Introduction to Engineering

Economy
Introduction to Engineering Economy

Engineering is the art of doing that well with

one dollar which any burgler can do with two.
-Arthur M. Wellington(1887)
Introduction to Engineering Economy

Economics is the branch of knowledge

concerned with the production, consumption,
and transfer of wealth.
 Introduction to Engineering Economy
Engineering Economy involves the systematic evaluation
of the economic merits of proposed solutions to
engineering problems. To be economically acceptable
(i.e., affordable), solutions to engineering problems must
demonstrate a positive balance over long term costs, and
they must also:
Promote the well being and survival of an organization.
Embody creative and innovative technology and ideas.
Permit identification and scrutiny of their expected
outcomes, and translate profitability to the “border line”
through a valid and acceptable measure of merit.
The Principles of Engineering Economy
• Develop the alternatives
• Focus on the differences
• Use a consistent viewpoint
• Use a common unit of measure
• Consider all relevant criteria
• Make risk and uncertainty explicit
• Revisit your decisions
Cost concepts & Design economics
 Fixed and Variable costs
• Fixed costs are those unaffected by changes in
activity level over a feasible range of
operations for the capacity or capability.

• Variable costs are those associated with an

operation that vary in total with the quantity
of output or other measures of activity level
Graphical representation of total cost,
fixed cost and variable cost

Total cost = Fixed cost + Variable cost

 Variable cost
(Rs/unit, $/unit, $/service)

How to workout Total variable cost?

Simple, sum up all the cost associated with the
activity.
How to workout Total variable cost/unit?
Sum all the costs associated with the activity and
divide by number of units produced.
 Example of a photocopier
Shop rent: Rs. 10,000 per month
Salary of a worker: 5000 per month
Monthly maintenance cost: 1000 per month
Electricity charges: 2000 per month
Print capacity month: 2500 pages per month
Fixed and variable costs
Fixed and variable costs
 Direct, Indirect & Standard Costs
Direct costs are costs that can be reasonably
measured and allocated to a specific output or work
activity. Examples are labor and material costs etc.
Indirect costs are difficult to allocate to a specific
output or work activity. Examples are general
purpose tools or machines.
Standard Costs are planned costs per unit of output
that are established in advance of actual production
or service delivery.
 Incremental costs

An incremental cost is the additional cost that

result from increasing the output of a system by
one (or more )units
 Recurring Cost
Recurring Cost term means the regular cost
incurred repeatedly, or for each item produced or
each service performed on a recurring or repeated
basis.
 Non-recurring costs
Costs that occur on a one-time basis, and are
unlikely to occur again in the normal course of
business. Non-recurring costs include: capital
expenditures, unusual charges, design,
development and investment costs, various
kinds of losses, legal costs, and moving expenses
 Cash Cost & Book Cost

Cash Cost involves payment of cash against

purchase of an item or service.

Book costs are costs that do not involve cash

payments but rather represents the recovery of
past expenditure over a fixed period of time.
Exmple is depreciation
 Sunk cost and opportunity costs
Sunk cost is the cost that has occurred in past
and has no relevance in future costs.

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 forgone.
 Life cycle cost

Figure 2-1 Phases of the Life Cycle and Their

Relative Cost
The general economic environment
Consumer and Producer goods and services

Consumer goods or 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 other producer goods.
 Measures of Economic worth

• Necessities
• Luxuries
• Price
• Demand
General Price
Demand Relationship
The constant “a” is the
intercept on the price
axis and embodies the
effects of all factors
other than price that
effect demand.
“b” is the slope of the
demand curve and
show how the price of
the good affect the
quantity demanded.
Total Revenue Function as a Function of Demand
Combined Cost and Revenue Functions, and Breakeven
Points, as Functions of Volume, and Their Effect on
Typical Profit (Scenario 1)

Profit (loss)

In order for a profit to occur,

Combined Cost and Revenue Functions, and Breakeven
Points, as Functions of Volume, and Their Effect on
Typical Profit (Scenario 1)

In order for a profit to occur,

two conditions must be met.
1. (a-cv) > 0 , the price per
unit that will result in no
demand has to be
greater than the variable
cost per unit
2. TR must exceed total cost
(CT) for the period
involved.
Combined Cost and Revenue Functions, and Breakeven
Points, as Functions of Volume, and Their Effect on
Typical Profit (Scenario 1)
If the above conditions are
met we can find the optimal
demand at which the
maximum profit occurs

d(profit)/dD = a-cv-2bD = 0

D*= a-cv/2b
d2 (profit)/dD2 = -2b
Combined Cost and Revenue Functions, and Breakeven
Points, as Functions of Volume, and Their Effect on
Typical Profit (Scenario 1)
Economic breakeven points
occurs at:
Total revenue = Total cost
aD – bD2 = CF - cvD
Figure 2-6 Typical Breakeven Chart with Price (p) a
Constant (Scenario 2)

Total revenue = Total cost

aD – bD2 = CF – cvD
pD’ = CF + cvD’
D’ = CF / ( p – cv)
 Problems
Problem 2-14, 2-16, 2-20 to be done in class.