ENGINEERING

ECONOMY
Engineering Economy is the
discipline concerned with the
economic aspects of engineering
and involves the systematic
evaluation of the costs and benefits
of proposed technical and business
projects and ventures. The
principles and methodology of
engineering economy are integral
part of the daily management and
operation of private sector
companies and corporations,
regulated public utilities,
government units or agencies and
nonprofit organizations.
Engineering economy
involves formulating,
estimating, and evaluating
the expected economic
outcomes of alternatives
designed to accomplish a
defined purpose. These
decisions involve the
fundamental elements of
cash flows of money,
time, and interest rates.
 Decisions are made routinely to choose one alternative
over another by individuals in everyday life; by engineers on the
job; by managers who supervise the activities of others; by
corporate presidents who operate a business; and by government
officials who work for the public good. Most decisions involve
money, called capital or capital funds , which is usually limited
in amount. The decision of where and how to invest this limited
capital is motivated by a primary goal of adding value as future,
anticipated results of the selected alternative are realized.
Engineers play a vital role in capital investment decisions based
upon their ability and experience to design, analyze, and
synthesize. The factors upon which a decision is based are
commonly a combination of economic and noneconomic
elements. Engineering economy deals with the economic factors.
Principles of Engineering Economy

1. Develop the Alternatives. The choice(decision) is

among alternatives. The alternatives need to be
identified and then defined for subsequent analysis. A
decision situation involves making a choice among two
or more alternatives. Developing and defining the
alternatives for detailed evaluation is important because
of the resulting impact on the quality of the decision.
2. Focus on the Differences. Only the differences is
expected future outcomes among the alternatives are
relevant to their comparison and should be considered in
the decision. Differences in the future outcomes of the
alternatives that are important. The purpose of an
engineering economic analysis is to recommend a future
course of action based on the differences among feasible
alternatives.
3. Use a Consistent Viewpoint. The
prospective outcomes of the alternatives,
economic and other should be consistently
developed from a defined point of view. The
viewpoint is important particularly in decision
making and used consistently in the description,
analysis, and comparison of the alternatives.
4. Use a common unit of measure. Using a
common unit of measurement to enumerate as
many of the prospective outcomes as possible
will make easier the analysis and comparison
of the alternatives. It is desirable to make
directly comparable the maximum numbers of
prospective using a monetary unit such as
dollars or peso as the common unit of
measurement.
5. Consider all relevant criteria. Selection of a
preferred alternative(decision making) requires the
use of a criterion or criteria. The decision process
should consider the outcomes enumerated in the
monetary unit and those expressed in some other
unit of measurement or made explicit in a
descriptive manner.
6. Make uncertainty explicit(clear). Uncertainty
is inherent in projecting(or estimating) the future
outcomes of the alternatives and should be
recognized in their analysis and comparison. The
analysis of the alternatives involves projecting or
estimating the future consequences associated with
each of them. Estimating the magnitude and the
impact of future outcomes of any course of action
is uncertain.
 Engineering Economy and the Design Process
Engineering Economic Analysis Engineering Design Process
Procedure
Steps: Activity:
[Link] recognition, formulation, and evaluation 1. Problem/need definition
2. Problem/need formulation and evaluation
2. Development of the feasible alternatives 3. Synthesis of possible solutions( alternatives)
* synthesis- combination, put together
3. Development of the net cash flow for each [Link], optimization and evaluation
alternatives * optimization-to make something as good or as
effective as possible.
4. Selection of a criterion(or criterion)
5. Analysis and comparison of the alternatives

6. Selection of the preferred alternatives 5. Specification of preferred alternative

*specification- detailed description of work
7. Performance evaluation and post-evaluation of 6. Communication
results
The time frame of engineering economy is
primarily the future . Therefore, the
numbers used in engineering economy are
best estimates of what is expected to
occur . The estimates and the decision
usually involve four essential elements:
1. Cash flows
2. Times of occurrence of cash flows
3. Interest rates for time value of
money
4. Measure of economic worth for
selecting an alternative
 Performing an Engineering Economy Study

The steps in an engineering economy study are as follows:

1. Identify and understand the problem; identify the objective of the project.
2. Collect relevant, available data and define viable solution alternatives.
3. Make realistic cash flow estimates.
4. Identify an economic measure of worth criterion for decision making.
5. Evaluate each alternative; consider noneconomic factors; use sensitivity
analysis as needed.
6. Select the best alternative.
7. Implement the solution and monitor the results.
 Cost Concepts and the Economic Environment

Accomplishing engineering design

to meet economic needs and to achieve
competitive operations in private and
public sector organizations depends on a
prudent balance between what is
technically feasible and what is
economically acceptable. However there is
no shortcut method available to reach this
balance between technical and economic
feasibility.
The word cost has meaning that
vary in usage since the cost concepts used
in an engineering economy study will
depend on the problem or situation and the
decision to be made.
 Cost Terminology
• First cost (also known as initial cost, investment
cost) is the cost of getting an activity started.
Ordinarily occurs only once for any given activity.
Example: cost of land and design and construction
cost of a factory building
• Fixed costs are those that are unaffected by
changes in activity level over a feasible range of
operations for the capacity available. Example:
insurance and taxes on facilities, interest on
borrowed capital
• Variable costs are those associated with an
operation that will vary in total with the quantity of
output. Example: cost of materials, labor, fuel
consumption
• Incremental Cost refers to the
additional cost, or revenue, that will
result from increasing the output of a
system by one or more units.
Example of incremental cost is the
cost of producing a barrel of oil and
cost of educating a student.

• Operation and maintenance

costs are costs experienced
continually over the useful life of
an investment project or venture;
contains most of the recurring
costs associated with operating a
business or project. Examples:
wages, materials, cost of power
• Direct costs are those that can be reasonably
measured and allocated to a specific output or
work activity. Example: cement needed to make
hollow blocks, labor and material cost directly
associated with a product, service or construction
activity.
• Indirect costs (other terms are overhead cost or
burden) are those that are difficult to attribute or
allocate to a specific output or work activity.
Example: cost of electricity needed to provide
lighting to a factory; cost of common tools,
general supplies and equipment maintenance.
• Overhead cost consists of plant operating costs
that are not direct labor or direct material costs.
Examples of overhead includes electricity,
general repairs, property taxes and supervision.
• Sunk cost is one that has occurred -can not be recovered and cost spent
in the past and has no relevance to for the past period
estimates of future costs and Ex. replace of water pump, building in
revenues related to an alternative manufacturing plant, spend in
course of action. Example: In automobile
deciding whether one should
replace an old machine with a new
one, the purchase cost of the old
machine is generally treated as a
sunk cost -potential benefit acquired when an
• Opportunity cost is the cost of the alternative is selected
best rejected (foregone)opportunity Ex. Not attending college of 4 years,
and is often hidden or implied. your finances for college is the
opportunity cost
• Working capital refers to the
funds required for current assets(
other than fixed assets such as
equipment, facilities and etc.)
that are needed for the start and
subsequent support of operation
activities. The amount of
working capital needed will vary
with the project involved.
Example: Capital for inventory
of products and services, capital
for spare parts, tools, trained
personnel for maintenance
activities
The General Economic Environment

Consumer and Producer Goods and Services. Consumer goods and services
are those products or services that are directly used by people to satisfy their wants.
Food, clothing, home, cars, television sets, haircuts, movie, and medical services are
examples. The producers of consumer goods and services must be aware of, and are
subject to the changing wants of the people to whom their products are sold. The
demand for such goods and services is directly related to people and many in cases
may be determined with considerable certainty.

Producer goods and services are used to produce consumer goods and services
or other producer goods. Machine tools, factory buildings, buses, and farm machinery
are examples. The amount of producer goods needed are determined indirectly by the
amount of consumer goods or services that are demanded by people.
Measures of Economic Worth

Goods and services are produced

and desired , because directly or
indirectly they have utility. Utility is the
power to satisfy human wants and needs.
Thus they may be used or consumed
directly, or may be used to produce other
goods or services that may be used
directly. Utility most commonly is
measured in terms of value, expressed in
some medium exchange as the price that
must be paid to obtain particular item.
Example: Iron to make razor blade,
lumber into furniture
Necessities versus Luxuries

Economic status is an important factor in

one’s views regarding luxuries and necessities.
Most goods and services may consider necessities
in one person but luxury to other. For example, a
person living in a community find that car is a
necessity to get to and from work however if
transportation is adequate and available, having a
car is luxury. The classification of goods and
services into luxuries and necessities is less easy
for producer goods than for consumer goods.
There is a relationship between the price that
must be paid and the quantity that that will be
demanded or purchased.
 Price and Demand 𝑝=𝑎−𝑏𝐷 𝐷=
𝑎− 𝑝
𝑏
As the selling price per Where: = selling price
unit() is increased, D = demand( number of unit)
= intercept on the price(
there will be less -b= slope
demand(D) for the
product, and as the
selling price is
decreased, the demand
will increase.
Example: Discount on
pants and polo shirts.
y, slope intercept formula
The extent to which prize 𝒑
changes influence demand
varies according to the Tomatoe-Php 100
Oppo Reno- Php 20, 000

elasticity of the demand.

The demand for products is
said to be elastic when a
decrease in the selling price
results in a considerable
increase in sales. If a change
in selling prize produces
little or no effect on the
demand, the demand is
elastic. Tomatoe-Php 5.00 Oppo Reno-Php 5,000
𝑫
Demand(Consumer)
 Competition

• Perfect Competition occurs in a situation in which

any given product is supplied by a large number of
vendors and there is no restriction on additional
vendors entering the market. There is assurance of
complete freedom on the part of the of both buyer and
seller.
• Monopoly exist when a unique product or service is
available from a single vendor and that vendor can
prevent the entry of all others in to the market. The
buyer is at the complete mercy of the vendor in terms
of the availability and price of the product.
• Oligopoly exists when there are so few suppliers of
the product or service that action by one will almost
inevitably result in similar action by the others.
Example. 3 gasoline station community
The Total Revenue Function(Total Sales)

The total revenue, TR, is the result from a business venture during a given
period is the product of the selling price per unit, and the number of units sold, D.

TR =price x demanda( napagbentahan)

TR =

Maximum Total Demand

Revenue is the income that a
business has from its normal
business activities, usually
from the sale of goods and
services to customers
Cost, Volume, and Breakeven Point

Fixed cost remain constant over a wide range of activities as long as the
business does not permanently discontinue operations, but variable costs vary in total
with the volume of output.

𝑪𝑻 =𝑪 𝑭 + 𝑪 𝑽 Where: total cost

fixed cost
variable cost
𝑪𝑽 =( 𝒄𝒗 )( 𝑫) variable cost per unit or unit cost
D= demand
 Maximum Profit

Benta Gastos

=
 Break Even Analysis

This involves investment of capital wherein at a certain level of production, the

total income of the company would just be equal to the total expenses resulting in no loss
nor profit. This was illustrate in a chart called break even chart which shows the fixed
costs, variable cost, the expected profit or loss at any production levels. The intersection of
the income and the variable cost indicates the break even point of the point where there is
no loss nor profit

outflow(gastos)=inflow(kita)
Total Cost = Total Revenue
TC=TR
 Break-Even Point

Benta Gastos
Total Revenue = Total Cost
Kamatis
Break
Puhunan/Cost = 20.00/kg x 100 kg = 2000.00
Even/Balik
Benta/Revenue = 40/kg x 50 kg = 2000.00 Puhunan
50 kg = profit/ kita
Sample Problem

1. The cost of producing a ton of Arabica coffee is P500 for labor and P385 for
material inputs. The fixed charge in operating the coffee plantation is P200,000
per month. The other variable cost is P 15 per ton. Each ton of Arabica coffee can
be sold for P 2,500 each. How many tons of coffee must be produced per month to
break even.
a. 75 tonsb. 125 tons c. 82 tons d. 92.5 tons e. none of choice
2. A manufacturer produces certain items at a labor cost per unit of 315, material cost
per unit of 100, variable cost of 3.00 each. If the item has a selling price of 995. How
many units must be manufactured each month for the manufacturer to break even if
the monthly overhead is 461, 600.
3. A company which manufactures electric motors has a production capacity of 200
motors per month. The variable cost are 150 per motor. The average selling price of
the motors is 275.00. Fixed cost of the company amounts to 20,000 per month which
includes taxes. The numbers of motors that must be sold each month to break even is
closest to:
a. 40 b. 150 c. 80 d. 160
1. The cost of producing a ton of Arabica coffee is P500 for labor and P385 for material inputs. The fixed
charge in operating the coffee plantation is P200,000 per month. The other variable cost is P 15 per ton.
Each ton of Arabica coffee can be sold for P 2,500 each. How many tons of coffee must be produced per
month to break even.
a. 75 tons b. 125 tons c. 82 tons d. 92.5 tons e. none of choice

outflow(gastos)=inflow(kita)
Total Cost = Total Revenue
TC=TR
2. A manufacturer produces certain items at a labor cost per unit of 315,
material cost per unit of 100, variable cost of 3.00 each. If the item has a selling
price of 995. How many units must be manufactured each month for the
manufacturer to break even if the monthly overhead is 461, 600.
 3. A company which manufactures electric motors has a production capacity of 200 motors per month. The
variable cost are 150 per motor. The average selling price of the motors is 275.00. Fixed cost of the company
amounts to 20,000 per month which includes taxes. The numbers of motors that must be sold each month to break
even is closest to:
a. 40 b. 150 c. 80 d. 160

outflow(gastos)=inflow(kita)
Total Cost = Total Revenue
TC=TR
4. Magma Tierra is engaged in the research, design and manufacturing of farm implements. The company estimates
that the relationship between unit price and demand per month for a potential product is approximated by p = 112 -
0.01 D. Fixed costs are estimated to be P72,OOO per month, and the estimated variable costs are P26 per unit. How
much is the maximum profit that the company can realize per month?

a. P 96,000 b. 111 ,800 c. 112,900 d. 296,700 e. 156,300

𝒑 =𝒂 −𝒃𝑫
𝒑 =𝒂 −𝒃𝑫
𝑷𝒓𝒐𝒇𝒊𝒕=𝑡𝑜𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒− 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡
5. A company has established that the relationship between the sales price for one of its products and the
quantity sold per month is approximately D=780 – 10p units.( D is the demand or quantity sold per month
and p is the price in dollars). The fixed cost is 800 per month and the variable cost is 30 per unit produced.
What number of unit should be produced per month and sold to maximize profit?
6. A company produces and sells a consumer products and thus far has been able to
control the volume of the product by varying the selling price. The company is
seeking to maximize its net profit. It has been concluded that the relationship between
price and demand per month is approximately D=500-5p., where p is the price. The
fixed cost is 1,000 per month and the variable cost is 20 per unit. What is the optimal
number of units that should be produced and sold per month?
7. White sugar, which sells for P26.50 per kg-pack, can be repacked and sold by a retailer
at a variable cost of P200 per 50kg-sack. If each sack of sugar costs P750 and fixed costs
amount to P30,000 per month, how many sacks of white sugar must the retailer repack
and sell each month to break even?
a. 80 sacks b. 70 sacks c. 60 sacks d. 90 sacks
8. A manufacturing company leases for 100,000 per year a building that houses its
manufacturing facilities. In, addition, the machinery in the building is being paid for in
installments of 20,000 per year. Each unit of the product produced costs 15 in labor and
10 in materials and can be sold for 40 .

1. How many units per year must be sold for the company to break-
even(choose the closest answer).
a. 4, 800 c. 8,000 e. 4,000
b. 3,000 d. 6,667
2. If 10,000 units per year are sold, what is the annual profit( closest
answer)
a. 280,000 c. 50,000 e. 150,000
b. -50,000 d. 30,000
3. If the selling price is lowered to 35 per unit, how many units must be sold
each year for the company to earn a profit of 60,000 per year.
a. 12, 000 c. 10,000 e. 16,000
b. 18,000 d. 5, 143