Engineering Economics
Lecture 1
Book We are going to follow
“Principles of Engineering Economics with Applications”
by
Zahid A. Khan,
Arshad N. Siddiquee,
Brajesh Kumar,
Mustufa H. Abidi
Economics
• Economics is about choice and is at the heart of all decision-making.
Individuals, businesses and governments are all faced with making
choices in situations where resources are scarce.
• Studying economics gives insights into the general environment of
resource allocation decisions, opportunity costs and project evaluation
which are crucial in many areas.
• These insights are not obvious, and can be counter-intuitive to those who
don’t apply economic reasoning.
Engineering Economics
• Is concerned with the formulation, estimation and evaluation of
the economic outcomes of alternatives that are available to accomplish a
defined purpose.
• Engineering economics can be defined as a collection of mathematical
techniques that simplify economic comparison.
• Engineers use the knowledge of engineering economics in
analyzing, synthesizing and drawing conclusions as they work on projects
of different sizes.
• Study of wants efforts wealth satisfaction:
• Every human being is doing some business and every human being has some wants and these
wants are unlimited. To fulfill these wants a person does efforts, by doing efforts he gets wealth
and with this earned wealth he satisfies his wants.
• Study of human behavior with relation to ends and scarce means:
• As long as a person is alive, his wants go on increasing. But the person cannot fulfill all the
wants. The reason is that the resources required to fulfill these wants are limited. Besides the
fact of scarcity of resources, we also find that resources have alternative uses.
• Hence economics is a subject which studies human behavior as a relationship between ends
and scarce means which have alternative uses.
• Economics studies problem of choice:
• Scarcity and choice go together. If things were available in abundance, then there would have
been no problem of choice; the point is that “problems of choice” arise because of scarcity.
Production:
• A process of creation of utility or value in goods or services (or
both).
“Production may be defined as the creation of utilities.”
• Factors of Production: Factors of production are the essential
elements which cooperate with one another in the process of
production. The various factors of production are shown in Fig.
1.3.
Factors of Production
Factors of Production
Land
It is that factor of production which is available to humankind as a free gift of
nature.
Labor
It is the physical or mental effort of human beings in the process of production.
Services of a doctor, lawyer, teacher, worker in the factory, all constitute labor.
Capital
Capital is man-made material and is a source of production. It consists of the part
of production which is used for further production.
Entrepreneurship
Entrepreneurship refers to the skills of the entrepreneur:
(a) to organize business
(b) to undertake risks of business
Consumption
In economics, consumption has a special meaning; it means the use of
or utility of goods and services for the direct satisfaction of individual
and collective wants.
For example: When you eat bread, you are using up the want-
satisfying capacity of bread, that is, its utility.
Consumption
Individual Consumption
It is that consumption which leads to the final satisfaction of the wants of an individual.
Collective consumption
It is that consumption which leads to the final satisfaction of collective wants. For example:
Uses of roads, dams, bridges or parks.
Investment or Capital formation
Investment or capital formation is the third vital process or essential activity
of an economy. “Investment is that part of production during a year which is
not consumed but saved as capital formation for further production.”
The excess of production over consumption in an accounting year is called
capital formation or investment.
I=Y−C
I = Investment, Y = Income, C = Consumption.
Some fundamental relationships
• Production = Consumption + Investment
Q=C+I
Q = Production
• Income = Consumption + Saving
Y=C+S
S = Saving
• Saving = Investment
S=I
I=Y–C Q=C+I Q–C=Y–C
Q=Y
Y=C+S C+S=C+I
S=I
• In other words, the circular flow of income can be explained
using the flowchart shown in Fig. 1.5.
The flow of production, income and expenditure never stops.
It is a circular flow without a beginning or an end.
• Production generates income, income generates demand for
goods and services, and demand generates expenditure on
the goods and services which leads to their production, so
that the circle of production, consumption and expenditure
always continues.
Performance of economic
activities
Economic activities are undertaken by the following sectors of
the economy:
• Household Sector:
• This sector includes households, who consumes goods and services,
and provides factor services.
• Firms or Business Sector:
• The firm produces goods and services by using factor services.
• Government Sector:
• The government sector undertakes both consumption as well as
production.
Flow of income
There are two types of flow of income in an economy:
• Real flow of income
• Monetary flow of income
Real flow of income:
It involves the flow of factor services from the household sector to
the producing sector and the corresponding flow of goods and
services from producing sector to household sector.
Monetary flow of income:
It refers to the flow of factor income e.g.: rent, interest, profit,
wages and so on from the producing sector to the household
sector as rewards for their factor services.
The households spend their income on the goods and services
produced by the producing sector.
According to it, the money flows back to the producing sector.
CIRCULAR FLOW OF INCOME IN DIFFERENT
SECTORS
• Two sector model It studies the circular flow of Income between the
household and
producing sector on the assumption that there are only two sectors in the
economy
Three Sector Model
It refers to the study of the circular flow of income among:
(i) Household sector
(ii) Producing sector
(iii) Government sector
Here the assumption that the economy comprises of these three sectors.
It is a closed economy
Four Sector Model
It studies the study of the circular flow of income among:
(i) Household sector
(ii) Producing sector
(iii) Government sector
(iv) Foreign sector or rest of the world.
In other words, it studies the flow of income in an open economy. The model studies all
sectors of the economy, dropping all the simple assumptions made earlier