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Introduction to Engineering Economics

Engineering Economics
Engineering economics is a subcategory of economics for application to engineering projects. Every engineer seeks the solutions to every problem, and the economic practicability of each prospective solution is generally measured along by the technical features.
It is the application of economic techniques to the evaluation of design and engineering substitutes. The prominent role of engineering economics is to assess the appropriateness of a given project also with estimate its value and justify it from an engineering position. Engineering Economics is the study of how to make economic decisions in engineering projects.
Engineers have to participate in various decision-making process in a business firm or industry. So Engineering Economics is required to the engineers to make good economic decisions remaining within the certain constraints.
Engineering economics is the application of economic doctrines and designs to engineering projects. It is essential to all fields of engineering as no matter how technically complete an engineering project is but it will fail if it is not economically viable. Engineering economic analysis is regularly applied to various potential designs for an engineering project in order to select the optimum design, thereby taking into account the both technical and economic viability.
Many basic economic principles may be applied in an engineering economic analysis depending on their application. Time value of money is one such principle with wide applicability which is used to calculate the future value of something from the given present value, or the present value from the given future value, at a given interest rate. Example: time value of money may be used to calculate how much a project will cost (value) once it is actually finished, annual investments or withdrawals may also be calculated. A cash-flow diagram is regularly used to help in the calculation of the time value of money.
When comparing costs among two or more possible substitutes, Engineering economics may either use present or future worth analysis or annual cost. Present or future value analysis converts all the cash flows of a project into equivalent present or future worth. The time period of analysis of the project must be the same for all options for this method to be effective.
Annual cost analysis determines the annual rate of return for a project or projects.
For government engineering projects, a method called benefit/cost analysis is often used.
In manufacturing engineering, break-even analysis is often used which is used to determine the percentile capacity for the manufacturing operation at which total cost is equal to income.Engineers may also use economics to calculate depreciation of value.
All disciplines of engineering employ engineering economics. Engineering economics is a mandatory section of the fundamentals of engineering exam which is required for engineers who desire to achieve professional licensure.

Origin of Engineering Economy
The fundamental aspects of engineering practice are cost considerations and comparisons. However, the development of engineering economy methodology which is now used in all engineering work is relatively new. That does not mean that historically costs were usually ignored in engineering decisions. However, the outlook that ultimate economy is a primary concern to the engineer and the availability of sound technique to address this concern differentiates this aspect of modern engineering practices from that of past.
Arthur M. Wellington, a civil engineer, the pioneer in this field, in the latter part of the 19th century specifically addressed the role of economic analysis in engineering projects. His work was followed by Eugene Grant who published the first edition of his textbook which was the milestone in the development of engineering economy as we know at present. He placed emphasis on developing an economic point of view in engineering. In 1942, Woods and DeGarmo wrote the first edition of this book later entitled ‘Engineering Economy’.

Principles of Engineering Economy
The four fundamental principles that must be applied in all engineering economic decisions are

  • A nearby penny is worth a distant dollar
  • All that counts are the differences among substitutes.
  • Additional risk is not taken without the expected additional return
  • Marginal revenue must exceed the marginal cost

Other secondary principles are:

  • Develop the alternatives
  • Use a common unit of measure
  • Use a consistent viewpoint
  • Consider all relevant criteria
  • Make uncertainty explicit
  • Revisit the decision

Role of Engineers in Engineering Economic Decisions
The term 'engineering economic decision' defined as any investment decision associated with an engineering project. The aspect of an economic decision that is of most interest from an engineer’s perception is the evaluation of benefits and costs associated with making a capital investment. These decisions are to be made by the Engineers considering all the factors such as cash flows, time of occurrence, interest. The decision affects what will be done and the numbers used in this analysis are the best estimates of what is expected to occur in the future.

Types of Engineering Economic Decisions are

  • Selection of equipment or process
  • Replacement of equipment
  • New product or product expansion
  • Reduction of cost
  • Improvement in quality or service.

Steps for Decision-Making Process

  • Understand the problem and define the objectives.
  • Collect relevant information.
  • Define the viable alternative solutions and make realistic assessments.
  • Identify the criteria for decision making using one or more features.
  • Evaluate each and every alternative using sensitivity analysis to enhance the estimate.
  • Select the best and reliable alternative.
  • Implement the best solution and regularly monitor the results.

Cash Flow Diagram
Cash flow is defined as the stream of monetary values, costs, and benefits, resulting from project investment. It is the statement that shows the actual amount coming into or going out of the firm. It considers the cash inflows (costs) and cash outflows (benefits).
The cash flow of engineering projects over time are represented on a cash flow Diagram (CFD). It illustrates the size, sign and timing of individual cash flows and forms the base for engineering economic analyses. Basically, cash flow diagram includes the three things; time, all cash inflows (income, withdrawals) and cash outflows (deposits, expenditures).
The convention on drawing the CFD are

  • All time interval divided into an appropriate number of equal periods.
  • All cash inflows are shown by the upward arrow.
  • All cash outflows are shown by the downward arrow.
  • Arrow length approximately proportional to the magnitude of cash flow.
  • The end of period ‘t’ is the same as the beginning of period ‘t+1’.
     Figure - 01

Chan S.Park, Contemporary Engineering Economics, Prentice Hall, Inc.
E. Paul De Garmo, William G.Sullivan and James A. Bonta delli, Engineering
Economy, MC Milan Publishing Company.
James L. Riggs, David D. Bedworth and Sabah U. Randhawa,Engineering
Economics, Tata MCGraw Hill Education Private Limited.


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