Engineering Economy: Basic Concept & Principles

Background

Engineering economy, often known as economic analysis in engineering or engineering finance, is the study of how to allocate resources to achieve a certain goal in the most effective way possible. It is a discipline of engineering concerned with the financial aspects of decision-making, such as evaluating and comparing alternatives based on their costs and advantages.

The engineering economy has expanded to embrace a wide range of applications, such as infrastructure project design and construction, the creation of new technologies, and the optimization of manufacturing processes. It is a necessary tool for engineers because it enables them to assess the long-term financial repercussions of their actions and select the most cost-effective options.

One of the key concepts in the engineering economy is the time value of money, which states that the value of a given amount of money changes over time due to inflation and the opportunity cost of not investing the money elsewhere. This concept is used to compare the costs and benefits of different alternatives by taking into account the time frame in which they will occur.

Engineering economics also entails the use of financial methods, such as net present value and internal rate of return, to assess the profitability of various solutions. These tools enable engineers to assess the costs and benefits of several alternatives and select the one that will deliver the highest return on investment.

To summarize, the engineering economy is a critical discipline that enables engineers to make informed judgments about how to allocate resources in the most cost-effective manner. Its beginnings may be traced back to the early 18th century, and it has expanded to embrace a wide range of applications in the design and construction of infrastructure projects, the development of new technologies, and the optimization of manufacturing processes.

Key Concepts in Engineering Economics

1. Time value of money: This concept states that the value of a given amount of money changes over time due to inflation and the opportunity cost of not investing the money elsewhere.
2. Net present value (NPV): This is a measure of the profitability of an investment, calculated by taking the present value of the expected cash flows and subtracting the initial investment.
3. Internal rate of return (IRR): This is the discount rate that makes the NPV of an investment equal to zero. It is used to compare the profitability of different investments.

4. Benefit-cost ratio (BCR): This is the ratio of the benefits of an investment to its costs. A BCR greater than 1 indicates that the investment is financially viable.
5. Demand and Supply: Demand and supply are free market economic principles or forces that govern what producers want to produce and what buyers want to buy and pay for.

Why Does an Engineer Need To Understand Economics?

An engineer needs to understand economics for several reasons:

1. Cost-benefit Analysis: Engineers are often required to make resource allocation decisions in order to achieve a specific goal. Economics assists them in weighing the costs and benefits of several choices and selecting the most cost-effective solution.
   
2. Financial Feasibility: Engineers need to consider the financial feasibility of their projects in order to ensure that they are viable and will provide a good return on investment. Economics provides the tools and concepts needed to evaluate the profitability of different alternatives.
   
3. Resource Allocation: Engineers frequently must make decisions on how to best allocate limited resources. Economics assists them in understanding the trade-offs involved and making informed decisions.
   
4. Long-term Planning: Many engineering projects have long-term implications and require long-term planning. Economics helps engineers to consider the long-term financial implications of their decisions and to choose the most cost-effective options.
   
5. Essential in Everyday Life: The knowledge gained from studying economics is useful in both personal and social scenarios. The ability to evaluate operating and maintenance costs is critical in determining which materials should be utilized and why.  In order to maintain financial stability, should an engineer be mandated to pay his or her bills (electricity, internet, garbage, etc…)? Economics exposes students to the many vocabularies and problem-solving skills needed by engineers, making them less frightened.
   

Overall, understanding economics is essential for engineers as it allows them to make informed decisions about the allocation of resources and to ensure the financial viability of their projects.

Principles of an Engineering Economy

The principles of engineering economy are a set of guidelines that help engineers evaluate and compare the costs and benefits of different alternatives in order to make informed decisions about the allocation of resources. Some of the key principles are:

1. Develop the Alternatives:  The principle of developing alternatives refers to the process of identifying and evaluating different options or courses of action in order to choose the most suitable one. This principle is often applied in engineering economics, where it involves identifying and evaluating the costs and benefits of different alternatives in order to choose the most cost-effective option.
   
   Developing alternatives is an important step in decision-making as it allows engineers to consider a range of options and choose the one that best meets their needs and goals. It helps to ensure that the decision-making process is thorough and well-informed and that the chosen option is the best one available.
   
   To develop alternatives, engineers may use a variety of tools and techniques, such as brainstorming, SWOT analysis, and cost-benefit analysis. They may also involve other stakeholders, such as clients, users, and subject matter experts, in the process to ensure that all relevant perspectives are considered.
   
2. Focus on Differences: The principle of focusing on the difference relates to the concept that while comparing options, it is vital to consider their differences rather than their similarities. This theory is frequently used in engineering economics to compare the costs and advantages of many alternatives in order to select the most cost-effective solution.
   
   Focusing on the difference allows engineers to find the important elements that distinguish the options and make informed conclusions about which one is best. It is a key decision-making phase because it allows engineers to evaluate solutions based on the exact criteria that are most relevant to their needs and goals.
   
   Engineers may use a range of tools and techniques, such as cost-benefit analysis, net present value, and internal rate of return, to assess the alternatives based on certain financial parameters in order to focus on the difference. They may also assess other aspects such as technical feasibility, risk, and stakeholder preferences to ensure that all relevant concerns are taken into account.
   
   Imagine that an engineer is considering two alternatives for a manufacturing process: using a traditional manufacturing method or adopting a new automation technology. The engineer needs to choose the most cost-effective option based on a detailed cost-benefit analysis.
   
   To focus on the differences between the alternatives, the engineer might compare the costs and benefits of each option based on specific criteria such as the initial investment, operating costs, and production efficiency. The engineer might also consider other factors such as the technical feasibility, risk, and stakeholder preferences of each option.
   
   By focusing on the differences between the alternatives, the engineer can identify the key factors that differentiate the options and make an informed decision about which one is the most suitable. For example, the engineer might find that automation technology has a higher initial investment but lower operating costs and higher production efficiency, making it the more cost-effective option in the long run.
   
3. Use a Consistent Viewpoint: The principle of using a consistent viewpoint refers to the idea that when evaluating different alternatives, it is important to use the same perspective or frame of reference in order to make fair and accurate comparisons. This principle is often applied in engineering economics, where it involves comparing the costs and benefits of different alternatives in order to choose the most cost-effective option.
   
   Using a consistent point of view allows engineers to compare alternatives on a level playing field and avoid bias toward one choice over another. It is a critical phase in the decision-making process because it enables engineers to make informed and unbiased conclusions about which alternative is best.
   
   Prospective results of economic and other choices should be constantly developed from a specified standpoint (perspective). The decision maker’s point of view is frequently the owner’s point of view. For the success of engineering projects, many perspectives, such as donor, financier, beneficiary group, and stakeholders, may be considered. The viewpoint, however, must be consistent throughout the analysis.
   
   Imagine that an engineer is considering two alternatives for a transportation project: building a traditional highway or building a new light rail system. The engineer needs to choose the most cost-effective option based on a detailed cost-benefit analysis.
   
   It is important that the engineer uses a consistent viewpoint when evaluating the alternatives. For example, if the engineer compares the initial investment of the highway and light rail options in different units of measurement, such as dollars and euros, it would be difficult to accurately compare the options and make an informed decision. To avoid this, the engineer might convert all of the costs and benefits to a common unit of measurement, such as dollars, in order to make fair and accurate comparisons.
   
4. Use a Common Unit of Measurement: The principle of using a common unit of measurement refers to the idea that when evaluating different alternatives, it is important to use a consistent unit of measurement in order to make fair and accurate comparisons. This principle is often applied in engineering economics, where it involves comparing the costs and benefits of different alternatives in order to choose the most cost-effective option.
   
   Using a common unit of measurement helps engineers to ensure that they are comparing the alternatives on a level playing field and that they are not biased towards one option over another. It is an important step in the decision-making process as it allows engineers to make informed and unbiased decisions about which alternative is the most suitable.
   
   For economic consequences, monetary units such as dollars or rupees are the common measure.
   
5. Consider all Relevant Criteria: The principle of considering all relevant criteria refers to the idea that when evaluating different alternatives, it is important to consider all factors that are relevant to the decision in order to make an informed and well-rounded choice. This principle is often applied in engineering economics, where it involves comparing the costs and benefits of different alternatives in order to choose the most cost-effective option.
   
   Considering all relevant criteria helps engineers to ensure that they are making a well-informed decision that takes into account all of the factors that are important to the project or situation. It is an important step in the decision-making process as it allows engineers to make a more comprehensive and balanced assessment of the different alternatives.
   
6. Make Uncertainty Explicit: The principle of making uncertainty explicit relates to the idea that it is critical to acknowledge and account for any uncertainty or uncertainty in the data or assumptions used in the analysis while evaluating different alternatives. This theory is frequently used in engineering economics to compare the costs and advantages of many alternatives in order to select the most cost-effective solution.
   
   Making uncertainty explicit assists engineers in recognizing and understanding the potential risks and uncertainties connected with each choice, allowing them to make more educated and careful judgments. It is a critical decision-making stage because it helps engineers to anticipate and plan for probable risks and uncertainties.
   
   Assume an engineer is considering two options for a bridge project: building a regular concrete bridge or constructing a new sort of composite bridge consisting of steel and concrete. Based on a comprehensive cost-benefit analysis, the engineer must select the most cost-effective solution.
   
   The engineer examines the costs of materials, labor, and other aspects for each possibility as part of the study. However, because composite materials are a relatively new technology, the pricing is not yet fully established in the market, and there is some uncertainty about the cost.
   
   To express uncertainty, the engineer may do a sensitivity analysis to determine how changes in the cost of composite materials affect the overall cost-benefit ratio of the composite bridge option. This could include estimating the cost of resources depending on various situations, such as the best-case scenario, the worst-case scenario, and the most likely scenario. As a result, the engineer will have a better understanding of the potential risks and uncertainties connected with the composite bridge option and will be able to make a more informed decision about which option is the most cost-effective.
7. Revisit Your Decision: The principle of revisiting your decision refers to the idea that it is important to periodically review and assess your decisions in order to ensure that they are still relevant and appropriate given any changes in the circumstances. This principle is often applied in engineering economics, where it involves reviewing and assessing the costs and benefits of different alternatives in order to ensure that the chosen option is still the most cost-effective.
   
   Revisiting your decision helps engineers to adapt to changing circumstances and to ensure that their decisions are still aligned with their goals and objectives. It is an important step in the decision-making process as it allows engineers to make any necessary adjustments and to ensure that they are on track to achieve their desired outcomes.
   
   By periodically reviewing and reassessing their decisions, engineers can ensure that they are making the most cost-effective and appropriate choices.

What is the role of Engineers in an Economic decision?

Engineers play a crucial role in economic decision-making, as they are often responsible for evaluating and comparing the costs and benefits of different alternatives in order to choose the most cost-effective option. In this role, engineers use principles of engineering economics to analyze the financial feasibility of different projects and to make informed decisions about the allocation of resources.

Some specific tasks that engineers may perform in the economic decision-making process are:

1. Identifying and evaluating different alternatives: Engineers may use tools such as cost-benefit analysis, net present value, and internal rate of return to compare the costs and benefits of different alternatives and choose the most cost-effective option.
   
2. Assessing financial feasibility: Engineers may use financial metrics such as return on investment (ROI) and payback period to evaluate the profitability of different alternatives and ensure that they are financially viable.
   
3. Analyzing risk: Engineers may use tools such as sensitivity analysis and risk assessment to identify and evaluate the potential risks and uncertainties associated with different alternatives and to make more informed decisions.
   
4. Collaborating with other stakeholders: Engineers may work with clients, users, and subject matter experts to ensure that all relevant perspectives are considered in the decision-making process.
   

Overall, the role of engineers in economic decision-making is to use their technical expertise and financial analysis skills to evaluate the costs and benefits of different

Design Process in an Engineering Economy

The design process in the engineering economy involves a series of steps that engineers follow to identify, evaluate, and choose the most cost-effective solution to a given problem. The specific steps of the design process may vary depending on the specific context and goals of the project, but generally, it includes the following stages:

1. Define the problem: The first step in the design process is to clearly define the problem that needs to be solved. This involves identifying the needs and goals of the project, as well as any constraints or limitations that may impact the design.
   
2. Generate ideas: The next step is to generate ideas for potential solutions to the problem. This may involve brainstorming sessions with a team of engineers or other stakeholders or using tools such as SWOT analysis to identify strengths, weaknesses, opportunities, and threats.
   
3. Evaluate alternatives: Once a range of potential solutions has been identified, the next step is to evaluate the alternatives based on their costs and benefits. This may involve using tools such as cost-benefit analysis, net present value, and internal rate of return to compare the financial feasibility of different options.
   
4. Select the best solution: Based on the evaluation of the alternatives, the next step is to choose the most cost-effective solution. This may involve considering additional factors such as technical feasibility, risk, and stakeholder preferences in order to make a well-rounded decision.
   
5. Implement the solution: Once the best solution has been chosen, the final step is to implement it. This may involve designing and building the solution, as well as testing and verifying that it meets the desired specifications and requirements.
   

Overall, the design process in the engineering economy is a systematic and iterative process that helps engineers to identify and choose the most cost-effective solution to a given problem.