1. Engineering Economic Analysis Canadian Edition Chapter 1: Making Economic Decisions

2. 1-2EECE 450 — Engineering Economics Chapter 1 … Distinguishes between simple and complex problems. Discusses the role and purpose of engineering economic analysis. Describes the economic decision- making process. Relates economic criteria and problems.

3. 1-3EECE 450 — Engineering Economics Decision making Decision making is a major aspect of everyday life. Individuals, households, and firms face daily problems Engineers need tools to analyze and solve the economic problems they face. Complex problems can be broken down to produce sensible solutions. We make better decisions when we know the decision making process and we know how to use the appropriate tools to make comparisons between competing alternatives.

4. 1-4EECE 450 — Engineering Economics People are Surrounded by Problems Which career should I pursue? What level of preparation is required for the career chosen? Where may the preparation be obtained? How will I get ready and go to class? The problems are often not isolated from each other.

5. 1-5EECE 450 — Engineering Economics Organizations Have Opportunities Should we use a drilling machine or a boring machine? When must we replace the drilling machine? What is the better alternative: a mechanized machine or a computerized machine? Where do we locate machinery in the plant? We arrive at decisions about problems and opportunities like these through economic analysis.

6. 1-6EECE 450 — Engineering Economics Problems Problems can be classified into simple, intermediate, and complex. Classifying problems can be difficult due to their complexity and ‘personality’. One approach is to classify a problem according to its degree of difficulty.

7. 1-7EECE 450 — Engineering Economics Simple Problems No requirement for sophisticated models or extensive analysis Limited number of variables and future consequences These problems are manageable. Changes in value over time are not crucial Pay with cash or by credit card? Travel to work by car or by public transit? Buy a softcover or a hardcover novel?

8. 1-8EECE 450 — Engineering Economics Intermediate Problems Must be organized and analyzed Are sufficiently important to justify serious thought and action Have significant economic aspects Are primarily economic Are the principal subject of this course Assume an economic situation in equilibrium Are generally adequately solved with single- criteria decision making

9. 1-9EECE 450 — Engineering Economics Complex Problems Such problems represent a mixture of three elements: economic political social Complex problems are beyond the scope of this course, but the economic aspects of complex problems will be discussed.

10. 1-10EECE 450 — Engineering Economics The Role of Engineering Economic Analysis Assists in making decisions where: the decision is sufficiently important that serious thought and effort are required; careful analysis requires that the decision variables be carefully organized and the consequences be understood; economic issues are a significant component of the analysis leading to a decision.

11. 1-11EECE 450 — Engineering Economics Examples of Engineering Economic Analysis Focus on costs, revenues, and benefits that occur at different times All engineering designs call for spending money. Engineering questions Which projects are worthwhile? How should projects be designed? Questions or issues for engineers as individuals How to achieve goals? Making the best investment decisions

12. 1-12EECE 450 — Engineering Economics Economics Economics is the social science that studies how people cope with the problem of scarcity: choices made by individuals, businesses, govern- ments, and societies as they cope with scarcity. Scarcity: inability to satisfy all of a society’s wants or desires at a specific point in time. Scarcity involves making choices. A choice is a tradeoff which involves a cost:  giving up something to get something else;  the highest-valued alternative given up is the opportunity cost of the activity chosen. Whatever we choose to do, we could have done something else instead.

13. 1-13EECE 450 — Engineering Economics Satisfying Needs: The Engineer’s Role Engineering and scientific knowledge Social needs The engineer

14. 1-14EECE 450 — Engineering Economics Two Concerns of Engineering Engineers have the dual task of determining: 1.What society wants (what it needs), and 2.How best to combine economic resources, processes, etc. to produce the goods and services desired by society. Efficiency: physical and economic efficiency must be considered.

15. 1-15EECE 450 — Engineering Economics Physical and Economic Efficiency Physical efficiency Measure of the success of engineering activity in the physical environment; ratio of outputs to inputs Maximum physical efficiency ratio is 1 (or 100%) Physical units include BTUs, kilowatt-hours, etc. Economic efficiency Ratio of value to cost; must exceed 1 or 100% An engineer must produce outputs that are most valued (of greatest satisfaction) by society (economic efficiency)

16. 1-16EECE 450 — Engineering Economics Evolution of Economic and Physical Efficiency 1970s+ ECONOMIC SPHERE ENGINEERING SPHERE Economic Efficiency Significant overlap ENGINEERING SPHERE 1950s ECONOMIC SPHERE (Economic efficiency ) Independent decision making Physical efficiency (Physical efficiency )

17. 1-17EECE 450 — Engineering Economics The Decision Making Process 1.Recognize the problem. 2.Define the goal or objective. 3.Assemble relevant data. 4.Identify feasible alternatives. 5.Select the criterion for determining the best alternative. 6.Construct a model. 7.Predict each alternative’s outcomes or consequences. 8.Choose the best alternative. 9.Audit the result.

18. 1-18EECE 450 — Engineering Economics At first, the problem is given. Later, you might have to analyze the information provided to determine the real problem. 1. Recognize the Problem A problem exists when: a standard or expectation is not being met. a new standard or expectation is established and needs to be achieved. (An opportunity.)

19. 1-19EECE 450 — Engineering Economics 2. Define the Goal or Objective A goal or objective is the standard or expectation we wish to meet. A goal is a general statement about what we expect.  Pay all our bills on time. An objective is narrow and specific.  Schedule a payment to be made on the auto loan on Tuesday via internet banking.

20. 1-20EECE 450 — Engineering Economics 3. Assemble Relevant Data Information may be published or come from individual knowledge. Deciding which data is relevant may be a complex process. Two important sources of data are the organization’s accounting and purchasing departments.

21. 1-21EECE 450 — Engineering Economics Example 1-1 3. Assemble Relevant Data …

22. 1-22EECE 450 — Engineering Economics 4. Identify Feasible Alternatives The best alternative should be implemented. Sometimes, the best alternative is to maintain the current situation or the “status quo”. When alternatives are considered, they should include both conventional and innovative approaches. Only feasible alternatives should be retained for further analysis.

23. 1-23EECE 450 — Engineering Economics 5. Select the Criterion to Determine the Best Alternative A criterion (or a set of criteria) is a standard or a measure of merit that is used to evaluate the alternatives to determine which is best. The “best” alternative is relative, not absolute. Selecting criteria to use is not easy because different groups often support different criteria. The criterion most often used in economic decision-making is to use money in the most efficient manner.

24. 1-24EECE 450 — Engineering Economics Panoply of Standards The following standards should always be considered: Minimize negative environmental consequences. Improve the distribution of income or wealth. Minimize costs. Ensure the gains of winners exceed the losses of losers. Maximize profit or sales. Minimize project completion time. Minimize the creation of inefficiencies, like unemployment.

25. 1-25EECE 450 — Engineering Economics Three Categories of Economic Decision Making Problems 1.For fixed input situations, maximize the benefits or other outputs. 2.For fixed output situations, minimize the costs or other inputs. 3.Where inputs and outputs vary, maximize (Benefits – Costs).

26. 1-26EECE 450 — Engineering Economics 6. Construct the Model Model construction requires merging the various elements: objective and relevant data, feasible alternatives, and selection criteria. In economic decision making, the models are usually mathematical. A model is a representation of reality. A model must represent the important parts of the system at hand. A model must be adequate to solve the problem.

27. 1-27EECE 450 — Engineering Economics 7. Predicting the Outcomes for Each Alternative To avoid complications, we assume that a decision is based on a single criterion. If necessary, multiple criteria can be combined into a single criterion. Usually, the consequences or alternatives are stated in the form of money, i.e. costs and benefits. Costs and benefits may occur over a short or long time period.

28. 1-28EECE 450 — Engineering Economics 8. Choosing the Best Alternative When choosing the best alternative, both economic and non-economic criteria must be considered. During the prior steps in the decision making process, only dominant alternatives may be included based on either economic or non- economic criteria. The elimination of feasible alternatives may predetermine the outcome of the decision making process.

29. 1-29EECE 450 — Engineering Economics 9. Audit the Results Compare the results of changes to the predictions to assure that the chosen alternative was implemented as planned and the results are as expected. Fix deviations from planned changes. Make sure prediction errors are not repeated. Identify added opportunities. Audits promote realistic economic analysis and implementation.

30. 1-30EECE 450 — Engineering Economics Example 1-2 Some short time-period economic decisions are illustrated in this example.

31. 1-31EECE 450 — Engineering Economics The Engineering Process Key steps by the engineering community must be taken to ensure that their activities will satisfy social needs/wants. economic efficiency Engineering activities that are not valued by society will waste scarce resources. Increase the gap between social wants and the capacity to satisfy them.

32. 1-32EECE 450 — Engineering Economics Why ‘Engineering Economics’? The engineer has a dual role: consumer and business decision maker. Engineering: consider problems in which economic aspects dominate. Economics: Time-value mechanics Economic efficiency  Scarcity of resources  Unlimited social needs Choices must be made — not all wants can be satisfied.

33. 1-33EECE 450 — Engineering Economics Suggested Problems from Chapter 1: 1-3, 1-9, 1-14, 1-18, 1-23, 1-31, 1-32, 1-35, 1-37, 1-38, 1-40, 1-41, 1-42.