Introduction to
Engineering
Economics
Introduction to Engineering Economics
Engineering Economics is the process of analyzing, comparing, and
evaluating economic outcomes when multiple alternatives exist to achieve a
specific goal. It provides a structured approach to making informed financial
decisions by applying mathematical techniques that simplify economic
comparisons.
Introduction to Engineering Economics
Engineers frequently use economic principles to analyze projects, synthesize
information, and reach conclusions, regardless of project size.
Engineering Economics is central to decision-making, as it involves
fundamental financial elements such as cash flow, time, and interest rates.
While computers, mathematical models, and guidelines aid in the process, it
is ultimately people who make the final decisions. Since these decisions
impact future outcomes,
Four Key Components
of Engineering Economics
1. Cash flows – The movement of money in and out of a project.
2. Timing of cash flows – When cash inflows and outflows occur.
3. Interest rates – The cost or benefit of money over time.
4. Economic worth – A measure used to compare alternatives.
The Economic Environment
in Engineering Economics
The Economic Environment in Engineering Economics
Types of Goods and Services
• Consumer Goods and Services – Products
or services that are directly used by
individuals to meet their needs and wants.
• Producer Goods and Services – Items
used to manufacture consumer goods or
other producer goods, contributing to the
production process.
The Economic Environment in Engineering Economics
Classification of Goods Based on Necessity
• Necessities – Essential products or services required to sustain life and
daily activities. Their demand remains relatively stable even when prices
fluctuate.
• Luxuries – Non-essential products or services that individuals desire but
will only purchase if they have extra financial resources after covering
necessities
The Economic Environment in Engineering Economics
Concepts of Demand and Supply
• Demand – The amount of a particular product or service that consumers are willing to buy at
a specific price, place, and time.
• Elastic Demand – Occurs when a drop in price leads to a significantly higher increase in sales.
• Inelastic Demand – Happens when a decrease in price results in only a slight increase in
sales.
• Unitary Elasticity of Demand – A situation where the total revenue (price multiplied by volume
sold) remains unchanged despite price fluctuations.
• Supply – The amount of a product or service that sellers are willing to offer at a specific price,
place, and time
The Economic Environment in Engineering Economics
Market Structures
• Perfect Competition – A market scenario where multiple vendors offer the same
product or service, and there are no barriers preventing new competitors from
entering the market.
• Monopoly – The opposite of perfect competition, where a single supplier
dominates the market with no competition.
• Perfect Monopoly – A situation where a unique product or service is exclusively
available from one supplier, who has complete control over market entry.
• Oligopoly – A market structure where only a few suppliers exist, and the actions of
one seller significantly impact the decisions of others.
Economic Laws in
Engineering
THE LAW OF SUPPLY AND DEMAND & THE LAW OF DIMINISHING
RETURNS
Law of Supply and Demand
In a perfectly competitive market, the price of a product is determined by the
point where supply and demand are equal.
This equilibrium price ensures that the quantity of goods produced by
suppliers matches the quantity that consumers are willing to purchase.
When demand exceeds supply, prices tend to rise, encouraging more
production. Conversely, when supply surpasses demand, prices fall, leading
to reduced production.
Law of Supply and Demand
The Law of Diminishing Returns
When one factor of production is limited—either
due to cost constraints or an absolute quantity
cap—there comes a point where increasing the
use of other variable factors results in a less
than proportional increase in output. Initially,
adding more input leads to a significant rise in
productivity, but beyond a certain point, the
gains diminish.
Cost Concepts
for Decision Making
Cost Concepts for Decision Making
1. Fixed Costs - Fixed costs remain unchanged regardless of variations in production
or activity levels within a certain operational range. These costs do not fluctuate
with the number of units produced. Examples include:
• Insurance and property taxes on facilities
• Salaries of administrative and general management personnel
• License fees
• Interest expenses on borrowed capital
Cost Concepts for Decision Making
2. Variable Costs change in total depending on the level of production or activity but
remain constant per unit. Examples include:
• Costs of raw materials
• Direct labor expenses
• Utility costs that vary with production output
Cost Concepts for Decision Making
3. Incremental Costs and Revenue
• Incremental Cost – The additional cost incurred when production or activity
level increases by one or more units.
• Incremental Revenue – The extra income generated from increasing output by
one or more units.
Illustrative Problems
Understanding Cost Concepts
in Decision-Making
Understanding Cost Concepts in Decision-Making
1. Direct and Indirect Costs
• Direct Costs are expenses that can be clearly linked to a specific product, service,
or activity. These typically include raw materials and labor directly involved in
production. For instance, the materials used to manufacture a pair of scissors are
considered direct costs.
• Indirect Costs are expenses that cannot be easily assigned to a particular output
but are necessary for operations. These are often distributed proportionally using
various allocation methods. Examples include shared tools, general supplies, and
equipment maintenance.
Understanding Cost Concepts in Decision-Making
2. Overhead and Standard Costs
• Overhead Costs cover operational expenses that are neither direct labor nor direct
material. These include electricity, property taxes, maintenance, and administrative
supervision.
• Standard Costs are predetermined costs per unit of output, established before
production begins. These costs help in estimating future expenses, measuring
performance, preparing bids, and valuing inventory.
Understanding Cost Concepts in Decision-Making
3. Cash, Book, and Sunk Costs
• Cash Costs involve actual monetary transactions and impact cash flow.
• Book Costs do not require cash payments but represent past expenditures
distributed over time, such as depreciation on assets like buildings or machinery.
• Sunk Costs are past expenses that no longer affect future decisions and should be
excluded from economic analysis. An example is money spent on a nonrefundable
deposit.
Understanding Cost Concepts in Decision-Making
4. Opportunity Costs
• Opportunity Cost refers to the potential benefits lost when choosing one
alternative over another. For instance, a student who forgoes a ₱1,000,000 annual
salary to study and spends ₱250,000 on education has an opportunity cost of
₱1,250,000
Understanding Cost Concepts in Decision-Making
5. Life-Cycle Costs Life-cycle costs encompass all expenses associated with a
product, structure, or system from acquisition to disposal. These include:
• Investment Cost (Capital Investment): Initial expenses required to acquire assets
or complete a project.
• Operation and Maintenance (O&M) Cost: Recurring expenses related to resources
like labor, equipment, and energy during the operation phase.
• Disposal Cost: Expenses incurred in decommissioning, shutting down operations,
or safely disposing of assets. In some cases, selling remaining assets can offset
these costs.
Present Economic Studies
Present Economic Studies
In engineering economics, there are instances where interest rates do not play a
significant role in decision-making. These cases are commonly referred to as present
economy problems.
Such studies typically focus on comparing different alternatives in terms of design,
materials, or methods to determine the most cost-effective option.
Illustrative Problems
