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ECGD4214ECGD4214

Systems Engineering & EconomySystems Engineering & Economy

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Lecture 1Lecture 1Part 1Part 1

Introduction toIntroduction toEngineering EconomicsEngineering Economics

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Presentation OutlinePresentation Outline IntroductionIntroduction PurposePurpose ObjectiveObjective Examples of daily life applicationsExamples of daily life applications Basic issuesBasic issues The Decision-Making ProcedureThe Decision-Making Procedure Principles Governing the Engineering Principles Governing the Engineering

Economy ProcedureEconomy Procedure Projects within OrganizationsProjects within Organizations

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Introduction Engineering Economics is the discipline concerned Engineering Economics is the discipline concerned

with the economic aspects of engineering, and with the economic aspects of engineering, and involves the systematic evaluation of the costs and involves the systematic evaluation of the costs and benefits of proposed technical and business benefits of proposed technical and business projects.projects.

The principles and methodology of engineering The principles and methodology of engineering economics are crucial to the daily management of economics are crucial to the daily management of private companies, government agencies, and private companies, government agencies, and nonprofit organizations.nonprofit organizations.

They are used to assist with decision making in They are used to assist with decision making in situations such as selecting among alternative situations such as selecting among alternative engineering designs, public works projects, engineering designs, public works projects, replacement of assets, and in assessing the replacement of assets, and in assessing the economic merits of alternative uses of your economic merits of alternative uses of your personal funds. personal funds.

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PurposePurpose

Dealing with economic analysis and evaluation of Dealing with economic analysis and evaluation of engineering projectsengineering projects

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ObjectiveObjective

Implementation of systematic evaluation of costs and benefits of engineering projects in order to:

- Decide whether or not to carry out a project

- Choose among independent projects, i.e., capital budgeting

- Choose between alternative technologies for a project

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Examples of daily life applicationsExamples of daily life applications

Purchase/rental of automobiles

Economics of home rental/rehabilitation/building

Personal investments

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Basic issuesBasic issues

- Identification and quantification of life-cycle benefits and costs of project or project alternatives

- Analysis of time value of money

- Effects of depreciation, taxes, inflation, and uncertainty

- For a single project, do benefits exceed costs by a sufficient enough margin?

- private firms: easier to determine

- public projects: more difficult

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Basic issuesBasic issues

for selection among several alternatives

comparison of relative benefits and costs

selection among mutually exclusive projects

selection among independent projects

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A. Scientific Approach

• Cause - effect relationship

Understand

Explore

Suggest

The Decision-Making Process

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The Decision-Making Process

B. Practitioner Operational Approach1. Problem definition Problem tree for baseline conditions Indicators based

2. Set up Objectives Planning horizon Needs assessment Objective Tree (SMART) Indicators based

3. Development of Possible Alternatives

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The Decision-Making Process

4. Analysis and Comparison the Alternatives

Develop decision or evaluation criteria (sustainability based). Criteria include: social, economic/financial, environmental, and institutional factors

Quantification of life-cycle costs and benefits for each alternative

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The Decision-Making Process

5. Selection of the Preferred Alternative(s) and decision making

6. Implementation of recommended solution(s)

7. Performance Monitoring, Post-evaluation and feedback

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Categories ofDecision Making Process

Decision making under Decision making under certaintycertainty in in which the data are known which the data are known deterministicallydeterministically

Decision making under Decision making under riskrisk in which in which the data can be described by the data can be described by probability distributions.probability distributions.

Decision making under Decision making under uncertaintyuncertainty in which the data cannot be assigned in which the data cannot be assigned weights that represent their degree weights that represent their degree of relevance in the decision process.of relevance in the decision process.

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Principles Governing the Engineering Economy Procedure

Define goals and objectivesDevelop alternativesFocus on the differencesUse a consistent viewpointUse a common unit of measureConsider all relevant criteriaMake uncertainty explicitRevisit your decisions

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Projects within Organizations

Projects form part of the overall organizational planning process as shown in the diagram

Projects play a major role in implementing organizational strategy

Vision

Mission

ProjectsProgramsStrategy

Sector Goal(s)

Objectives

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Lecture 1Lecture 1Part 2Part 2

Cost ConceptsCost Concepts&&

Economic EnvironmentEconomic Environment

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Cost ConceptsCost Concepts

1. Fixed, Variable, Average, and Marginal Costs1. Fixed, Variable, Average, and Marginal Costs

- - Variable CostsVariable Costs:: Costs that vary with the level of activityCosts that vary with the level of activity Examples: labor, material, …Examples: labor, material, …

- - Fixed CostsFixed Costs:: Costs that do not vary with the level of activityCosts that do not vary with the level of activity Examples: rent, property tax, insurance, or Examples: rent, property tax, insurance, or

interest interest expense.expense.

- Total Costs: - Total Costs: The total sum of variable cost(s) and fixed The total sum of variable cost(s) and fixed

cost(s).cost(s).

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Cost Concepts (Cost Concepts (continuedcontinued))

- Average Costs:- Average Costs: Computed as total costs divided by the number Computed as total costs divided by the number

of units producedof units produced Typically decreases with increased quantity Typically decreases with increased quantity

produced (may increase at higher production)produced (may increase at higher production)

- - Marginal CostsMarginal Costs::

The change in total costs that arises when The change in total costs that arises when the quantity produced changes by one the quantity produced changes by one unit. “The cost of the next unit produced”. unit. “The cost of the next unit produced”.

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22 . .Recurring vs Non-recurring CostsRecurring vs Non-recurring Costs

- Recurring CostsRecurring Costs: Costs occurring : Costs occurring repetitively over the life of the repetitively over the life of the project/activityproject/activity

- Non-recurring CostsNon-recurring Costs: One-time costs: One-time costs

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3. Direct vs Indirect (Overhead) Costs3. Direct vs Indirect (Overhead) Costs

- Direct Costs- Direct Costs:: costs directly associated with costs directly associated with product or serviceproduct or service

- Indirect (overhead) Costs- Indirect (overhead) Costs:: costs that cannot costs that cannot easily be allocated to specific activity or easily be allocated to specific activity or serviceservice

4. Sunk Costs4. Sunk Costs

- Past costs that is irrelevant for current - Past costs that is irrelevant for current analysisanalysis

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5. Opportunity Costs5. Opportunity Costs

Potential loss of benefits, revenue or Potential loss of benefits, revenue or income based on next best use of income based on next best use of moneymoney

6. Life-cycle Costs6. Life-cycle Costs

Summation of all costs over all phases of Summation of all costs over all phases of the lifetime of project, from conception, the lifetime of project, from conception, design, construction, operation and design, construction, operation and service, to replacement or disposal:service, to replacement or disposal:• Phases of lifecycle costs Phases of lifecycle costs • Potential for cost savings at different Potential for cost savings at different

phasesphases

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7. Incremental CostsDifferences in costs between alternative investments or activities

8. Cash Costs Versus Book Costs- A cash cost requires the cash transaction of

money out of one person’s pocket into the pocket of someone else.

Example: When you buy dinner for your friends or make your monthly car payment, you are incurring a cash cost or cash flow.

- Book costs do not require the transaction of money. They are cost effects from past decisions that are recorded in the accounting books of a firm (asset depreciation)

- Cash costs and cash flows are the basis of engineering economic analysis

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9. The9. The Break Even PointBreak Even PointItIt is the point where total revenue received is the point where total revenue received equals total costs associated with the sale of equals total costs associated with the sale of the product the product ((i.e., TRi.e., TR==TCTC). ). A break even point A break even point is typically calculated in order for different is typically calculated in order for different businessesbusinesses to determine if it would be to determine if it would be profitable to sell a proposed productprofitable to sell a proposed product. .

10. Cost Estimating10. Cost EstimatingApproximating the cost of resources Approximating the cost of resources

11. Cost Budgeting11. Cost BudgetingAllocating costs to tasks Allocating costs to tasks

12. Cost Control12. Cost ControlControlling changes to budget elementsControlling changes to budget elements

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Economic EnvironmentEconomic Environment

1. Supply Function1. Supply Function

- Fixed costs- Fixed costs

- Variable costs- Variable costs

- Total and average costs- Total and average costs

2. Demand Function2. Demand Function

- Fixed price- Fixed price

- Price as a function of demand- Price as a function of demand

- Alternate demand functional forms- Alternate demand functional forms

- Total revenue function- Total revenue function

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3 .Demand-Supply Interaction

3.1 Fixed selling price:

-Break even point -How many units if single producer?

3.2 Price as a function of demand:

-Break even points -Range of profitable production

-Optimal production level

Economic EnvironmentEconomic Environment

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The Average Total Cost CurveThe Average Total Cost Curve

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I want to maximize profitsI want to maximize profits..How much output should I sell, at the given priceHow much output should I sell, at the given price??The answer isThe answer is: : increase output until P = MPincrease output until P = MP = = MC MC

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General supply and demand curvesGeneral supply and demand curveswith intersection showing free market equilibriumwith intersection showing free market equilibrium

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An outAn out- - or rightor right- - shift in demandshift in demandchanges the equilibrium price and quantitychanges the equilibrium price and quantity

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An outAn out- - or rightor right- - shift in supplyshift in supplychanges the equilibrium price and quantitychanges the equilibrium price and quantity

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Total utility and marginal utility

Total and Marginal UtilityTotal and Marginal Utility

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LifeLife CycleCycle CostCost TypicalTypical