Engineering Economics &

Management (Theory)
HSS-411

This course is designed to increase the understanding of the students about

economics, the economic effects of decisions and methods for comparing
engineering alternatives using economic criteria. You will learn various managerial
skills and how the knowledge of project management can be applied to manage
projects professionally.
Introduction to Economics
• Flow in an economy,
• Law of supply and demand,
• Concept of Engineering Economics –
• Engineering efficiency,
• Economic efficiency,
• Scope of engineering Economics –
• Element of costs,
• Marginal cost,
• Marginal Revenue,
• Sunk cost,
• Opportunity cost,
• Break-even analysis,
• Elementary Economic Analysis –
• – Material selection for product Design selection for a product, Process planning.
Define Engineering Economics.
• Engineering economics defined as how limited resources used to
satisfy unlimited human wants
• In other words, it can be defined as a set of principles, concepts,
techniques and methods by which alternatives with in a project can
be compared and evaluated for the best monetary return.
• Engineering economics deals with the methods that enable one to
take economic decisions towards minimizing costs and/or maximizing
benefits to business organizations.
Marginal costing
• Marginal costing is defined by the ICWA as, “the ascertainment by
differentiating between fixed costs, of marginal costs and of the effect
on profit of changes in volume or type of output
Law of the Demand
• It states that other things being equal demand when price falls and
contracts when price rises.
What is BEP
• The Break-even point is, therefore, the volume of output at which
neither a profits made nor a loss is incurred. It is a point where the
total sales are equal to total cost
Differentiate ‘technical efficiency’ and
‘economical efficiency’
1. 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.

Technical efficiency (%) = Output × 100

Input

The technical efficiency of a diesel engine is as follows:

Heat equivalent of mechanical

Technical efficiency (%) = energy produced × 100
Heat equivalent of fuel used
2. Economic efficiency:
It is the ratio of output to input of a business system.

Economic efficiency (%) = Output × 100 = Worth × 100

Input Cost
Define opportunity cost.
• Opportunity cost defined as the potential benefit that is given up as
you seek an alternative course of action.
• In other words, the expected return or benefit forgone in
rejecting one course of action for another
What is sunk cost?
• A cost which was incurred or sunk in the past and is not relevant to
the particular decision making is a sunk cost or sunk loss.
• It may be variable or fixed or both.
Define P/V ratio.
• Profit-Volume ratio expressed as a percentage indicates the relative
profitability of different products.
What are the elements of cost?
• The elements of cost are:
Materials cost
Labor cost
Expenses
What is elasticity of demand?
• Elasticity of demand may be defined as the degree of responsiveness
of quantity demanded to a Change in price.
 Scope of Engineering Economics
• Engineering economics plays a very important role in all engineering decisions. It is concerned with the monetary
consequences (or) financial analysis of the projects, products and processes that engineering design.
• Engineering economics helps an engineer to assess and compare the overall cost of available alternatives for engineering
projects or plants or machine, etc. According to the analysis, an engineer can take a decision from the alternative in most
economical one as the best.

• Engineering economic concepts are used in the important fields like increasing production, improving productivity,
reducing human efforts, increasing wealth by maximizing profits, controlling and reducing cost.

• Engineering economics provides a number of tools and techniques to solve engineering problems related to product mix,
output level, pricing the product, investment, quantum of advertisement, etc.

• Engineering economics helps to understand the market conditions, general economic environment in which the firm is
working.

• Engineering economics provide basis for resource allocation problem.

• Engineering economics deals with the identification of economic choice, and is concerned with the decision making of
engineering problems of economic nature
Factors influencing process design
1. Volume of output
2. Volume Vs variety
3. Quality of the product
4. Types of equipment's
5. Environment effect
6. Forms of transformation process
7. Produce-to-stock Vs Produce-to-Order
8. Output characteristics Vs Process Selection
Factors influencing process design
1.Volume of output:
• The quantity and rate of production affects the methods of
production.
• Generally, more advanced methods of manufacturer can be used
when output is large. The number of identical units to be produced
exercises important influence on manufacturing design.
• In multi product Organizations, standardization of component parts
and product are very important in process
designing
2.Volume vs Variety:
• Variety requires skilled technicians, general purpose machines &
complex production planning and control.
• High volume requires automation, mass production machines and
simple production planning and control

• One extreme end shows very high variety (and hence very low
product variety but very high volumes.
3.Quality of the product:
• Product quality determines the quality of component parts and
materials which in turn determines the methods and equipment to be
used. Therefore, drawing, specifications, bills of materials, part lists,
etc., should be read by the process engineer to determine process
design
4.Types of equipment's:
• The process engineer should attempt to design manufacturing
processes that are adaptable to and will balance the productive load
of existing equipment that may be used in the manufacture of the
product.
5.Environment effect:
• Process selection responds to environmental changes, especially
changes in technology. A process may have to be replaced as it might
have been obsolete.
• Even the technology involved in organizing the operations function
tells up on the process selected
6.Forms of transformation process:
• Process selection also refers to the selection of sub processes, and the subprocess of
these sub processes also.
• When the output contains of a product there are assemblies and sub assemblies and this
break-up continues till the
elementary level of components become incapable of being broken down further.
• These components and sub-components can either be made by the organization
or purchased from outside. For example, if an organization assembles certain
products like transistor, radios, etc., it has to outline in detail the assembly
process.
• Here, the point to be noted in that there is no ideal process for an ideal
product- there is room for improvement in both the process used and the output
generated
7.Produce-to-stock Vs Produce-to-Order:
• One important consideration affecting selection of the process is that of
making production either for storage and selling or receiving an order first from
the customers, and then starting the production process.
• Standardization and variety reduction lead to batch production which forms the inventory
from which stock to sell are drawn, is replenished by further batch production once it reaches
a minimum pre-determined level. The system employed here is anticipated of demand.
• There is to waiting time involved for the customer. Such products are
inventory able. The risk is much more in the case of perishables and short shelf life products
• Produce-to-order is customaries producing where the manufacturing
process follows the respect of customers in this process. Non inventory services
are always produces to order, ensuring that the waiting time for the customer is
as short as possible
8.Output characteristics Vs Process
Selection:
• The selection of process form project type, intermittent type,
continuous type or continuous-process type depends upon the
characteristics of the output
Elements of Costs
Elements of Costs:
• Cost can be broadly classified into variable cost and overhead cost.
• Variable cost varies with the volume of production while overhead cost is fixed,
Irrespective of the production volume.
• Variable cost can be further classified into
• direct material cost
• direct labor cost
• direct expenses.
• The overhead cost can be classified into factory overhead, administration overhead,
selling overhead, and distribution overhead
• Direct material costs are those costs of materials that are used to produce the
product.
• Direct labor cost is the amount of wages paid to the direct labor involved in the production activities.
• Direct expenses are those expenses that vary in relation to the
production volume, other than the direct material costs and direct
labor costs.
• Overhead cost is the aggregate of indirect material costs, indirect
labor costs and indirect expenses.
• Administration overhead includes all the costs that are incurred in
administering the business
• Selling overhead is the total expense that is incurred in the
promotional activities and the expenses relating to sales force.
• Distribution overhead is the total cost of shipping
the items from the factory site to the customer sites
Derivation of Selling Price
• The selling price of a product is derived as shown below:
(a) Direct material costs + Direct labor costs + Direct expenses = Prime cost
(b) Prime cost + Factory overhead = Factory cost
(c) Factory cost + Office and administrative overhead= Costs of production
(d) Cost of production + Opening finished stock – Closing finished stock=
Cost of goods sold
(e) Cost of goods sold + Selling and distribution overhead = Cost of sales
(f) Cost of sales + Profit = Sales
(g) Sales/Quantity sold = Selling price per unit

• In the above calculations, if the opening finished stock is equal to the closing
finished
stock, then the cost of production is equal to the cost of goods sold
Other Costs/Revenues
• The following are the costs/revenues other than the costs which are
presented in the
previous section:
Marginal cost
Marginal revenue
Sunk cost
Opportunity cost
Marginal Cost
• Marginal cost of a product is the cost of producing an additional unit
of that product.

• Let the cost of producing 20 units of a product be Rs. 10,000, and the
cost of producing 21 units of the same product be Rs. 10,045.Then the
marginal cost of producing the 21st unit
is Rs. 45.
2. Marginal Revenue
• Marginal revenue of a product is the incremental revenue of selling
an additional unit of that product.

• Let, the revenue of selling 20 units of a product be Rs. 15,000 and the
revenue of selling 21 units of the same product be Rs. 15,085. Then,
the marginal revenue of selling the 21st unit is Rs. 85.
3. Sunk Cost
• This is known as the past cost of an equipment/asset.

• Let us assume that an equipment has been purchased for Rs. 1,00,000
about three years back. If it is considered
for replacement, then its present value is not Rs. 1,00,000. Instead, its
present market value should be taken as the present value of the
equipment for further analysis.
• So, the purchase value of the equipment in the past is known as its
sunk cost. The sunk cost should not be considered for any analysis
done from now onwards
Opportunity Cost
• In practice, if an alternative (X) is selected from a set of competing
alternatives(X, Y), then the corresponding investment in the selected
alternative is not available for any other purpose.
• If the same money is invested in some other alternative (Y), it may fetch some
return. Since the money is invested in the selected alternative (X), one has to
forego the return from the other alternative (Y).
• The amount that is foregone by not investing in the other alternative (Y) is
known as the opportunity cost of the selected alternative (X). So the
opportunity cost of an alternative is the return that will be foregone by not
investing the same money in another alternative
Break-even point
• The main objective of -even analysis is to find the cut-off production volume from
where a firm will make profit.
Let
s = selling price per unit
v = variable cost per unit
FC = fixed cost per period
Q = volume of production

• The total sales revenue (S) of the firm is given by the following formula:
S=sQ

• The total cost of the firm for a given production volume is given as
TC = Total variable cost + Fixed cost= v Q + FC
Break-even Chart For any production quantity which is less than the break-even
quantity, the total cost is more than the total revenue.
At the intersection point, the total cost is Hence, the firm will be making loss.
equal to the total revenue. This point is
also called the no-loss or no-gain situation. The intersection point
of the total sales
revenue line and the
total cost line is
called the break-even
point.

Volume of production
on the X-axis is
known as the
breakeven sales
quantity.
Factors influencing supply and demand
Laws of supply:
• It states that the quantity of a commodity supplied varies directly with the price, other determinants of supply remaining
constant.
• 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 labor 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 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.
Factors influencing supply
The shape of the supply curve is affected by the following factors:
Cost of the inputs
Technology
Weather
Prices of related goods
• Law of demand:

• States that other things being equal demand when price falls and contracts
when
price rises.

• Market demand is the total quantity demanded by all the purchasers together.

• Elasticity of Demand - Elasticity of demand may be defined as the degree of

responsiveness of quantity demanded to a Change in price.
• 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.
Demand and Supply Curve From Fig. 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 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:
Income of the people
Prices of related goods
Tastes of consumers
Word Problems

Notes