Economics Pre-Mid

Topic 1 (Introduction to Engineering Economics)

Economics – the study of how limited resources is used to satisfy unlimited human
wants, how individuals and societies choose to use scarce resources that nature and
previous generations have provided
Resources:
 Land – all gifts of nature, such as water, air, minerals, sunshine, plant and
tree growth, as well as the land itself which is applied to the production
process
 Labor – effort, skills, and knowledge of people applied to the production
process
 Capital
o Real Capital – tools, building, and machinery produced and used for
the production process
o Financial Capital – assets and money used in the production process
o Human Capital – education and training applied to labor in the
production process
Origins of Engineering Economy
Pioneered by Arthur M. Wellington, a civil engineer during the latter part of the
19th century, addressed the role of economic analysis in engineering projects, with
interest in railroad building. Followed by other contribution which emphasized
techniques depending on financial and actuarial mathematics
Principles of Engineering Economy
 Develop the Alternatives – carefully define the problem, the decision
(choice) is among the alternatives. Alternatives need to be identified and
defined for subsequent analysis
 Focus on the Differences – only differences in expected future outcomes of
alternatives are relevant and considered
 Use a Consistent Viewpoint – outcome of alternatives should be
consistently developed from a defined viewpoint (perspective)
 Use a Common Unit of Measure – using a common unit of measurement
will make analysis and comparison of alternatives easier
 Consider All Relevant Criteria – criteria are followed in selecting preferred
alternative (decision making), considering outcomes enumerated
 Make Uncertainty Explicit – uncertainty of future outcomes should be
recognized in the analysis and comparison
 Revisit Your Decisions – improving decision making by comparing initial
projected outcomes of the selected alternative with actual results achieved
Engineering Economy and the Design Process
An engineering economy study is accomplished using a structured procedure
and mathematical modeling techniques. The economic results are then used in
a decision situation that involves two or more alternatives and normally includes
other engineering knowledge and input.
Engineering Economic Analysis Procedure
 Problem recognition, formulation, and evaluation.
 Development of the feasible alternatives.
 Development of the cash flows for each alternative.
 Selection of a criterion (or criteria).
 Analysis and comparison of the alternatives.
 Selection of the preferred alternative.
 Performance monitoring and post-evaluation results.

Topic 2 (Cost Concepts and the Economic Environment)

Cost Estimating - the process by which the present and future cost consequences
of engineering designs are forecasted
 Provide information used in setting a selling price for quoting, bidding,
or evaluating contracts.
 Determine whether a proposed product can be made and distributed at
a profit (EG: price = cost + profit)
 Evaluate how much capital can be justified for process changes or other
improvements
 Establish benchmarks for productivity improvement programs
Cost Estimating Approaches
 Top-Down Approach
o Uses historical data from similar engineering projects
o Used to estimate costs, revenues, and other parameters for current
projects
o Modifies original data for changes in inflation/deflation, activity level,
weight, energy consumption, size, and etc.
o Best used is in early estimating process
 Bottom-Up Approach
o More detailed cost-estimating method
o Breaks down project into smaller manageable units and estimate costs,
etc.
o Smaller unit costs are added together with other types of costs to
obtain overall cost estimate
o Works best when detail concerning desired output is defined and
clarified
Cost – amount of expenses (actual and notional) incurred on or attributed to a
specific thing or activity
  Fixed Cost – costs that are unaffected by the increase or decrease in the
number of goods produced or sold
o Employee salaries
o Taxes and benefits
o Rentals
o Utility Expense
 Variable Cost – costs that are directly related to production and operations
which varies depending on the business activity level
o Packing Materials
o Ingredients
 Incremental Cost - additional cost (or revenue) that results from increasing
the output of a system by one (or more) units
 Direct Cost – costs attributed directly to production or of a specific output
o Materials
o Labor
 Indirect Cost – costs attributed indirectly to production or of a specific
output
o Maintenance
 Standard Cost - Standard cost is like a planned budget for making a
product. It predicts how much materials, labor, and overhead should cost if
everything goes perfectly.
o Raw Materials
o Operating Expenses
 Sunk Cost – historical cost which has no relevance in estimating future costs
and revenues
o Equipment
 Opportunity Cost - the cost of the best rejected (i.e., foregone) opportunity
and is hidden or implied
 Life-Cycle Cost - the summation of all costs, both recurring and
nonrecurring, related to a product, structure, system, or service during its life
span
Cash Cost vs. Book Cost
 Cash Cost – involves payment in cash and results in cash flow
 Book Cost – does not involve cash transaction
o Depreciation

Elements of Cost
 Material
 Labor
 Expense
Overhead – aggregate sum of indirect material, labor, and expenses