URDANETA CITY UNIVERSITY
San Vicente West, Urdaneta City
College of Engineering and Architecture
CORRELATION
ENGINEERING ECONOMY
January 23-24, 2021
BASIC ECONOMIC PRINCIPLES
ECONOMICS is one of the social sciences which consists of that
body of knowledge dealing with people and their assets or
resources. Economics has also been defined as the sum total
of knowledge which treats of the creation and utilization of
goods and services for the satisfaction of human wants.
BASIC TERMS AND PRINCIPLES OF ECONOMICS
1. TANGIBLE AND INTANGIBLE FACTORS
In many economic studies, there are two basic type
of factors to be considered. These are: tangible and
intangible factors
Tangible Factors are those which can be expressed in
terms of monetary values, while Intangible Factors
are those which are difficult or impossible to express
in terms of monetary values.
2. COMPETITION
Most economic laws are premised and stated for
situations in which free or perfect competition exists.
Perfect competition occurs when a certain product is
offered for sale by many vendors or suppliers, and
there is no restriction against other vendors from
entering the market.
3. MONOPOLY
It is the opposite of perfect competition. A perfect
monopoly occurs when a unique product or service is
available only from a single supplier and entry of all
other possible suppliers is prevented.
4. OLIGOPOLY
Occurs when there are few suppliers and any action
taken by anyone of them will affect the course of
action of the others.
5. PRICE AND PRODUCTION
The price of a good or commodity is defined to be
the amount of money or its equivalent which is given
in exchange for it. On the other hand, goods that
have little demand command a low price in relation
to the cost of production.
6. LOCAL AND NATIONAL MARKET
A market is defined to be a place where sellers and
buyers come together. A limited locality where
certain goods such as those which are perishable are
sold, is said to be a local market. Certain goods sold
all over the country are said to be have a national
market. Goods that are exported to other countries
are said to have a world market.
7. CONSUMER AND PRODUCER GOODS
In general, there are two kinds of goods – consumer
goods and producer goods. Consumers goods are
those that are consumed or used directly by people
or are things and services which serve to satisfy
human needs. Examples are clothes, shoes, food,
houses, medical and dental services etc..
Producer goods are those which produce goods and
services for human consumption, such as lathes,
generators, tools, ships, busses and airplanes. These
are instrumental in producing something or
furnishing service for people.
8. DEMAND
Demand is the quantity of a certain commodity that
is bought at a certain price at a given place and time.
9. LAW OF DEMAND
The law of demand may be stated as:
The demand for a commodity varies inversely as the
price of the commodity, though not proportionately.
10. ELASTICITY OF DEMAND
Elastic Demand occurs when a decrease in selling
price will cause a greater than proportionate increase
in the volume of sales. Goods which are considered
luxuries are said to have elastic demand, because a
small decrease in cost will usually result in a big
increase in sales.
11. UTILITY OF DEMAND
Utility is defined to be the capacity of a commodity to
satisfy human want.
12. LAW OF DIMINISHING UTILITY
It is an increase in the quantity of any good
consumed or acquired by an individual will decrease
the amount of satisfaction derived from that good.
13. MARGINAL UTILITY
The marginal utility of the commodity is the utility of
the last unit of the same commodity which is
consumed or acquired. The last unit of similar
commodities consumed or acquired is called marginal
unit.
14. SUPPLY
Is the quantity of a certain commodity that is offered
for sale at a certain price at a given place and time.
15. LAW OF SUPPLY
The supply of a commodity varies directly as the price
of the commodity, though not proportionately.
As the price increase, the supply also increases.
Likewise, as price decreases, the supply will also
decrease.
16. LAW OF SUPPLY AND DEMAND
The law may be stated as follows:
When free competition exists, the price of a product
will be that value where supply is equal to the
demand.
17. LAW OF DIMINISHING RETURNS
This law is originally applied to agriculture,
correlating the input of men, fertilizers and other
variable factors to the output in crops or harvest.
18. MARGINAL REVENUE AND MARGINAL COST
 URDANETA CITY UNIVERSITY
San Vicente West, Urdaneta City
College of Engineering and Architecture

Marginal Revenue is that amount received from the problem, it is assumed as ordinary.
sale of an additional unit of a product. Marginal cost
is the additional cost of producing one more unit. Ordinary Simple Interest is computed on the basis of banker’s
year.
19. PHYSICAL AND ECONOMIC EFFICIENCY
In the economic world, man always strives to gain Banker’s year
more than he invests, whether it be materials, money 1 year = 12 months
or energy. 1 month = 30 days (all months)
1 year = 360 days
Output
Efficiency = Input
Exact Simple Interest is based on the actual number of days in
Output in Physical Units a year. One year is equivalent to 365 days for ordinary year
Physical Efficiency = and 366 days for leap year. A leap year is when the month of
Input in Physical Units
February is 29 days, and ordinary year when February is only
Income in Pesos 28 days. Leap year occurs every four years.
Economic Efficiency =
Cost in Pesos

Annual Net Profit Note:

Rate of Return = Capital Invested Leap years are those which are exactly divisible by 4 except
century years, but those century years that are exactly
Capital Invested divisible by 400 are also leap years.
Payout Period = Net Annual Cash Flow

If d is the number of days, then ...

20. COMPROMISE BETWEEN PERFECTION AND
ECONOMY
In Ordinary Simple Interest
Perfection is a human ideal worth striving for. 𝒅
t=
𝟑𝟔𝟎
INTEREST AND DISCOUNT
In Exact Simple Interest
𝒅
DEFINITION OF INTEREST t = 𝟑𝟔𝟓 (for ordinary year)
From the viewpoint of the borrower, interest is the amount of
money paid for the use of borrowed capital. For the lender, 𝒅
interest is the income produced by the money which he has t = 𝟑𝟔𝟔 (for leap year)
lent.

SIMPLE INTEREST COMPOUND INTEREST

In simple interest, only the original principal bears interest and In compound interest, the interest earned by the principal at
the interest to be paid varies directly with time. the end of each interest period (compounding period) is
added to the principal. The sum (principal + interest) will earn
The formula for simple interest is given by another interest in the next compounding period.

I = Pin Using the same nomenclature as that for simple interest, the
total amount due after n periods for compound interest is
The future amount is given by the formula:
F = P+I
F = P+Pin F=P(1+i)n
F = P(1+in)
The factor (1+i)n is called the “Single Payment Compound
Where Amount Factor” and is designated as SPCAF.
I = interest
P = principal, present amount, capital CONTINUOUS COMPOUNDING
F = future amount, maturity value
i = rate of simple interest expressed in decimal F = Pe rn
form
n = time in years, term in years Where e is the natural logarithms.

Ordinary and Exact Simple Interest NOMINAL RATE OF INTEREST

In an instance when the time t is given in number of days, the
fractional part of the year will be computed with a
denominator of 360 or 365 or 366. With ordinary simple
interest, the denominator is 360 and in exact simple interest,
the denominator is either 365 or 366. We can therefore
conclude that ordinary interest is greater than exact interest.
Note:
When simple interest (ordinary or exact) is not specified in any
The compound interest, the rate of interest usually quoted is
nominal rate of interest which specifies the rate of interest
and the number of interest periods per year. Thus, a nominal
rate of interest of 8% compounded quarterly means that there
are 4 interest periods each year, the rate per period being
8%/4 = 2%. In the formula stated above, in this case i=0.02.
 URDANETA CITY UNIVERSITY
San Vicente West, Urdaneta City
College of Engineering and Architecture

EFFECTIVE RATE OF INTEREST

The effective rate of interest is the actual rate of interest on

the principal for one year.

Effective Rate of Interest = (1 + i) n - 1

PRESENT VALUE:

𝐅
P = F (1 + i)-n = (𝟏+𝐢)𝐧

DISCOUNT
From the cash flow diagram shown above, the future
amount F is the sum of payments starting from the end of the
Discount on a negotiable paper is the difference between
first period to the end of the nth period. Observe that the total
what it is worth in the future and its present worth. Thus,
number of payments is n and the total number of
compounding periods is also n. Thus, in ordinary annuity, the
Discount = Future Value – Present Value
number of payments and the number of compounding periods
are equal.
The rate of discount is the discount on one unit of principal
oer unit of time. If d is the rate of discount, then
𝟏 Future amount of ordinary annuity, F
d = 1 - 𝟏+𝒊
For the equivalent rate of interest corresponding to a rate of 𝑨[(𝟏+𝒊)𝒏−𝟏
F=
𝒊
interest i, we have;
𝐴[(1+𝑖)𝑛 −1
𝒅 The factor is called equal-payment-series
i = 𝟏−𝒅 𝑖
compound-amount factor and is denoted by (F/A,i,n).

Present amount of ordinary annuity, P

ANNUTIES AND CAPITALIZED COST
Annuity 𝑨[(𝟏+𝒊)𝒏−𝟏] 𝑭
An annuity is a series of equal payments made at equal P= = (𝟏+𝒊)𝒏
(𝟏+𝒊)𝒏 𝒊
intervals of time. Financial activities like installment payments,
monthly rentals, life-insurance premium, monthly retirement (1+𝑖)𝑛 −1
The factor (1+𝑖)𝑛 𝑖
is called equal-payment-series present-
benefits, are familiar examples of annuity.
worth factor and is denoted by (P/A,i,n).
Annuity can be certain or uncertain. In annuity certain, the
specific amount of payments is set to begin and end at a Periodic payment of annuity, A
specific length of time. A good example of annuity certain is Value of A if F is known:
𝑭𝒊
the monthly payments of a car loan where the amount and A=
(𝟏+𝒊)𝒏−𝟏
number of payments are known. In annuity uncertain, the 𝑖
The factor (1+𝑖)𝑛 −1
is called equal-payment-series sinking-
annuitant may be paid according to certain event. Example of
annuity uncertain is life and accident insurance. In this fund factor and is denoted by (A/F,i,n).
example, the start of payment is not known and the amount
of payment is dependent to which event. Value of A if P is known:
𝑷(𝟏+𝒊)𝒏𝒊
A=
(𝟏+𝒊)𝒏−𝟏
Annuity certain can be classified into two, simple
annuity and general annuity. In simple annuity, the payment (1+𝑖) 𝑛 𝑖
period is the same as the interest period, which means that if The factor (1+𝑖)𝑛 −1
is called equal-payment-series capital-
the payment is made monthly the conversion of money also recovery factor and is denoted by (A/P,i,n).
occurs monthly. In general annuity, the payment period is not
the same as the interest period. There are many situations Deferred Annuity. Is one where the payment of the first
where the payment for example is made quarterly but the amount is deferred a certain number of periods after the first.
money compounds in another period, say monthly. To deal
with general annuity, we can convert it to simple annuity by
making the payment period the same as the compounding
period by the concept of effective rates.

TYPES OF ANNUTIES
Annuties in engineering economy are usually classified into
four categories: These are: (1) ordinary annuity, (2) deferred
annuity, (3) annuity due, and (4) perpetuity.

Ordinary Annuity. Is one where the equal payments are made

at the end of each payment period starting from the first
period.
 URDANETA CITY UNIVERSITY
San Vicente West, Urdaneta City
College of Engineering and Architecture

Future amount of deferred annuity, F

𝑨[(𝟏+𝒊)𝒏 −𝟏] ARITHMETIC AND GEOMETRIC GRADIENTS
F= 𝒊

DEFINITIONS
Present amount of deferred annuity, P
𝑨[(𝟏+𝒊)𝒏−𝟏] 𝑭 In certain cases, Engineering Economy problems involve a
P= = series of disbursements or receipts that increase or decrease
(𝟏+𝒊)𝒌+𝒏 𝒊 (𝟏+𝒊)𝒌+𝒏
in each succeeding period by varying amounts.
Annuity Due. Is one where the payments are made at the start If the change in succeeding periods is constant, then
of each period, beginning from the first period. the series is known as uniform arithmetic gradient.
A geometric gradient series is a sequence consisting
of end of period-of-period payments, where each payment
increases or decreases by a fixed percentage. In geometric
gradient, payment begins at the first period.

UNIFORM ARITHMETIC GRADIENT

Parameters:
A = uniform periodic amount equivalent to the arithmetic
gradient series
G = arithmetic gradient change in the periodic amounts at the
end of each period
P = present of the uniform gradient
F = future worth or accumulated amount of the uniform
gradient at the end of n periods.
As indicated in the figure above, F1 is the sum of ordinary
annuity of n payments. The future amount F of annuity due at (A/G,i%, n) = factor to convert a uniform arithmetic gradient
the end of nth period is one compounding period away series to an equivalent uniform series
from F1. In symbol, F = F1(1 + i).
1 𝑛
= 𝑖 − (1+𝑖)𝑛 −1
Future amount of annuity due, F
𝑨[(𝟏+𝒊)𝒏 −𝟏]
F= (1+i) = F1(1+i)
𝒊 (P/G,i%, n) = factor to convert a uniform arithmetic gradient
series to its present worth
Present amount of annuity due, P 1 1−(1+𝑖)−𝑛 𝑛
𝑨[(𝟏+𝒊)𝒏 −𝟏] 𝑭 =𝑖[ − (1+𝑖)𝑛 ]
𝑖(1+𝑖)𝑛
P= (𝟏+𝒊)𝒏 𝒊
= (𝟏+𝒊)𝒏
1 (1+𝑖)𝑛 −1 𝑛
= [ − ]
Perpetuity. Is an annuity where the payment periods extended 𝑖 𝑖(1+𝑖)𝑛 (1+𝑖) 𝑛
forever or in which the periodic payments continue
indefinitely. (F/G,i%, n) = factor to convert a uniform arithmetic gradient
series to its future worth

1 (1+𝑖)𝑛 −1
=𝑖[ 𝑖
− 𝑛]

GEOMETRIC GRADIENTS
𝑐 1− 𝑤 𝑛
P= (
1+𝑖 1−𝑤

𝐶𝑛
P = 1+𝑟

𝑨
P= DEPRECIATION AND DEPLETION
𝒊

Elements of Annuity Depreciation is defined as the decrease in the value of a

A = amount of periodic payment property such as machinery, equipment, building or other
P = present amount of all periodic payments structure, due to the passage of time.
F = future worth of all periodic payments after the last
payment is made Depletion certain natural resources such as mines, quarries, oil
i = interest rate per compounding period and gas, wells, and timber lands are called “wasting” or
n = total number of payments “depleting” assets due to the gradual extraction of the
m = nominal rate (see compounded interest) contents of such properties.
t = number of years
DETERMINATION OF DEPRECIATION COST
The methods often used to determine annual depreciation
cost are the following:
1. Straight Line Formula
2. Sinking Fund Formula
 URDANETA CITY UNIVERSITY
San Vicente West, Urdaneta City
College of Engineering and Architecture

3. Matheson Formula. This is also known by other years, and noting that the digits 1, 2, 3,….. (n-1), n
names like: Constant Percentage Method, Fixed form an arithmetic progression, then.
𝒏
Percentage Method, Declining Balance Method, or ∑ Years = 𝟐 (n+1)
Diminishing Balance Method. 2. Determine the loss in value due to depreciation, Co-
4. Sum of the Years-Digit-Method (SYD Method) Cn.
5. Service-Output or Production Units Method 3. The respective annual depreciation charges are:
6. Straight Line Plus Average Interest Formula For the first year,
𝑛
(Co-Cn) ∑𝑦𝑒𝑎𝑟𝑠
7. Double rate declining Balance Method 𝑛−1
8. Operating Day Method For the second year, (Co-Cn)
∑𝑦𝑒𝑎𝑟𝑠
9. Retirement Method … …
10. Annual Inventory Method. For the (n-1)th year,
2
(Co-Cn) ∑𝑦𝑒𝑎𝑟𝑠
1
THE STRAIGHT-LINE FORMULA For the nth year, (Co-Cn)
∑𝑦𝑒𝑎𝑟𝑠
In this method the loss in value is considered to be directly
proportional to the age of the property. No interest is For any year m, m<n, the annual depreciation charge
assumed to be paid on the amounts set aside in the gradually decreases as the property gets older. The
depreciation fund. depreciation for the first year is n times the
We shall adopt the following symbols: depreciation charge for the last year n.
n=useful life of the property in years
m=age of the property at any time less than or equal to n THE DOUBLE RATE DECLINING-BALANCE METHOD
(m≤n) In this method the depreciation during any year is a constant
d=annual cost of depreciation ratio of the book value at the beginning of the year. If the
Dm=accured or total depreciation up to m years. useful life is n years, the straight line rate is 1/n and the
Co=original or the first cost of the property double-rate declining balance rate is 2/n.. The depreciation
Cm=book value of the property at the end of m years charge is computed by multiplying the unamortized value at
Cn=book value at the end of life, n years, (salvage or scrap the beginning of each year by 2/n. Consequently, the salvage
value, as the case may be). value is not used in the computations.
𝑪𝒐−𝑪𝒏
Then d= The book value at the end of any year is calculated as follows:
𝒏
𝒎 𝟐
Dm = md = (Co-Cn) 𝒏 Cm = Co (1 - 𝒏)m
Cm = Co – Dm
The depreciation expense in any year m is 2/n times the book
value at the beginning of year m.
𝟐 𝟐 𝟐𝑪𝒐 𝟐
=Co (1 - )m-1 ( ) = (1 - )m-1
𝒏 𝒏 𝒏 𝒏
THE SINKING FUND FORMULA
Using the same symbols as those for the straight-line formula,
the formulas for this method are:

𝟏
d = (Co - Cn) 𝑭
( ,𝒊%,𝒏)
𝑨
𝑭
,𝒊%,𝒎
Dm = (Co - Cn) 𝑨𝑭
,𝒊%,𝒏
𝑨
Cm = Co -Dm

MATHESON FORMULA
This method assumes that the annual cost of depreciation is a
fixed percentage of the book value at the beginning of the
year. In addition to the previous symbols for the straight-line
formula, Let:
k = ratio of the depreciation in any one year to the book value
at the beginning of that year. This is constant throughout the
life of the property.

The formulas are:

𝒎 𝑪𝒎 𝒎 𝑪𝒏
k=1 - √ =1- √
𝑪𝒐 𝑪𝒐
dm= kCm-1
Cm = Co (1 - k)m
Cn = Co (1 – k)n

SUM OF THE YEARS DIGIT (SYD) METHOD

The steps in the method are:
1. Determine the sum of the years (∑ years) of the life
of the property. If n is the life of the property in