1 ECGD4214 Systems Engineering & Economy

2 Lecture 1 Part 1 Introduction to Engineering Economics

3 Presentation Outline Introduction Introduction Purpose Purpose Objective Objective Examples of daily life applications Examples of daily life applications Basic issues Basic issues The Decision-Making Procedure The Decision-Making Procedure Principles Governing the Engineering Economy Procedure Principles Governing the Engineering Economy Procedure Projects within Organizations Projects within Organizations

4 Introduction Engineering Economics 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. Engineering Economics 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. The principles and methodology of engineering economics are crucial to the daily management of private companies, government agencies, and nonprofit organizations. The principles and methodology of engineering economics are crucial to the daily management of private companies, government agencies, and nonprofit organizations. They are used to assist with decision making in situations such as selecting among alternative engineering designs, public works projects, replacement of assets, and in assessing the economic merits of alternative uses of your personal funds. They are used to assist with decision making in situations such as selecting among alternative engineering designs, public works projects, replacement of assets, and in assessing the economic merits of alternative uses of your personal funds.

5 Purpose Purpose Dealing with economic analysis and evaluation of engineering projects Dealing with economic analysis and evaluation of engineering projects

6 Objective 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

7 Examples of daily life applications Examples of daily life applications Purchase/rental of automobiles Economics of home rental/rehabilitation/building Personal investments

8 Basic issues Basic 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

9 Basic issues for selection among several alternatives comparison of relative benefits and costs selection among mutually exclusive projects selection among independent projects

10 A. Scientific Approach Cause - effect relationship Understand Explore Suggest The Decision-Making Process

11 The Decision-Making Process B. Practitioner Operational Approach 1. 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

12 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

13 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

14 Categories of Decision Making Process Decision making under certainty in which the data are known deterministically Decision making under certainty in which the data are known deterministically Decision making under risk in which the data can be described by probability distributions. Decision making under risk in which the data can be described by probability distributions. Decision making under uncertainty in which the data cannot be assigned weights that represent their degree of relevance in the decision process. Decision making under uncertainty in which the data cannot be assigned weights that represent their degree of relevance in the decision process.

15 Principles Governing the Engineering Economy Procedure  Define goals and objectives  Develop alternatives  Focus on the differences  Use a consistent viewpoint  Use a common unit of measure  Consider all relevant criteria  Make uncertainty explicit  Revisit your decisions

16 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

17 Lecture 1 Part 2 Cost Concepts & Economic Environment

18 Cost Concepts 1. Fixed, Variable, Average, and Marginal Costs 1. Fixed, Variable, Average, and Marginal Costs - Variable Costs: Costs that vary with the level of activity Costs that vary with the level of activity Examples: labor, material, … Examples: labor, material, … - Fixed Costs: Costs that do not vary with the level of activity Costs that do not vary with the level of activity Examples: rent, property tax, insurance, or interest expense. Examples: rent, property tax, insurance, or interest expense. - Total Costs: The total sum of variable cost(s) and fixed cost(s).

19 Cost Concepts (continued) - Average Costs:  Computed as total costs divided by the number of units produced  Typically decreases with increased quantity produced (may increase at higher production) - Marginal Costs: The change in total costs that arises when the quantity produced changes by one unit. “ The cost of the next unit produced ”.

20 2. Recurring vs Non-recurring Costs - Recurring Costs: Costs occurring repetitively over the life of the project/activity - Non-recurring Costs: One-time costs

21 3. Direct vs Indirect (Overhead) Costs 3. Direct vs Indirect (Overhead) Costs - Direct Costs: costs directly associated with product or service - Indirect (overhead) Costs: costs that cannot easily be allocated to specific activity or service 4. Sunk Costs 4. Sunk Costs - Past costs that is irrelevant for current analysis

22 5. Opportunity Costs 5. Opportunity Costs Potential loss of benefits, revenue or income based on next best use of money 6. Life-cycle Costs 6. Life-cycle Costs Summation of all costs over all phases of the lifetime of project, from conception, design, construction, operation and service, to replacement or disposal: Phases of lifecycle costsPhases of lifecycle costs Potential for cost savings at different phasesPotential for cost savings at different phases

23 7. Incremental Costs Differences 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

24 9. The Break Even Point 9. The Break Even Point It is the point where total revenue received equals total costs associated with the sale of the product (i.e., TR=TC). A break even point is typically calculated in order for different businesses to determine if it would be profitable to sell a proposed product. 10. Cost Estimating 10. Cost Estimating Approximating the cost of resources 11. Cost Budgeting 11. Cost Budgeting Allocating costs to tasks 12. Cost Control 12. Cost Control Controlling changes to budget elements

25 Economic Environment 1. Supply Function - Fixed costs - Variable costs - Total and average costs 2. Demand Function - Fixed price - Price as a function of demand - Alternate demand functional forms - Total revenue function

26 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 Environment

27 The Average Total Cost Curve

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

29 General supply and demand curves with intersection showing free market equilibrium

30 An out- or right- shift in demand changes the equilibrium price and quantity

31 An out- or right- shift in supply changes the equilibrium price and quantity

32 Total utility and marginal utility Total and Marginal Utility

33 Life Cycle Cost Typical