COVENANT UNIVERSITY

GEC 321 (ENGINEERING ECONOMICS)

LECTURE 1
NATURE AND SCOPE OF ECONOMICS
INTRODUCTION
It is possible that any mention of the word economics to the ordinary person in
Africa would conjure notions of money, wealth, business, employment, inflation,
poverty and the like. It is right to include these notions among the issues
economics deals with. It would be wrong to limit the concerns of economics to
such issues, hence the need for general statement on what the study of economics
is all about.
There is a consensus among economists of various schools of thought that the
Scottish Philosopher and Scholar, Adam Smith (1723-1790) was the founder of
modern economics. As Hanson correctly pointed out:
“Adam Smith was the first writer to produce a work devoted purely to
economics. Though published in 1776 before the industrial revolution
was fully underway, his “Wealth of Nations” is a landmark in the
development of economics as an independent subject of study”.
It is an incontrovertible fact that Adam Smith’s idea pervade all aspects of
economic knowledge today. His “Wealth of Nations” would continue to be an
indispensable book of reference for generations to come.
Although the pioneering work on economics is credited to Adam Smith, it was
Alfred Marshall (1842-1924) who first used or suggested the term “Economics” in
place of the narrower term “Political Economy”, the appellation used by his
predecessor and most of his contemporaries. In his monumental work, Principles of
Economics, published in 1890, Marshall drew a clear line of demarcation between
ethics, theology, politics and economics. His book eventually replaced. S. Mil’s
work, Principles of Political Economy (1848) which was widely used in the British
and American Universities for about 50 years.

Over the years however, a considerate number of people have contributed

immensely in the development of economics. The subject has expanded
considerably, covering all issues and problems relating to how the society uses its
resources toward achieving a desirable standard of living.
MEANING OF ECONOMICS
The term economics emanated from two Greek words: Oiko- a house and Nemo- to
manage. Thus, economics may be literally defined as the management of
households. To a layman, economics is synonymous with economize in which
case, he sees an economist as a miser. However, economics is concerned with
greater issues than the above consideration. This led to the innumerable definitions
of economics by several economists.
The subject economics has no specific definition. this is due to varied opinion and
ideology and even environmental study by individual scholars on scope and
coverage. It has been defined in many ways by various economists as a social
science which studies humans and their behaviors. some of the definitions given by
some of the scholars include the following;
 Adam smith defined economics as an inquiry into the nature and causes of
wealth of nations.
 Maynard Keynes saw it as a method rather than a doctrine, an apparatus of
mind, a technique of thinking which helps its possessors to draw correct
conclusions.
 Alfred Marshal defined economics as a study of mankind in the ordinary
business of life.
 Davenport looked at economics as the science that treats phenomenon from
the stand point of price.
 John start viewed it as the practical science of production and distribution of
wealth.
 The most generally acceptable definition of economics is the one put
forward by Professor Lionel Robinson. He defined economics as the science
which studies human behavior as a relationship between ends and scarce
means which have alternative uses. This definition covers some major
 aspects of economics such as scarcity, want, human behavior and choice.
The end in the definition refers to human wants desires or needs. Human
wants are numerous relative to available resources required to satisfy them.
The scarce means refers to a limited available resources used in satisfying
the numerous human wants, that is to say, resources required for the
satisfaction of human wants which are referred to as “means” are scarce
relative to their demand. The alternative uses in the definition means that
this scarce resources can be used for different purposes. that is to say, the
pressing needs have to be satisfied first leaving others that are less
important.

NATURE AND SCOPE OF ECONOMICS

A more satisfactory discussion of the scope of economics must combine a concise
statement of the subject matter of economics, whether economics is a science or an
art and some of the vital questions to which the subject tends to find answers.
Basically, economics is a science because its fundamental objective is to establish
valid generalization about the principles underlying the choices people make with
respect to the use of scarce resources. Thus, it will be easier to predict the
outcomes of people’s behavior as well as formulate policies to bring about the
desired outcomes. However, economics is more appropriately referred to as a
social science in the sense that it studies how people behave as distinct from the
study of inanimate matter which is the province of physical or pure sciences such
as physics and chemistry. Other social science includes: sociology, geography,
psychology, anthropology, political science, religious studies, government, etc.
Economics as a social science is also concerned with the study of firms or
companies and the government which is responsible for the provision of goods and
services for its people in order to satisfy their wants. Economics does not assume
the same level of accuracy and precision as any of the pure or natural sciences like
physics. This is due to the fact that it deals with human behavior which can change
from time to time.
CONCEPTS OF ECONOMICS
Each morning you wake up, you have the feeling that you need one thing or the
other. This problem is not peculiar to you, it is an experience common to people all
over the world. Though, the most pressing wants otherwise known as the basic
necessities of life are food, housing and clothing, our innate inquisitiveness and our
interactions with people within and outside our society lead frequently to the
emergence of new wants, the discovery of new resources and new uses of existing
resources. For example, our wants of satellite dishes, television and video sets, fax
and computer machine were unknown to previous generations. As one want is
satisfied, another one crops up. The problem of unlimited wants even transcends
income levels, it is a problem confronting both the rich and the poor. If we ponder
to ask ourselves why at any point in time we lack something, we would really
discover that it is because the productive resources are not available in sufficient
quantity.
The basic concepts are wants, ends, scarcity, choice, scale of preference and
opportunity cost.

WANTS: Wants can be defined as insatiable desires or need by human beings to

own goods and services that give satisfaction. Human wants are insatiable because
the means of satisfying them are limited. The basic needs of man are food, housing
and clothing. These needs are numerous.
ENDS: These are desires which individuals want to satisfy.
SCARCITY: This refers to limited supply of resources which are used for the
satisfaction of unlimited wants. This simply means limited quantity supplied
relative to the quantity demanded. Scarcity arises as a result of resources available
not been able to satisfy consumers wants. The wants are numerous. The available
resources within the environment can never at any time be in abundance to satisfy
all human wants. This result to the need to making choice of the most important
ones and leaving others that are less important.
CHOICE: Choice can be defined as a system of selecting or choosing one out of a
a number of alternatives. Choice becomes necessary because of scarcity of
resource. It means the distribution of our resources among different competing
economic ends. When we choose one thing, we may have to sacrifice some other
things because our resources may not be enough to satisfy both at the same time.
The choice facing our society is between social services and durable consumer
goods.
SCALE OF PREFERENCE: This can be defined as a list of a consumer’s wants
arranged in the order of their relative importance. It is a list showing the order in
which we want to satisfy our wants, arranged in order of priority. The most
pressing or important ones come first and the least pressing ones come last. It is
important for individuals and firms in the following ways:
 1. It helps to rank needs or wants in order of their relative importance.
2. Assists in managing finance properly.
3. It assists individuals, firms and governments to make a rational choice.
4. It enables individual to identify quickly the most pressing needs among
others.
5. Helps in efficient use of available resources.
6. It helps in maximization of satisfaction by economic agents.
OPPORTUNITY COST: It means forgone alternative. It is the satisfaction of one
want at the expense of another want. Human wants are numerous while the
resources for satisfying them are scarce or limited. This constraint forces
individual, firms and government to make choices. Opportunity cost is very
important to individuals, firms, government in the following ways:
Individual: It enables individual make wise choice between competing
wants and help make maximum use of scarce resources relative to unlimited
wants.
Firms: The concept helps business firms to decide on how to employ its
scarce resources.
Government: It helps government decide how to utilize its scarce resources.

IMPORTANCE OF ECONOMICS
The study of economics is very important to individuals, firms and government in
the following ways:
 It helps in the allocation of resources. The knowledge of economics has
enabled the government, firms and individuals allocate their limited
resources in a more efficient and effective way.
 The knowledge of economics helps us make rational decision in terms of
alternatives.
 It assists us to determine what to produce, when to produce, factor of
production and how to produce goods and services required to satisfy human
wants.
 It enables the government to develop certain programme that are of benefit
to the people.
 It helps solve the problem of economic growth and development through
efficient economic planning and proper economic decision.
 BASIC CONCEPTS OF ENGINEERING ECONOMY

INTRODUCTION
Engineering is the profession in which knowledge of the mathematical and natural
sciences gained by study, experience and practice is applied with judgment to
develop ways to utilize economically the material and forces of nature for the
benefit of mankind.

Economic theories are used to take decisions relating to uncertain and changing
business environment. Economic theories deal with the principles of demand,
pricing, cost, production, competition, trade cycles, national income and so on.

As design and manufacturing process become more complex, the engineer is

making decisions that involve money more than ever before. The competent and
successful engineer at present must have an improved understanding of the
principles of economics. Engineers are planners and builders. They are also
problem solvers, managers and decision makers. In the beginning of the 20 th
century, engineers were mainly concerned with the design, construction, operation
of machines structures and processes. They have accorded least attention to the
human and physical resources that have provided the final products. Many factors
have contributed to an expansion of engineering responsibilities and concerns.
Apart from the conventional work, now engineers are expected not only to create
novel technological solutions but also to make skillful financial analysis of the
effects of implementation.

Engineering economics, previously known as engineering economy, is a subset of

economics concerned with the use and application of economic principles in the
analysis of engineering decisions. As a discipline, it is focused on the branch of
economics known as microeconomics in that it studies the behavior of individuals
and firms in making decisions regarding the allocation of limited resources. Thus,
it focuses on the decision making process, its context and environment. It is
pragmatic by nature, integrating economic theory with engineering practice. But it
is also a simplified application of micro-economic theory in that it avoids a number
of micro-economic concepts such as price determination, competition and
demand/supply. As a discipline though, it is closely related to others such as
Statistics, Mathematics and Cost Accounting. It draws upon the logical framework
of economics but adds to the analytical power of mathematics and statistics. It
quantifies the benefits and costs associating with engineering projects to determine
if they save enough money to warrant their capital investments. It requires the
application of engineering design and analysis principles to provide goods and
services that satisfy the consumer at an affordable cost. It is also relevant to the
design engineer who considers material selection. It is a subject of vital importance
to Engineers. This subject helps one understand the need for the knowledge of
Economics for being an effective manager and decision maker. It is concerned with
the systematic evaluation of the benefits and costs of projects involving
engineering design and analysis. It is the application of economic techniques to the
evaluation of design and engineering alternatives. The role of engineering
economics is to assess the appropriateness of a given project, estimate its value,
and justify it from an engineering standpoint.

Some of the typical questions that can be addressed in engineering economy are:
 Should a new bonding technique be incorporated into the manufacture of
automobile brake pads?
 If a computer-vision-system replaces the human inspector in performing
quality tests on an automobile welding line, will operating costs decrease
over a time horizon of 5 years?
 Is it an economically wise decision to upgrade the composite material
production center of an airplane factory in order to reduce costs by 20%?
 Should a highway bypass be constructed around a city of 25,000 people or
should the current roadway throughout the city be expanded/
 Will we make the required rate of return if we install the newly offered
technology onto our medical laser manufacturing line?

IMPORTANCE OF ENGINEERING ECONOMY

 Engineers are called upon to analyze and select the most economical
alternative among several design alternatives.
 Engineers often play a major role in investment decisions based on the
analysis and design of new products or processes.
 Decisions made by the engineer during the engineering phase of a product’s
development determine the majority of the costs of manufacturing the
product.

Example 1
Two lead engineers with a mechanical design company and a structural analysis
firm work together often. They have decided that due to their joint and frequent
commercial airline travel around the region, they should evaluate the purchase of a
plane co-owned by the two companies. What are some of the economic-based
questions the engineer should answer as they evaluate the alternatives to (1) co-
own a plane or (2) continue to fly commercially?
Solution
Some questions (and what is needed to respond) for each alternative are as follows:
 How much will it cost each year? (cost estimates are needed)
 How do we pay for it? (A financing plan is needed)
 Are there tax advantages? (Tax law and tax rates are needed)
 What is the basis for selecting an alternative? (A selection criterion is
needed)
 What is the expected rate of return? (Equations are needed)
 What happens if we fly more or less than we estimate now (Sensitivity
analysis is needed).
SPECIAL CHARACTERISTICS OF ENGINEERING ECONOMICS:

For the clear understanding of the subject matter one must have the knowledge of
the special characteristics of Engineering Economics:

1. Engineering Economics is closely aligned with Conventional Micro-Economics.

2. Engineering Economics is devoted to the problem solving and decision making

at the operations level.

3. Engineering Economics can lead to sub-optimization of conditions in which a

solution satisfies tactical objectives at the expense of strategic effectiveness.

4. Engineering Economics is useful to identify alternative uses of limited resources

and to select the preferred course of action.

5. Engineering Economics is pragmatic in nature. It removes complicated abstract

issues of economic theory.

6. Engineering Economics mainly uses the body of economic concepts and

principles.
7. Engineering Economics integrates economic theory with engineering practice.

OBJECTIVES OF ENGINEERING ECONOMICS

 To improve the distribution of wealth: Circulation of wealth is necessary to

reduce the gap between the rich and the poor community. Circulation and
well distribution of wealth also ensures that all the people receive basic
necessities of life e.g. medical, educational, security etc.
 Study of money for public welfare

ECONOMIC DECISION-MAKING PROCESS

1) Collect relevant information regarding the project:

Initial Costs: Design, Manufacturing, Marketing, Testing, Installation,
Construction, Taxes, down payments, etc.
Annual Costs: Operating, Maintenance, Finance Payments, Insurance,
Income taxes, etc.
Periodic Costs: Overhauls, Improvements and Modifications.
Annual Receipts: Income generated and Savings due to increased
productivity.
Salvage Value: Income generated by sale or cost to remove obsolete
equipment.
Financing Method and Interest Rate.
2) Recognize and Define Feasible Alternatives:
Consider all possible options including the “DO NOTHING” alternative.
The generated alternatives may not be economically viable. Examine each
alternative and remove any overlapping options. If the productivity is about
the same for each alternative, focus only on the costs.
3) Consider the future consequences of each alternative:
Look at environmental impacts, effects on employee productivity, marketing
potential, public relations, etc.
4) Determine whose viewpoint is to be selected when evaluating alternatives:
Private vs. Governmental viewpoint. Very important when the public sector
is involved.
5) The consequences of each alternative must be expressed in monetary units.
You must consider the “time value of money”. It is sometimes very difficult
to put a monetary value on a consequence.
6) When comparing alternatives, focus on the differences between the alternatives:
 The past is common to all alternatives: look towards the future when
comparing alternatives. There can be no consequences before the moment of
decision.
7) Develop several criteria to be used in evaluating the alternatives:
Primary criterion: Economic analysis of alternatives based on a Minimum
Attractive Rate of Return (MARR) value.
Secondary criterion: Look at “intangibles” and “side-effects”.
8) Evaluate each alternative using a sensitivity analysis to enhance the evaluation:
Evaluation methods include: Present Worth (PW), Annual Worth (AW),
Future Worth (FW), Rate of Return (ROR), Capitalized Cost (CC),
Benefit/Cost Ratio (B/C) and Payback Period Analysis using a Minimum
Attractive Rate of Return (MARR).
9) Select the best alternative based on the economic analysis while remembering
the secondary criterion.