science is a field of study where the basic principles of different physical
systems are formulated and tested. Engineering is the application of
science. It establishes varied application systems based on different
scientific principles. From the discussions in the previous section, it is clear
that price has a major role in deciding the demand and supply of a product.
Hence, from the organization’s point of view, efficient and effective
functioning of the organization would certainly help it to provide
goods/services at a lower cost which in turn will enable it to fix a lower price
for its goods or services. The following section discusses the different types
of efficiency and their impact on the operation of businesses and the
definition and scope of engineering economics

Types of Efficiency

Efficiency of a system is generally defined as the ratio of its output to input.

The efficiency can be classified into technical efficiency and economic
efficiency.

Technical efficiency
It is the ratio of the output to input of a physical system. The physical
system may be a diesel engine, a machine working in a shop floor, a
furnace, etc.
𝑜𝑢𝑡𝑝𝑢𝑡
𝑇𝑒𝑐ℎ𝑛𝑖𝑐𝑎𝑙 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 (%) = 𝑋 100
𝑖𝑛𝑝𝑢𝑡

The technical efficiency of a diesel engine is as follows:

12
 ℎ𝑒𝑎𝑡 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡 𝑜𝑓
𝑚𝑒𝑐ℎ𝑎𝑛𝑖𝑐𝑎𝑙 𝑒𝑛𝑒𝑟𝑔𝑦 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑
𝑇𝑒𝑐ℎ𝑛𝑖𝑐𝑎𝑙 𝑒𝑓𝑓𝑒𝑐𝑖𝑒𝑛𝑐𝑦 (%) = 𝑋 100
𝐻𝑒𝑎𝑡 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡 𝑜𝑓
𝑓𝑢𝑒𝑙 𝑢𝑠𝑒𝑑

In practice, technical efficiency can never be more than 100%. This is

mainly due to frictional loss and incomplete combustion of fuel, which are
considered to be unavoidable phenomena in the working of a diesel
engine.

Economic efficiency
Economic efficiency is the ratio of output to input of a business system

𝑜𝑢𝑡𝑝𝑢𝑡 𝑤𝑜𝑟𝑡ℎ
𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝑒𝑓𝑓𝑒𝑐𝑖𝑒𝑛𝑐𝑦 (%) = 𝑋 100 = 𝑋 100
𝑖𝑛𝑝𝑢𝑡 𝑐𝑜𝑠𝑡

‘Worth’ is the annual revenue generated by way of operating the business

and ‘cost’ is the total annual expenses incurred in carrying out the
business. For the survival and growth of any business, the economic
efficiency should be more than 100%.

Economic efficiency is also called ‘productivity’. There are several ways of

improving productivity.
1. Increased output for the same input
2. Decreased input for the same output
3. By a proportionate increase in the output which is more than the
proportionate increase in the input

13
4. By a proportionate decrease in the input which is more than the
proportionate decrease in the output
5. Through simultaneous increase in the output with decrease in the
input.

Increased output for the same input.

In this strategy, the output is increased while keeping the input constant.
Let us assume that in a steel plant, the layout of the existing facilities is
not proper. By slightly altering the location of the billet-making section,
and bringing it closer to the furnace which produces hot metal, the scale
formation at the top of ladles will be considerably reduced. The molten
metal is usually carried in ladles to the billet-making section. In the long
run, this would give more yield in terms of tonnes of billet produced. In
this exercise, there is no extra cost involved. The only task is the
relocation of the billet-making facility which involves an insignificant cost.

Decreased input for the same output.

In this strategy, the input is decreased to produce the same output. Let
us assume that there exists a substitute raw material to manufacture a
product and it is available at a lower price. If we can identify such a
material and use it for manufacturing the product, then certainly it will
reduce the input. In this exercise, the job of the purchase department is
to identify an alternate substitute material. The process of identification
does not involve any extra cost. So, the productivity ratio will increase
because of the decreased input by way of using cheaper raw materials
to produce the same output.

14
Less proportionate increase in output is more than that of the
input.
Consider the example of introducing a new product into the existing
product mix of an organization. Let us assume that the existing facilities
are not fully utilized and the R&D wing of the company has identified a
new product which has a very good market and which can be
manufactured with the surplus facilities of the organization. If the new
product is taken up for production, it will lead to—
 an increase in the revenue of the organization by way of selling
the new product in addition to the existing product.
 an increase in the material cost and operation and maintenance
cost of machineries because of producing the new product
If we closely examine these two decreases, we will see that the
proportionate decrease in the input cost will be more than the
proportionate decrease in the revenue. Hence, there will be a net
increase in the productivity ratio.

Simultaneous increase in output and decrease in input.

Let us assume that there are advanced automated technologies like
robots and automated guided vehicle system (AGVS), available in the
market which can be employed in the organization we are interested in.
If we employ these modern tools, then:
 There will be a drastic reduction in the operation cost. Initially, the
cost on equipment would be very high. But, in the long run, the
reduction in the operation cost would break-even the high initial
investment and offer more savings on the input.
15
  These advanced facilities would help in producing more products
because they do not experience fatigue. The increased production
will yield more revenue.

In this example, in the long run, there is an increase in the revenue and
a decrease in the input. Hence, the productivity ratio will increase at a
faster rate.

16
 ENGINEERING ECONOMICS

HOME WORK – 1

1. Define organization?
2. Define management?
3. What are the functions of the manager?
4. Define engineering economics?
5. Illustrate the effect of price on demand and supply; illustrate with the
help of a diagram.
6. Discuss the factors which influence demand and supply.

17