Introduction to Engineering Economics Chapter # 1

BUITMS, Quetta CS6/TE6

Contents
1.1 What is economy? 1.2 What is Engineering Economy? 1.3 Domain of Engineering Economy 1.4 Principles of Engineering Economy 1.5 Decision Making 1.6 Uncertainty and Sensitivity Analysis 1.7 Creative Process to search for Solutions

1.1 What Is Economy?

It is the study of how people and society choose to employ scarce resources that could have alternative uses in order to produce various commodities and to distribute them for consumption, now or in the future,
(Paul Samuelson and William Nordhaus, Economics, 12th Ed., McGraw-Hill, New York, 1985. )

From the Greek, it means the management of household or private affairs and especially expenses. It is the careful management of material resources (dictionary)

1.2 What Is Engineering Economy?

The application of economic principles to engineering problems,
for example in comparing the comparative costs of two alternative projects or in determining the optimum engineering course from the cost aspect.

Techniques that simplify comparison of alternatives on an economic basis Most project decisions consider additional factors safety, environmental, political, public acceptance, etc.

1.2 What is Engineering Economy?

Engineering projects Use resources: raw materials, labor, money, time Can be undertaken in a variety of ways Choose one alternative to a problem Determine the economically best alternative In many decisions costs and benefits are the most important factors Cost accounting is a subset of accounting concerned with decision making and control in a firm. Determines the cost of products or services

1.2 What is Engineering Economy?

It answers many different questions. Such as Which engineering projects are worthwhile?
Has the mining or petroleum engineer shown that the mineral or oil deposits is worth developing?

Which engineering projects should have a higher priority?

Has the industrial engineer shown which factory improvement projects should be funded with the available funds?

How should the engineering project be designed?

Has civil or mechanical engineer chosen the best thickness for insulation?
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1.2 What is Engineering Economy?

Economics and Engineering Economics is a big part of an engineer's job.
The engineer must translate scientific ideas in products and systems Ideas need to make sense economically and the engineer must be able to convince others that this is so.

That is true of any organization that you might join upon graduation. Engineering economics is entirely involved with evaluating the comparison of alternatives that involve spending money in hopes of earning more
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1.3 Engineering Economics' Domain

Problems encountered by Engineers can be loosely divided into 3 groups for the purposes of Engineering Economy: 1. Too small to merit any attention (purchase of office supplies, routine maintenance, etc.) 2. Problems whose solution is determined by Engineering Economy (this course will deal) 3. Problems so big that EE plays only a supporting role in the final decision (pipelines, hydro dams, major bridges, etc.) So the principle is to match the scale of the analysis to the scale of the problem

1.3 Engineering Economics' Domain

Key Questions:
Which engineering projects are worthwhile?

Which projects should have higher priority?

How the project should be designed? How to achieve long-term financial goals? How to compare different ways to finance purchases? How to make short and long-term financial decisions?

1.3 Engineering Economics' Domain

Examples of Non-Monetary Factors: Meeting customer expectations consistently Maximization of employee satisfaction

Maintaining flexibility to meet changing demand

Maintenance of a desired public image Leveling cyclic fluctuations in production Improvement of safety in operations Reduction of pollutants

1.4 Principles of Engineering Economics

In fact EE is all about problem solving as follows: Develop the alternative Focus on the differences Use a consistent viewpoint Use a common unit of measure Consider all relevant criteria Make uncertainty explicit Revisit your decision Most of what you do here revolves around money

1.5 Decision Making

What is Decision? Decision is the selection among many courses of action Business Decisions examples Product design Process design (inspection, operations, raw materials) Machine selection Facility design
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1.5 Decision Making

Why is it difficult to make decisions? Complexity Uncertainty Risk Conflicting objectives Multiple decision makers Conflicting data, undefined constraints, incomplete data

All decisions are interrelated. You can't make one without affecting many others. This is especially true when multiple products, periods, stages are involved.

1.5 Decision Making

Real world is a mess of conflicting data, objectives, timing, methods etc. Can decision making be improved??
Good quality information helps reduce uncertainty For example: Which company to partner with? Role of IS in decision making
Information Systems improve effectiveness of decision making by providing with information related to decision

1.5 Decision Making

Can decision making can be improved? The factors of time and uncertainty are the defining aspects of any engineering economic decisions It is an iterative process and repeats as results are refined Communications skills are extremely important!

The organisation emphasises action rather than analysis

Politics are very important!

1.5 Decision Making

The Decision Making Process
1. 2. 3. 4. 5. 6. 7. 8.
A well structured decision making process is: Define/formulate problem (opportunity), boundary Choose objective(s)/set goals Identify alternatives Evaluate consequences Apply criteria for selection Select preferred course of action Specify and implement solution, adjust as required Audit/monitor results, revise as necessary

1.5 Decision Making

Decision Structure
Structured (operational) Situations where the procedures to follow when a decision is needed can be specified in advance
Semi structured (Tactical) - Decision procedures that can be prespecified, but not enough to lead to a definite recommended decision Unstructured (Strategic) Decision situations where it is not possible to specify in advance most of the decision procedures to follow

1.5 Decision Making

Decision Making Techniques
What-if Analysis end user makes changes to variables, or relationships among variables, and observes the resulting changes in the values of other variables Sensitivity Analysis value of only one variable is changed repeatedly and the resulting changes in other variables are observed

1.5 Decision Making

Goal-Seeking set a target value for a variable and then repeatedly change other variables until the target value is achieved

Optimization goal is to find the optimum value for one or more target variables given certain constraints then one or more other variables are changed repeatedly until the best values for the target variables are discovered

1.6 Uncertainty and sensitivity analysis

Typically Sensitivity analysis used when there is uncertainty about the assumptions made in estimating the value of certain key variables Engineers estimate: Whenever people predict the future, errors occur. To control uncertainty, make sure the information used is accurate It is an integral part of EE decisions since data regarding future activities are always uncertain. The goal is to minimize uncertainty when making decisions

1.7 Creative Process to search for Solutions

1. Exert the necessary effort. 2. Not get bogged down in details too soon. 3. Make liberal use of the questioning attitude. 4. Seek many alternatives. 5. Avoid conservatism. 6. Avoid premature rejection. 7. Avoid premature acceptance. 8. Consult others. 9. Attempt to divorce your thinking from the existing solution. 10. Try the group approach. 11. Remain conscious of the limitations of the mind in the process of idea generation.

Communication Skills in Brief

Engineers are accused of being poor communicators Graduates state that the most needed, but untaught skill they miss is communications skills and the skills of working in groups The decision making process requires data from and cooperation by others - asking the right questions at the right time are crucial Selection and implementation steps depend on written and spoken skills in the language used Listening skills are extremely important

Summary
Engineering Economy is defined as considering the time value of money in the decision making process of selecting alternative solutions for real projects If correctly done, it: states the consequences in a common measure only consider differences between alternatives makes separable decisions separately adopt a systems view use common planning horizon EE uses the proper steps in decision making