ENGINEERING

ECONOMICS
Engr.KRESTIE NEL B. TEPOSO
Grading System

Summative Test (Midterm and Final Exam) . . . . . . . . 60%

Performance-based Task :
Quiz . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20%
Culminating Activity . . . . . . . . . . . . . . . . . . 10%
Board Work/Seat Work . . . . . . . . . . . . . . . . 5%
Assignment . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
TOTAL 100%
1-2
 Introduction
1.1 Definitions
1.2. Principles of Engineering Economics
1.3. Engineering Economics and the Design
Process
1.4. Cost Concepts for Decision Making
Topics 1.5. Present Economic Studies
Money-Time Relationships and Equivalence
2.1. Interest and the Time Value of Money
2.2. The Concept of Equivalence
2.3. Cash Flows
Economic Study Methods
3.1. The Minimum Attractive Rate of Return
3.2. Basic Economic Study Methods: Present Worth, Future
Worth, Annual Worth, Internal Rate of Return, External
Rate of Return
3.3. Other Methods: Discounted Payback Period, Benefit/Cost
Ratio

Decisions Under Certainty

4.1. Evaluation of Mutually Exclusive Alternatives
4.2. Evaluation of Independent Projects
4.3. Effects of Inflation
4.4. Depreciation and After-Tax Economic Analysis
4.5. Replacement Studies 1-4
Decisions Recognizing Risk
5.1. Expected Monetary Value of Alternatives
5.2. Discounted Decision Tree Analysis

Decisions Admitting Uncertainty

6.1. Sensitivity Analysis
6.2. Decision Analysis Models

1-5
Course Outcomes
1. Solve problems on Interest, Discount, Annuities
and capitalized cost, bonds applying the principles of
Economics
2. Compute depreciation of engineering
equipment and properties using straight line formula,
sinking fund formula, Matheson formula, Sum of the
years method and others
3. Analyze economic situation of a
company/industry using break-even analysis
 ENGINEERING ECONOMY
• ECONOMICS – one of the social sciences which consists of that body of
knowledge dealing with people and their assets or resources
- Sum total of knowledge that treats the creation &
and utilization of goods and services for the satisfaction of
human wants.
ENGINEERING – is not a science but an application of science
- art composed of skill and ingenuity in adapting knowledge to the uses of
humanity
- the profession in which a knowledge of the mathematical and natural sciences
gained by study, experience, and practice is applied with judgment to develop
ways to utilize economically, the materials and forces of nature for the benefit of
mankind
•“Science is the foundation upon which the
engineer builds toward the advancement of
mankind. With the continued development of
science and the worldwide application of
Engineering, the standard of living maybe
expected to improve and further increase the
demand for those things that contribute to
people’s love for the comfortable and beautiful”
 ENGINEERING
ECONOMY/ECONOMICS
* As defined by Arreola
– branch of Economics which
involves the applications of
definite laws of Economics,
theories of investments and
business practices to
Engineering problems involving
cost
- the study of economic theories
and their applications to Engineering
problems with the concept of obtaining
the maximum benefit at the least cost
- also involves the study of cost features
& other financial data and their
applications in the field of Engineering
as a basis for decision.
 * As defined by
* As defined by Kasner Sullivan, et. al

– Engineering Economics is equated with - Engineering economy

practicality and economic feasibility. It is also is the systematic
the search for the recognition of alternatives evaluation of the merits
which are then compared and evaluated in of proposed solutions to
order to come up with the most practical engineering problems
design and creation
Origins of Engineering Economy
Engr. Arthur Wellington Made use of engineering
a Civil Engineer economics analysis in
(19th Century) building railroads in U.S.

Eugene Grant (1930) Published his book

“Principles of
engineering Economy

Emphasized on techniques that depended

on financial and actuarial mathematics
 Two (2) Aspects of Engineering:
1. Concerns itself with the materials and forces of nature
2. Concerns of the needs of people
Note: Because we live in a resource-constrained world, Engineering must
be closely associated with Economics. It is essential that Engineering
proposals be evaluated in terms of worth and cost before they are
undertaken.
Why should engineers study economics?
Engineering economics poses numerous benefits because it
allows those in industry to make strategic decisions for their
companies. While macroeconomic and financial competencies are
key for business operations, engineering economics further
provides a mechanism for decision-making.
ENGINEERING ECONOMY TECHNIQUES:

1. The Economy Analysis – considers all factors affecting

the economy of the project which can
be reduced to specific monetary
values.

It determines the initial cost of the project, the cost of

operation and maintenance, the needed working capital
and the probable income the project will generate when
in operation, the rate of return on the investment, and
all other cost factors.
ENGINEERING ECONOMY TECHNIQUES:

2. The financial Analysis – determines the

methods and sources of financing .
the project either through equity capital or
borrowed . or a combination of both. It is
dependent on the Economy analysis for necessary
data.
ENGINEERING ECONOMY TECHNIQUES:

3. The Intangible Analysis – determines all the

aspects of the proposed project .
which cannot be reduced to monetary values and
considers the uncertainty and the risks inherent in
the project.

-Its scope includes the so-called judgment factor

whose analysis depends upon the judgment of
responsible persons involved in the project.
Reasons for studying Engineering Economics
1. Engineers, as a group, have wrought immense changes in
improving the economic well-being of mankind through
their inventions and their applications of scientific principles
to the varied problems of industry

2. In the professional life of engineers, it is readily

observed that the most successful ones are those who
gradually divorce themselves from the technical aspects of
Engineering and who devote their time and efforts to
financial problems related to Engineering works.
Special characteristics of Engineering Economics:
Engineering Economics

1. is closely aligned with Conventional Micro-Economics.

2. is devoted to the problem solving and decision making at the
operations level.
3. can lead to sub-optimization of conditions in which a solution
satisfies tactical objectives at the expense of strategic effectiveness.
4. is useful to identify alternative uses of limited resources and to select
the preferred course of action.
5. is pragmatic in nature. It removes complicated abstract issues of
economic theory.
6. mainly uses the body of economic concepts and principles.
7. integrates economic theory with engineering practice.
Principles of Engineering Economics:

Principle 3. Use
Principle 2. Focus on the a consistent
Principle 1. Develop viewpoint.
the alternatives, the differences. Only the
difference in expected Prospective
choice is among the outcomes of the
alternatives outcomes is considered
alternatives,
economic, etc.

Principle 4. Use a common unit measurement of

the possible outcomes in comparing alternatives
 Principle 5. Consider all
relevant criteria. Consider both
monetary & other unit of
Principle 7. Revisit
measure in measurement of
your decisions.
outcomes
Projected results &
decisions should
Principle 6. Make be compared with
uncertainty explicit. actual results to
Uncertainty is inherent in improve the
projecting future outcomes decision process
and should considered in
their analysis and
comparison
Engineering Economic Analysis Procedure
1. Problem recognition, definition, and evaluation.

2. Development of the feasible alternatives.

3. Development of the cash flows

4. Selection of a criterion (or criteria)

5. Analysis and comparison of the alternative

6. Performance monitoring & post evaluation results

 COST CONCEPTS AND DESIGN ECONOMICS TERMINOLOGIES

TERMINOLOGIES

Fixed cost – those that are unaffected by changes in activity level over a
feasible range of operations for the capacity or capability available.
(Insurance and taxes on facilities, general management and administrative
salaries, license fees and interest costs of borrowed capital)

Variable cost – are those associated with an operation that vary in relation
to changes in quantity of output or other measures of activity level. For the
example, the cost of materials and labor used in a product or service are
variable costs – because they vary with the number of output units even
though the costs per unit stay the same.
TERMINOLOGIES
Incremental cost (incremental revenue) – refers to the additional cost or
revenue that will result for increasing the output of a system by one of more
units. This is often quite difficult to determine in practice. Thus if to produce
100 units will cost P200, and the total cost for producing 110 units is P215,
then the increment cost for additional 10 units is P15 or 1.50 per unit.

Recurring costs – costs that are repetitive and occur where an organization
produces similar goods or services on a continuing basis. Variable cost are also
recurring costs, because they repeat with each unit of output. Fixed cost that is
paid on a repeatable basis is a recurring cost (ex. office space rental)

Non-recurring costs – are those that are not repetitive even though the total
expenditures maybe cumulative over a relatively short period of time. Usually
it involves the developing or establishing a capability or capacity to operate.
Direct cost – those that can be reasonably measured and allocated to a specific
output or work (labor and materials). Indirect cost – costs that are difficult to
attribute or allocate to a specific output. They are costs allocated through a
selected formula (such as proportional to direct labor hours or direct materials)
to the outputs or work activities (ex. Cost of common tools, general supplies
equipment maintenance).
Overhead cost – used to mean all expenditures that are not direct cost
(administrative, insurance, taxes, electricity, general repairs)
Standard cost – representation cost per unit of output that are established in
advance of actual production or service delivery. They are developed from
anticipated direct labor hours, materials and overhead categories. Standard
costs play an important role in cost control and other management functions
like estimating future manufacturing costs.
Cash cost – cost that involves payment of cash.
Book cost – does not involve cash transaction; non-cash. The most common
example of book cost is the depreciation. It is included in an analysis for it
affects income taxes, which are cash flows.

Opportunity cost – is incurred because of the use of limited resources such

that the opportunity to use those resources to monetary advantage in
alternative use is foregone. It is the cost of the best rejected opportunity and is
often hidden or implied.

Sunk cost – is one that has occurred in the past and has no relevance to
estimates of future costs and revenues related to an alternative course of
action. It represents money which has been invested and which cannot be
recovered due to certain reasons. A sunk cost is common to all alternatives and
is not part of the future cash flows and can be disregarded in an engineering
economic analysis.
Life cycle cost (LCC) – refers to the summation of cost estimates from
inception to disposal for both equipment and projects as determined by an
analytical study and estimate of total costs experienced during their life. The
objective of LCC analysis is to choose the most cost effective approach from a
series of alternatives so the least long term cost of ownership is achieved.

LCC analysis helps engineers justify equipment and process selection based
on total costs rather than the initial purchase price. Usually the cost of
operation, maintenance, and disposal costs exceed all other costs many times
over. Life cycle costs are the total costs estimated to be incurred in the
design, development, production, operation, maintenance, support, and final
disposition of a major system over its anticipated useful life span (DOE,
1995). The best balance among cost elements is achieved when the total LCC
is minimized (Landers, 1996).
Investment cost – first cost or cost incurred during the acquisition phase. It
is the capital required for most of the activities in the acquisition phase.

Capital investment – series of expenditures over an extended period on a

large construction project.
Working capital – refers to the funds required for current assets
(equipment, facilities) that are needed for the start-up and support of
operational activities.

Disposal cost – includes those non recurring costs of shutting down the
operation and the retirement and disposal of assets at the end of the
life cycle. Ex. Costs associated with personnel, materials.
Operation and maintenance cost – includes many of the recurring annual
expense items associated with the operation phase of the life cycle.

The direct and indirect costs of operation in five primary resource areas,
1) people
2) machines
3) Materials
4) energy
5) information – are major parts of the costs in this category.
 BASIC TERMS and PRINCIPLES OF ECONOMICS

Two basic types of factors:

1. Tangible Factors- those which can be expressed in terms of
monetary values

2. Intangible Factors – those which are difficult to express or

impossible to express in terms of monetary values. Also called
irreducible factors.
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.

Monopoly – the opposite of perfect competition. It

occurs when a unique product or service is available
only from a single supplier and entry of all other
possible suppliers is prevented.

Oligopoly – occurs when there are few suppliers and any

action taken by anyone will definitely affect the course of
action of the others.
State whether Monopoly, perfect competition or oligopoly
1. A businessman sells a new product very sellable to the students. New buyers
can only buy this from him. Since the product became an instant need and the
demand for it increases, the businessman produces more at a higher cost.

2. In a certain barangay, a barbecue stall was becoming popular since many bought the
food especially for those who had no time to cook in the evening. Knowing the
situation, another stall was placed the next week and the following week, two
additional stalls were installed making the area as the BARBEQUE CORNER. This is
advantageous to the customers since the price became cheaper and they can choose
among the many stalls.
3. Saudi Arabia reduced the amount of oil sent the Philippines thus it created a big
chaos in the business world. There were no air flights thus other products were not
transported from Metro Manila to the provinces.
4. A certain university required students to wear their uniform but they have to
buy it from the school coop since the cloth has the school logo printed on it and no
other store sells it.
 Price – the amount of money or its equivalent which
is given in exchange for it.

Price regulates production. If prices go up,

production will increase. If price decreases,
production will also decrease or cease.
Market – a place where sellers and buyers come together.

Local market – when National market World market

goods which are – certain goods – goods which are
perishable are sold which are sold exported to other
in a limited locality. all over the countries
country
SOME ECONOMIC RELATIONSHIPS
Two kinds of goods:

1. Consumer goods – those that are consumed or used

directly by people.
Examples: clothes, shoes, food, medical and
dental services

2. Producer goods – those which produce goods and

services for human .
consumption
Examples: generators, ships, bus, airplanes.
 Necessities and Luxuries

Necessities are those Luxuries are those

products or services products or services
that are required to that are desired by
support human life human and will be
and activities, that will purchased if money
be purchased in available after the
somewhat the same required necessities
quantity even though have been obtained.
the price varies
considerably.
Demand – the quantity of a certain commodity that is
bought at a certain price at a new given
place and time. The higher the
LAW OF DEMAND PRICE, the
lower the
“The demand for a commodity DEMAND
varies inversely as the price of the
commodity, though not
proportionately.
PRICE DEMAND
PRICE DEMAND
• ELASTICITY OF DEMAND
Elastic Demand – occurs when a decrease in selling
price will cause a greater increase in the
volume of sales. Included here are the
luxuries.
•
Inelastic Demand – occurs when a decrease in
selling price will cause a less than
proportionate increase in sales. Included
here are the necessities.
FIESTA SALES @ 50%
DISCOUNT on all iPhone

ELASTIC DEMAND

Pork adobo is now at

P20/serving
Before: P35/serving
INELASTIC DEMAND
PRICE – DEMAND RELATIONSHIP for
NECESSITIES and LUXURIES

Demand luxuries

necessities

price
Utility – the capacity of a commodity to satisfy human want.
If the utility of a certain good to a certain individual
is great, his demand for that good will be great.

If the ballpen writes well

Then next time you buy same kind
(Because the utility of the pen is great)
If the ballpen does not function well
Then you will never buy this kind again
(Because the utility of the pen is less)
LAW OF DIMINISHNG UTILITY

“An increase in the quantity of any good

consumed or acquired by an individual will
decrease the amount of satisfaction”
Marginal Utility of a commodity –the additional satisfaction or
benefit (utility) that a consumer derives from buying an
additional unit of a commodity or service. The concept
implies that the utility or benefit to a consumer of an
additional unit of a product is inversely related to the
number of units of that product he already owns

Marginal Unit – the last unit of similar

commodities consumed or
acquired.
 FAMILY A of 7
has 7 slices of bread

What is the marginal utility

FAMILY B of 7
has 35 slices of bread
SUPPLY – the quantity of a certain commodity that
is offered for sale at a certain price at a
given place and time.
PRICE SUPPLY

LAW OF SUPPLY
“The supply of a commodity varies
directly as the price of the commodity,
though not proportionately”
PRICE SUPPLY

The law of supply explains that if people are

willing to pay more money for a product, a
company will produce or manufacture more of
that product to capitalize on the increased
revenue.
PRICE – SUPPLY Relationship
Price
There is scarcity of ginger supply in
the market since many are using it as
salabat so the price of ginger in the
market increases.

Most high school students use school items

Supply
printed with their favorite actor/ actress
even at higher price. Knowing this, the
producer manufactures more of this
product thus increasing the supply. But
Supply when time comes that the celebrities are
not that popular, buyers reduces thus
price
supply of same product should be reduced
or stopped.
Supply refers to the amount of goods that are available.
Demand refers to how many people want those goods.

When supply of a product goes up, the price of a product goes

down and demand for the product can rise because it costs
loss.
•At some point, too much of a demand for the product
will cause the supply to diminish. As a result, prices will
rise. The product will then become too expensive,
demand will go down at that price and the price will fall.
•Supply and demand should reach an equilibrium. The
amount of goods being supplied is the same as the amount
demanded and resources are allocated efficiently.
 LAW OF SUPPLY AND DEMAND
“When free competition exists, the price of a product will be
that value where supply is equal to the demand”
.

This is a combination of the laws of demand and supply.

No sale exists if the buyers and the sellers do not agree on a

common price for the commodity

The price is determined only when the demand is equal

to the supply and a sale occurs.
PRICE – SUPPLY – DEMAND RELATIONSHIP

Supply & demand

demand
supply
price
Corn crops are very plentiful over the course of the year
and there is more corn than people would normally buy. To
get rid of the excess supply, farmers need to lower the price
of corn and thus the price is driven down for everyone.

A huge wave of new, unskilled workers come to a city and all

of the workers are willing to take jobs at low wages. Because
there are more workers than there are available jobs, the
excess supply of workers drives wages downward.

There is a drought and very few strawberries are available.

More people want the strawberries than there are berries
available. The price of strawberries increases dramatically.
 LAW OF DIMINISHING RETURNS

“When one of the factors of production is fixed in quantity

or is difficult to increase, increasing the other factors of
production will result in a less than proportionate increase
in output”

Example:
The use of fertilizer improves crop production on
farms and in gardens; but at some point, adding
increasingly more fertilizer improves the yield by less
per unit of fertilizer, and excessive quantities can
even reduce the yield.
MARGINAL REVENUE – that amount
When free competition exists:
received from the sale of an
Marginal revenue = marginal
additional unit of a product.
cost
Marginal cost – the additional cost of
producing one more unit.

Where physical units are involved:

The effectiveness of the
utilization is measured by the Physical Efficiency = Output in physical units
well-known equation: Input in physical units
Efficiency = Output
Input
[this can never exceed 100%]
The effectiveness of the utilization is
measured by the well-known equation:
Efficiency = Output
Input

Where physical units are involved:

Physical Efficiency = Output in physical units
Input in physical units
[this can never exceed 100%]
When money is the material, effectiveness of the
utilization is measured by:

Economic Efficiency = Income in Pesos

Cost in Pesos

Note: Unless the economic or financial

efficiency exceeds 100%, the investment of
capital, from a strictly financial viewpoint is not
recommended.
A common measure of financial efficiency is:

Rate of Return = Annual Net Profit

Capital Invested

and also
Payout Period = Capital Invested
Net annual cash flow
Let's say Rolan opens a lemonade stand. He invests ₱500 in the
venture, and the lemonade stand makes about ₱10 a day. Considering
300 days in a year (with days-off), what is the rate of return in 1 year?

Solution:
Income = ₱ 10 x 300 = ₱3,000 a year
rate of return (in one year) = ₱ 3,000/ ₱ 500 = 6 = 600%.

There is one fundamental relationship you should be aware of

when thinking about rates of return:
the riskier the venture, the higher the expected rate of return.
Physical processes perform at less than 100% efficiency while economic
ventures are only feasible if they achieve greater than 100% efficiency.

Therefore, it is clear that in feasible economic ventures

the economic worth per unit of physical output must always be greater
than the economic cost per unit of physical input.

Example:
In making 50 native bags, the total cost is ₱9,000.00.
economic cost per bag = ₱9000/50 = ₱180.00 (physical input)

In selling the bag, what is economic worth of each bag? (physical output)

It should be greater than ₱180.00 say ₱200.00 or more

At ₱200.00/bag, how much is your What is the total income?
profit if all 50 bags were sold?
Income = ₱200.00/bag(50bags)
Gain = 200-180 = ₱20.00/bag = ₱10,000.00

Economic Efficiency = Income in Pesos = ₱10,000 = 1.11

Cost in Pesos 9,000
= ₱10,000 = 1.11 x 100 = 111%
9,000

Consequently, economic efficiency must depend more upon the worth and
cost per unit of physical outputs and inputs than upon physical efficiency.
Physical efficiency is significant, but only to the extent that it contributes to
economic efficiency.
Physical processes perform at less than 100% efficiency while economic
ventures are only feasible if they achieve greater than 100% efficiency.

Therefore, it is clear that in feasible economic ventures

the economic worth per unit of physical output must always be greater
than the economic cost per unit of physical input.

Economic Efficiency = Income in Pesos

Cost in Pesos

Consequently, economic efficiency must depend more upon the worth and
cost per unit of physical outputs and inputs than upon physical efficiency.
Physical efficiency is significant, but only to the extent that it contributes to
economic efficiency.