CHAPTER1

INTRODUCTIONTOENGINEERINGECONOMY

WHATISECONOMICS?

1)Thestudyofhowlimitedresourcesisusedtosatisfyunlimitedhumanwants

WHATISECONOMICS?2)Thestudyofhowindividualsandsocietieschoosetousescarceresourcesthatnatureandpreviousgenerationshaveprovided.

RESOURCE

• LAND• LABOUR• CAPITAL

LAND

Allgiftsofnature,suchas:water,air,minerals,sunshine,plantandtreegrowth,aswellasthelanditselfwhichisappliedtotheproductionprocess.

LABOR

Theefforts,skills,andknowledgeofpeoplewhichareappliedtotheproductionprocess.

CAPITAL•  RealCapital(PhysicalCapital)– Tools,buildings,machinery--thingswhichhavebeenproducedwhichareusedinfurtherproduction

•  FinancialCapital– Assetsandmoneywhichareusedintheproductionprocess

•  HumanCapital– Educationandtrainingappliedtolaborintheproductionprocess

The purpose of this course is to develop and illustrate the principles and methodology required to answer the basic economic question of any design: Do its benefits exceed its

costs?

•  IDENTIFYTHELAND•  IDENTIFYTHELABOR•  IDENTIFYTHECAPITAL

•  And,doitsbenefitexceeditscosts?

Engineering economy…

involvesthesystematicevaluationoftheeconomicmeritsofproposedsolutionstoengineeringproblems.

Engineering economic analysis can play a role in many types of situations. •  Choosing the best design for a high-efficiency gas

furnace. •  Selecting the most suitable robot for a welding

operation on an automotive assembly line. •  Making a recommendation about whether jet

airplanes for an overnight delivery service should be purchased or leased.

•  Determining the optimal staffing plan for a computer help desk.

•  Other examples?

Example

In Kuala Lumpur, there are 310 traffic intersections that have been converted from incandescent lights to light-emitting diode (LED) lights. The study that led to this decision was conducted by sustainability manager of the city. The wattage used at the intersections has been reduced from 150 watts to 15 watts at each traffic light.

Example The resultant lighting bill has been lowered from $440,000 to $44,000 annually. The annual saving of $396,000 per year from the traffic light conversion more than paid $150,000 cost of installing the LED lights.

Solutions to engineering problems must

•  promote the well-being and survival of an organization,

•  embody creative and innovative technology and ideas,

•  permit identification and scrutiny of their estimated outcomes, and

•  translate profitability to the “bottom line” through a valid and acceptable measure of merit.

Engineering economy…

involvesthesystematicevaluationoftheeconomicmeritsofproposedsolutionstoengineeringproblems.

There are seven fundamental principles of engineering economy.

1) Develop the alternatives The choice (decision) is among alternatives. The alternatives need to be identified and then defined for subsequent analysis. How??? •  Carefully define the problem. The choice (decision) is among

alternatives.Thealternativesneedtobe identifiedandthendefinedfor subsequent analysis. The alternates can be developed using abrainstorming session. Themore creative and resourceful the teammembersare,thebettertheselectionofalternatesavailableforago/no-go decision would be. The problem can be reformulated andrestated to ease the flow of alternates. An open mind isrecommendedduringthedevelopmentofalternates.

•  Creativityandinnovationareessentialtotheprocess.

2) Focus on the differences Only the differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision

3) Use a consistent viewpoint The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint (perspective).

4) Use a common unit of measure Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will simplify the analysis of the alternatives

5) Consider all relevant criteria Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria). The decision process should consider both the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement (non-monetary) or made explicit in a descriptive manner. For example:

•Safety•Reliability(fromtheviewpointofuserservice)•Qualityintermsofconsumerexpectations•Aesthetics(howitlooks,andsoon)•Patentconsiderations

6) Make uncertainty explicit Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be recognized in their analysis and comparison.

For example: to make decision whether to buy a new car or not - If the original car is repaired and kept, there is a possibility that it would have a higher frequency of breakdowns (based on personal experience). If a cheaper repair facility is used, the chance of a later breakdown is even greater (based on personal experience). - The newer car purchased may be too expensive, based on the additional price paid (which is at least $6,000/30,000 miles = 20 cents per mile). -The newer car may also have been in an accident and could have a worse repair history than the presently owned car. .

7) Revisit your decisions Improved decision making results from an adaptive process, to the extent practicable, the initial projected outcomes of the selected alternative should be subsequently compared with actual results achieved

Example

•  Which Car to Lease? Saturn vs. Honda

Develop the alternative (1)

FOCUS ON THE DIFFERENCES Only the differences in expected future

outcomes among the alternatives are relevant to their comparison and should be considered in the decision.

Focus on the differences (2)

USE A CONSISTENT VIEWPOINT The prospective outcomes of the alternatives,

economic and other, should be consistently developed from a defined viewpoint (perspective).

USE A COMMON UNIT OF MEASURE

Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will make easier the analysis and comparison of alternatives.

Use a common unit of measures (4)

CONSIDER ALL RELEVANT CRITERIA

Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria). The decision process should consider the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner.

Consider all relevant criteria (5)

•  Want mechanical security •  Want minimum total cash outlay

MAKE UNCERTAINTY EXPLICIT Uncertainty is inherent in projecting (or

estimating) the future outcomes of the alternatives and should be recognized in their analysis and comparison.

•  Mechanical security is uncertainty. Probably need more research

MAKE UNCERTAINTY EXPLICIT (6)

Which Car to Lease? Saturn vs. Honda

1.  Recognizeadecisionproblem2.  Definethegoalsorobjectives3.  Collectalltherelevant

information4.  Identifyasetoffeasible

decisionalternatives5.  Selectthedecisioncriterion

touse6.  Selectthebestalternative

•  Needacar•  Wantmechanicalsecurity•  Gathertechnicalaswell

asfinancialdata•  ChoosebetweenSaturn

andHonda•  Wantminimumtotalcash

outlay•  SelectHonda

REVISIT YOUR DECISIONS Improved decision making results from an

adaptive process; to the extent practicable, the initial projected outcomes of the selected alternative should be subsequently compared with actual results achieved.

PresentFuturePast

EngineeringEconomyAccounting

Evaluatingpastperformance Evaluatingandpredictingfutureevents

Accounting Vs. E E