FARWESTERN UNIVERSITY

FACULTY OF ENGINEERING
1
MASTER OF SCIENCE DEGREE IN CONSTRUCTION PROJECT MANAGEMENT

ADVANCED ENGINEERING ECONOMICS

Lecture-1: Course Introduction

Instructor: Surya R Acharya, PhD

[email protected]
 ADVANCED ENGINEERING
ECONOMICS

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 Reference Books
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• N. Gregory Mankiw, Principles of Economics, 9th Edition, 2021
Cenage. [NGM]
• Chain S. Park, Contemporary Engineering Economics, 6th
Edition, 2016 Person [CSP]
• William G. Sullivan, Elin M. Wicks, C. Patrick Koelling,
Engineering Economy, 17th Edition 2019, Pearson [SWK]
• James L. Riggs, David D. Bedworth and Sabah U. Randhawa,
Engineering Economics, 4th Edition, 1996, MCGraw Hill [RBR]
Note:
• Ref book NGM will be used for basic economic concepts and
topics
• Ref books (CSP, SWK and RBR) are for topics related to
engineering economics
• For each unit of syllabus, appropriate chapter(s)/section(s) of
different books will be recommended.
• Additional materials from popular press or project related reports
 Reference books
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 Course Expectation!
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• Grasp Economic Perspective vis-à-vis
Engineering Perspective
• Understand key economic concepts relevant to
infrastrcture (construction) management.
o Syllebus (required) and Syllebus+ (optional)
• Review and deepen the understanding of
Engineering economics: Concepts, inidcators,
computation
• Understand the process of project appraisal:
Application of economics and engineering
economics.
 Today’s Lecture Contents
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1. Economics: Definition
2. Ten Principles of Economics (Chapter 1,
NGM)
3. How Economists Think? (Chapter 2, NGM)
4. Why and how to study Engineering
Economics?
 What is Economics?
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Dictionary
meaning

Oxford dictionary

Economics: made from two Greek words, Etymol

'eco' = home ogy
'nomos' = accounts.
• Original meaning is about keeping the family
account
• The meaning is now extended to cover wide-ranging
subjects
 Scarcity and Economics
1
0
• Scarcity: the limited resources but unlimited nature of
demand by the society
• Economics: study of how people allocate scarce
resources for production, distribution, and consumption,
both individually and collectively.
• Two major types of economics are microeconomics,
which focuses on the behavior of individual consumers
and producers, and macroeconomics, which examine
overall economies on a regional, national, or international
scale.
• Economics is especially concerned with efficiency in
production and exchange and uses models and
assumptions to understand how to create incentives and
https://www.investopedia.com/terms/e/
policies that will maximize efficiency.
economics.asp
• Capitalism, socialism, and communism are types of
economic systems.
 Brief history of Economic
thoughts
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1. Pre-classical economic thought
2. Classical political economy
3. Neoclassical economics
4. Historical schools and
institutionalism
5. Monetary macroeconomics
Source: B Sandelin, HM Trautwein, R Wundrak (2014) A Short History of Economic
Thought, Routledge
 Branches of Economics
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2
• Microecono
mics
Other
• Macroecono
• Behavioral s • Information
mics
economics economics
• Business economics • International
• Development economics
economics • Labor economics
• Ecological economics • Managerial economics
• Economic geography • Resource economics
• Environmental • Urban economics
economics • Public economics
• Energy economics • Monetary economics
• Financial economics • Transport economics
 Ten Principles of Economics
Chapter 1: Principles of Economics by N Gregory
Mankiw
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I. How people make decision
# 1. People face tradeoff
# 2. The cost of something is what you give up to get it
# 3. Rational people think at the margin
# 4. People respond to incentives

II. How people interact

# 5. Trade can make everyone better off
# 6. Market are usually a good way to organize economic activity
# 7. Governments can sometimes improve market outcomes

III. How the economy as a whole works

# 8. A country’s standard of living depends on its ability to produce goods
and services
# 9. Price rise when the government prints too much money
# 10. Society faces a short-run tradeoff between inflation and
unemployment
HOW PEOPLE MAKE
DECISIONS
Principle #1: People Face Tradeoffs
1. All decisions involve tradeoffs: to get
something, need to sacrifice something else
2. Individuals face trade-off while making choices
3. Society faces an important tradeoff: efficiency
vs. equality
• Efficiency: when society gets the most from its
scarce resources
• Equality: when prosperity is distributed uniformly
among society’s members
Development vs Environment
Inflation vs unemployment
HOW PEOPLE MAKE
DECISIONS
Principle #2: The Cost of Something
Is
What You Give Up to Get It
– How to decide while making trade-off?
Comparing the costs and benefits of
alternative choices.
– The opportunity cost of any item is
whatever must be given up to obtain it.
– Opportunity cost is the relevant cost for
decision making (benefits of missed stuff
+ additional cost of chosen stuff)
– Examples? Tax/subsidies on electric
HOW PEOPLE MAKE
DECISIONS
Principle #3: Rational People Think
at the Margin
Rational people
1. systematically and purposefully do the best
they can to achieve their objectives.
2. make decisions by evaluating costs and
benefits of marginal changes –
incremental adjustments to an existing plan.
Ex
1. Flight fare for standby passengers?
HOW PEOPLE MAKE
DECISIONS
Principle #4: : People Respond to
Incentives
• Incentive: something that induces a
person to act, i.e. the prospect of a
reward or punishment.
• (Rational) people respond to incentives.
Examples:
– When price of something increases,
people reduces consumption.
– If the wage is higher, people prefer to
work overtime
 Theory of incentive: Important field in
economics
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https://www.nobelprize.org/prizes/lists/all-prizes-in-economic-
sciences/
HOW PEOPLE INTERACT

Principle #5: Trade Can Make

Everyone Better Off
1. Trade: Specializing in producing one
good or service and exchange it for
other goods.
2. People/countries benefit from trade &
specialization:
1. Get a better price abroad for goods they
produce
2. Buy other goods more cheaply from
abroad than could be produced at home
HOW PEOPLE INTERACT

Principle #6: Markets Are Usually A Good Way

to Organize Economic Activities
1. An Economic System allocate resources by
deciding on
1. what to produce
2. how to produce
3. how much of each to produce
4. who (consumer) should get the product
2. Market: Collection of buyers and sellers. A market
economy allocates resources through the decentralized
decisions (guided by price and self-interest) of many
households and firms as they interact in markets.
3. Central Planning System: through decisions
HOW PEOPLE INTERACT

Principle #7: Governments Can

Sometimes Improve Market
Outcomes
• Basic role of government, property rights, security, court
etc
1. Market failure: when the market fails to allocate
society’s resources efficiently
1. Causes:
1. Externalities, when the production or consumption
of a good affects bystanders (e.g. pollution)
2. Market power, a single buyer or seller has
substantial influence on market price (e.g. monopoly)
3. Lack of supply even when people are willing to pay
the price
HOW THE ECONOMY AS A WHOLE
WORKS

Principle #8: A country’s standard of living

depends on its ability to produce goods &
services.
1. Huge variation in living standards across countries
and over time
2. Basic inputs for production: labor, capital, and
technology
3. The most important determinants of living
standards
4. Ability to utilize existing inputs (factors of
production)
1. Addition of factors of production
2. Productivity: the amount of goods and services
HOW THE ECONOMY AS A WHOLE
WORKS

Principle #9: Prices rise when the

government prints too much money.
1. Inflation: increases in the general level
of prices.
2. Various causes
1. Money supply: the faster the govt creates
money, the greater the inflation rate.
2. Demand-supply gap
HOW THE ECONOMY AS A WHOLE
WORKS

Principle #10: Society faces a short-run

tradeoff between inflation and
unemployment
• Trade-off between inflation and
unemployment (Phillip Curve)
• Phillip curve- debatable, but looks
reasonable in the short-run
 Thinking like an economist
Chapter 2 by N Gregory Mankiw
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• Every field of study has its own terminology
o Mathematics: integrals, axioms, vector spaces
o Civil Engineering: Compression, tension, share,
bending moment, bearing capacity
o Law: promissory estoppels, torts, venues
o Economics: supply, opportunity cost, elasticity,
consumer surplus, demand, comparative advantage,
deadweight loss
• Every field has its own way of approaching the
issues/problems
• Economists have also their own way of thinking
(within the broad concept of objective thinking)
 Economist as Scientist
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• Economists try to address their subject with a scientist’s
objectivity. They devise theories, collect data, and then
analyze these data to verify or refute their theories.
• The essence of science is the scientific method—the
dispassionate development and testing of theories about
how the world works. This method of inquiry is as
applicable to studying a nation’s economy as it is to
studying the earth’s gravity or a species’ evolution. As
Albert Einstein once put it, “The whole of science is
nothing more than the refinement of everyday
thinking.”
• Although Einstein’s comment is as true for social sciences
such as economics as it is for natural sciences such as
physics, most people are not accustomed to looking at
society through a scientific lens.
• How economists apply the logic of science to examine
 Economist as Scientist
The Scientific Method: Observation, Theory, and More
Observation
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• Logic of scientific thinking: What is? Why/how it is so? So-
what?
• Observation, explanation, testing and implications
• Observation of ’falling apple’ motivated Newton to develop
a theory of gravity
• interplay between theory and observation also occurs in
economics. Observe increasing prices and develop a theory
of inflation
• Although economists use theory and observation like other
scientists, they face an obstacle that makes their task
especially challenging: In economics, conducting
experiments is often impractical.
• To find a substitute for laboratory experiments, economists
pay close attention to the natural experiments offered by
history.
 Economist as Scientist
The Role of Assumptions
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• Physicists/engineers, in some cases, assume
frictionless space
• Economists make assumptions for the same
reason: Assumptions can simplify the complex
world and make it easier to understand.
• The art in scientific thinking—whether in
physics, biology, or economics—is deciding
which assumptions to make.
• Similarly, economists use different assumptions
to answer different questions.
• For studying the short-run effects of the policy,
we may assume that prices do not change
much.
 Economist as Scientist
Economic Models
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1. Model: A systematic description of an object or
phenomenon that shares important
characteristics with the object or phenomenon.
Scientific models can be material, visual,
mathematical, or computational and are often
used in the construction of scientific theories. [THE
AMERICAN HERITAGE® SCIENCE DICTIONARY]

2. Economists also use models to learn about the

world, and their models mostly consist of
diagrams and equations.
3. Just as the biology teacher’s model does not
include all the body’s muscles and blood
vessels, an economist’s model does not include
every feature of the economy.
 The Economist as Policy
Adviser
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• When economists are trying to explain the world,
they are scientists. When they are helping
improve it, they are policy advisers.
• In general, statements about the world come in
two types.
o Positive statements (descriptive): claims that
attempt to describe the world as it is. Ex. Minimum-wage
laws cause unemployment.
o Normative statements (prescriptive): claims that
attempt to prescribe how the world should be. Ex. The
government should raise the minimum wage.

• A key difference between positive and normative

statements is how we judge their validity. In
principle, we confirm or refute positive
statements by examining evidence. By contrast,
 Economists in Government
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• US President Harry Truman once said that he
wanted to find a one-armed economist. When
he asked his economists for advice, they always
answered, “On the one hand, . . . . On the other
hand, . . . .”
• Economists are aware that trade-offs are
involved in most policy decisions. A policy might
increase efficiency at the cost of equality. It
might help future generations but hurt the
current generation. An economist who says that
all policy decisions are easy is an economist not
to be trusted.
• Role of economists in wider range of
 Why Economists’ Advice Is Not Always
Followed
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• Economists who advise presidents and other
elected leaders know that their
recommendations are not always heeded. The
process by which economic policy is actually
made differs in many ways from the idealized
policy process assumed in economics textbooks.
• In the real world, figuring out the right policy is
only part of a leader’s job, sometimes the
easiest part. After a president hears from his
economic advisers what policy they deem best,
he turns to other advisers for related input.
• Economists offer crucial input to the policy
process, but their advice is only one ingredient
 Why Economists Disagree
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Why do economists so often appear to give
conflicting advice to policymakers? There
are two basic reasons:
•Economists may disagree about the validity
of alternative positive theories of how the
world works.
•Economists may have different values and
therefore different normative views about
what government policy should aim to
accomplish.
 Perception versus Reality
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• Because of differences in scientific judgments
and differences in values, some disagreement
among economists is inevitable.
• Yet one should not overstate the amount of
disagreement. Economists agree with one
another more often than is sometimes
understood.
• Table 1 contains twenty propositions about
economic policy. In surveys of professional
economists, these propositions were endorsed by
an overwhelming majority of respondents. Most
of these propositions would fail to command a
simi- lar consensus among the public.
35
 Why/How to Study Engineering
Economics
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• Engineering: core component of modern
economy/society
• Most engineering facilities, facing a derived
demand, have to interact with socio-economic
context- more than engineering!
• The way of supplying and managing engineering
infrastructure/services is constantly changing
• Dominant role of public sector; primary role of
private sector; multiple stakeholders
• Market approach getting more acceptance in
infrastructure management
• Innovative approach for infrastrcture services-
such as Uber; how did economics help?
 Issues on Infrastructure Development
Some Practical Examples from Nepal
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• Time and cost over-run of infrastructure project
• What should be the priority? Big or small
projects
• Should hydropower for domestic use or export?
• Were Pokhara and Bhairahawa airport wrong
projects?
• Do Nepal needs Nijgadh airport? Nagmati dam?
• How feasible is railway in Nepal?
☞ Well grounded knowledge in
• …..
Engineering Economics would help to
make an objective or expert opinion
on such issues!
38 Appendix
Use of Mathematics in Economics
 Math in
Economic
39 s

Mathematics-
the key
instrument of
economic
analysis.

Milgrom, Paul (2000) Putting auction theory to work: The simultaneous

ascending auction Journal of Political Economy [Paul Milgrom won
Noble Prize in 2020]
40

DW Diamond, RG Rajan (2006) Money in a Theory of Banking, American

Economic Review,
 A Castells, A Solé-Ollé
(2005) The regional
allocation of infrastructure
investment: The role of
equity, efficiency and
political factors, European
Economic Review

41
42
43

Milgrom, Paul (1989) Auctions and bidding: A primer Journal of

Economic Eerspectives