Holy Angel University

School of Engineering and Architecture

ENGECON

Introduction to Engineering Economy

Lecture No. 1 Engr. Veronica Lopez - Malong

Content
The Basics of Engineering Economy

The General Economic Environment

Cost Terminology

The Economic Environment

The Law of Supply and Demand

The Law of Diminishing Returns

 LECTURE 1 INTRODUCTION TO ENGINEERING ECONOMY

THE BASICS OF ENGINEERING ECONOMY

Engineering is the profession in which a knowledge of the mathematical and natural science gained by study,
experience and practice is applied with judgement to develop ways to utilize, economically the materials and
forces of nature for the benefit of mankind. In this definition, the economic aspects of engineering are
emphasized, as well as the physical aspects. Clearly, it is essential that the economic part of engineering be
accomplished well.

In manufacturing, engineering is involved in every detail of a product’s production, from the conceptual design to
the shipping. In fact, engineering decisions account for the majority of product costs. Engineers must consider the
effective use of capital assets such as building and machinery. One of the engineer’s primary tasks is to plan for
the acquisition of equipment (capital expenditure) that will enable the firm to design and produce products
economically.

Engineering economy is the discipline concerned with the economic aspect of engineering. It involves the
systematic evaluation with the economic merits of proposed solutions to the engineering problems. To be
economically acceptable (i.e., affordable), solutions to engineering problem must demonstrate a positive balance
of long-term benefits over long term cost. Engineering economics 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.

The General Economic Environment

There are numerous general economic concepts that must be taken into account in engineering studies.

• Consumer goods and services are those products or services that are directly used by people to satisfy
their wants. Examples are food, clothing, homes, cars, haircuts and medical services.
• Producer goods and services are used to produce consumer goods and services and other producer goods.
Examples are machine tools, factory buildings, buses and farm machinery.
• Price of goods and services is defined to be the present amount of money or its equivalent which is given
in exchange for it.
• Demand is a quantity of certain commodity that is bought at a certain price at a given place and time.
• Supply is a quantity of a certain commodity that is offered for sale at a certain price at a given place and
time.
• Perfect competition occurs in a situation in which any given product is supplied by a large number of
vendors and there is no restriction in additional suppliers entering the market.
• Perfect monopoly exists when a unique product or service is available from a single supplier and that
vendor can prevent the entry of all others into the market.
• Oligopoly occurs when there are few suppliers and any action taken by anyone of them will definitely
after the course of action of the others.
• Total Revenue is the product of the selling price per unit and the number of units sold.
• Total Cost is the sum of the fixed costs and the variable costs.
• Profit/ Loss is the difference between total revenue and the total costs.

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 LECTURE 1 INTRODUCTION TO ENGINEERING ECONOMY

Cost Terminology
Cost considerations and comparisons are fundamental aspects of engineering practice. Before the study of various
engineering economic decisions problems, the concept of various costs must be understood. At the level of plant
operations, engineers must make decisions involving materials, plant facilities and the in-house capabilities of
company level.

• Fixed costs are those unaffected by changes in activity level over a feasible range of operations for the
capacity or capability available. Examples are insurance and taxes on facilities, general management and
administrative salaries, license fees, and interest costs on borrowed capital.
• Variable costs are those associated with an operation that vary in total with the quantity of output or
other measures of activity level. Examples are the costs of material and labor used in a product or service.
• Incremental cost is the additional cost (or revenue) that results from increasing the output of the system
by one or more units.
• Recurring costs are those that are repetitive and occur when an organization produces similar goods or
services on a continuing basis.
• Nonrecurring costs are those which are not repetitive even though the total expenditure may become
cumulative over a relatively short period of time.
• Direct costs are costs that can be reasonably measured and allocated to a specific output or work activity.
Examples are labor and material costs.
• Indirect costs are those that are difficult to attribute or allocate to a specific output or work activity.
Examples are the costs of common tools, general supplies, and equipment maintenance.
• Overhead cost consists of plant operating costs that are not direct labor or direct material costs. Examples
are electricity, general repairs, property taxes and supervision.
• Standard costs are representative costs per unit of output that are established in advance of actual
production or service delivery.
• Cash costs are that involves payment of cash.
• Noncash costs (book costs) are costs that does not involve a cash payment, but rather represent the
recovery of past expenditures over a fixed period of time. Example is the depreciation charged.
• 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.
• Opportunity cost is incurred because of the use of limited resources such that the opportunity to use
those resources to monetary advantage in an alternative use is foregone.
• Life-cycle cost refers to a summation of all the costs, both recurring and nonrecurring, related to product,
structure system, or services during its life span.
• Investment cost is the capital required for most of the activities in the acquisition phase.
• Working capital refers to the funds required for current assets that are needed for the startup and support
of operational activities.
• Operational and Maintenance cost includes many of the recurring annual expense items associated with
the operation phase of the life cycle. Disposal cost includes those nonrecurring costs of shutting down
the operation and the retirement and disposal of assets at the end of the life cycle. These costs will be
offset in some instances by receipts from the sale of assets with remaining value.
• Economic life coincides with the period of time extending from the date of acquisition to the date of
abandonment, demotion in use, or replacement from the primary intended service.

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 LECTURE 1 INTRODUCTION TO ENGINEERING ECONOMY

• Ownership life is the period between the date of acquisition and the date of disposal by a specific owner.
• Physical life is the period between original acquisition and final disposal of an asset over the succession
of owner.
• Useful life is the time period that an asset is kept in productive service (either primary or backup). It is an
estimate of how long an asset is expected to be used in a trade or business to produce income.

THE ECONOMIC ENVIRONMENT

Engineering economy is the analysis and the evaluation of the factors that will affect the economic success of
engineering projects to the end that a recommendation can be made which will insure the best use of capital.

Consumer and producer goods and services

Consumer goods and services are those products or services that are directly used by people to satisfy their wants.

Producer goods and services are used to produce consumer goods and services or other producer goods.

Necessities and luxuries

Necessities are those products or services that are required to support human life and activities that will be
purchased in somewhat the same quantity even though the price varies considerably.

Luxuries are those products or services that are desired by humans will be purchased if money is available after
the required to support human life and activities that will be purchased in somewhat the same quantity even
though the price varies considerably.

Demand

Demand is the quantity of a certain commodity that is bought at a certain price at a given place and time.

Elastic demand occurs when a decrease in selling price result in a greater than proportionate increase in sales.

Inelastic demand occurs when a decrease in selling price produces a less than proportionate increase in sales.

Unitary elasticity of demand occurs when the mathematical product of volume and price is constant.

Competition, Monopoly and Oligopoly

Perfect competition occurs in a situation where a commodity or service is supplied by a number of vendors and
there is nothing to prevent additional vendors entering the market.

Monopoly is the opposite of perfect competition. A perfect monopoly exists when a unique product or service
available from a single vendor and that vendor can prevent the entry of all others into the market.
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 LECTURE 1 INTRODUCTION TO ENGINEERING ECONOMY

Oligopoly exists when there are so few suppliers of a product or service that action by one will almost inevitably
result in similar action by the others.

The Law of Supply and Demand

Supply is the quantity of a certain commodity that is offered for sale at ascertain price at a given place and time.

The law of supply and demand may be stated as follows: “Under conditions of perfect competition the price at
which a given product will be supplied and purchased is the price that will result in the supply and the demand
being equal”

Supply and Demand:

P – price
Q – quantity of goods
S – supply
D – demand

The four basic laws of supply and demand are:

✓ If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher
quantity.
✓ If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower
quantity.
✓ If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher
quantity.
✓ If supply decreases and demand remains unchanged, then it leads to higher equilibrium price and lower
quantity.

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 LECTURE 1 INTRODUCTION TO ENGINEERING ECONOMY

The Law of Diminishing Returns

The law of diminishing returns, also referred to as the law of diminishing marginal returns, states that in a
production process, as one input variable is increased, there will be a point at which the marginal per unit output
will start to decrease, holding all other factors constant. In other words, keeping all other factors constant, the
additional output gained by another one unit increase of the input variable will eventually be smaller than the
additional output gained by the previous increase in input variable. At that point, the diminishing marginal returns
take effect.

Examples of diminishing returns

Use of chemical fertilizers. A good example of diminishing returns includes the use of chemical fertilizers- a small
quantity leads to a big increase in output. However, increasing its use further may lead to declining Marginal
Product (MP) as the efficacy of the chemical declines.

Revising into early hours of the morning. If you revise economics for six hours a day, you will improve your
knowledge quite a bit. However, if you continue to revise into the early hours of the morning, the amount that
you learn increases by only a small amount because you are tired.

Employing extra workers. A cafe may wish to serve more customers during the busy summer months. However,
employing extra workers may be difficult because of a lack of space in the cafe.

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