THEgBASICSgOFgENGINEERINGgECONOMY
Engineeringgisgthegprofessiongingwhichgagknowledgegofgthegmathematicalga
ndgnaturalgscienceggainedgbygstudy,gexperiencegandgpracticegisgappliedgwithgjudge
mentgtogdevelopgwaysgtogutilize,geconomicallygthegmaterialsgandgforcesgofgnaturegf
orgthegbenefitgofgmankind.gIngthisgdefinition,gthegeconomicgaspectsgofgengineeringgar
egemphasized,gasgwellgasgthegphysicalgaspects.gClearly,gitgisgessentialgthatgthegecon
omicgpartgofgengineeringgbegaccomplishedgwell.
Ingmanufacturing,gengineeringgisginvolvedgingeverygdetailgofgagproduct’sgprod
uction,gfromgthegconceptualgdesigngtogthegshipping.gIngfact,gengineeringgdecisionsga
ccountgforgthegmajoritygofgproductgcosts.gEngineersgmustgconsidergthegeffectiveguseg
ofgcapitalgassetsgsuchgasgbuildinggandgmachinery.gOnegofgthegengineer’sgprimarygta
sksgisgtogplangforgthegacquisitiongofgequipmentg(capitalgexpenditure)gthatgwillgenableg
thegfirmgtogdesigngandgproducegproductsgeconomically.
Engineeringgeconomygisgthegdisciplinegconcernedgwithgthegeconomicgaspe
ctgofgengineering.gItginvolvesgthegsystematicgevaluationgwithgthegeconomicgmeritsgof
proposedgsolutionsgtogthegengineeringgproblems.gTogbegeconomicallygacceptableg(i
g
.e.,gaffordable),gsolutionsgtogengineeringgproblemgmustgdemonstrateg agpositivegbal
ancegofglonggtermgbenefitsgoverglonggtermgcost.
Engineeringgeconomicsgisgthegapplicationgofgeconomicgtechniquesgtogthege
valuationgofgdesigngandgengineeringgalternatives.gThegrolegofgengineeringgeconomi
csgisgtogassessgthegappropriatenessgofgaggivengproject,gestimategitsgvalue,gandgjustif
ygitgfromgangengineeringgstandpoint.
ThegGeneralgEconomicgEnvironment
Theregaregnumerousggeneralgeconomicgconceptsgthatgmustgbegtakengintogac
countgingengineeringgstudies.
EngineeringgEconomy Pageg1
, • Consumerggoodsgandgservicesgaregthosegproductsgorgservicesgthatgaregdir
ectlygusedgbygpeoplegtogsatisfygtheirgwants.gExamplesgaregfoods,g clothing,gh
omes,gcars,ghaircutsgandgmedicalgservices.
• Producerggoodsgandgservicesgaregusedgtogproducegconsumerggoodsgandg
servicesgandgothergproducerggoods.gExamplesgaregmachinegtools,gfactorygbu
ildings,gbusesgandgfarmgmachinery.
• Pricegofggoodsgandgservicesgisgdefinedgtogbegthegpresentgamountgofgmone
ygorgitsgequivalentgwhichgisggivengingexchangegforgit.
• Demandgisgagquantitygofgcertaingcommoditygthatgisgboughtgatgagcertaing price
atgaggivengplacegandgtime.
g
• Supplygisgagquantitygofgagcertaingcommoditygthatgisgofferedgforgsalegatgagcerta
ingpricegatgaggivengplacegandgtime.
• Perfectgcompetitiongoccursgingagsituationgingwhichganyggivengproductgisgsup
pliedgbygaglargegnumbergofgvendorsgandgtheregisgnogrestrictiongingadditionalgs
uppliersgenteringgthegmarket.
• Perfectgmonopolygexistsgwhengaguniquegproductgorgservicegisgavailablegfro
mgagsinglegsuppliergandgthatgvendorgcangpreventgthegentrygofgallgothersgintogt
hegmarket.
• Oligopolygoccursgwhengtheregaregfewgsuppliersgandganygactiongtakengbygan
yonegofgthemgwillgdefinitelygaftergthegcoursegofgactiongofgthegothers.
• TotalgRevenuegisgthegproductgofgthegsellinggpricegpergunitgandgthegnumbergof
unitsgsold.
g
• TotalgCostgisgthegsumgofgthegfixedgcostsgandgthegvariablegcosts.
• Profit/gLossgisgthegdifferencegbetweengtotalgrevenuegandgthegtotalgcosts.
CostgTerminology
Costgconsiderationsgandgcomparisonsgaregfundamentalgaspectsgofgengineer
inggpractice.gBeforegthegstudygofgvariousgengineeringgeconomicgdecisionsgproblems
,gthegconceptgofgvariousgcostsgmustgbegunderstand.gAtgtheglevelgofgplantgoperations,g
engineersgmustgmakegdecisionsginvolvinggmaterials,gplantgfacilitiesgandgthegin-
housegcapabilitiesgofgcompanyglevel.
EngineeringgEconomy Pageg2
, • Fixedgcostsgaregthosegunaffectedgbygchangesgingactivityglevelgovergagfeasibl
egrangegofgoperationsgforgthegcapacitygorgcapabilitygavailable.gExamplesgareg
insurancegandgtaxesgongfacilities,ggeneralgmanagementgandgadministrativegs
alaries,glicensegfees,gandginterestgcostsgongborrowedgcapital.
• Variableg costsg areg thoseg associatedg withg ang operationg thatg varyg ing total
withgthegquantitygofgoutputgorgothergmeasuresgofgactivityglevel.gExamplesg are
thegcostsgofgmaterialgandglaborgusedgingagproductgorgservice.
g
• Incrementalg costg isg theg additionalg costg (org revenue)g thatg resultsg from
increasinggthegoutputgofgthegsystemgbygonegorgmoregunits.
• Recurringgcostsgaregthosegthatgaregrepetitivegandgoccurgwhengangorganizati
ongproducesgsimilarggoodsgorgservicesgongagcontinuinggbasis.
• Nonrecurringgcostsgaregthosegwhichgaregnotgrepetitivegevengthoughgthegtot
algexpendituregmaygbecomegcumulativegovergagrelativelygshortgperiodgofgtime
.
• Directgcostsgaregcostsgthatgcangbegreasonablygmeasuredgandgallocatedgtoga
specificgoutputgorgworkgactivity.gExamplesgareglaborgandgmaterialgcosts.
g
• Indirectgcostsgaregthosegthatgaregdifficultgtogattributegorgallocategtogagspecific
outputgorgworkgactivity.gExamplesgaregthegcostsgofgcommongtools,ggeneralgs
g
upplies,gandgequipmentgmaintenance.
• Overheadgcostgconsistsgofgplantgoperatinggcostsgthatgaregnotgdirectglaborg or
directgmaterialgcosts.gExamplesgaregelectricity,ggeneralgrepairs,gpropertygtax
g
esgandgsupervision.
• Standardgcostsgaregrepresentativegcostsgpergunitgofgoutputgthatgaregestablis
hedgingadvancegofgactualgproductiongorgservicegdelivery.
• Cashgcostsgaregthatginvolvesgpaymentgofgcash.
• Noncashgcostsg(bookgcosts)garegcostsgthatgdoesgnotginvolvegagcashgpayme
nt,gbutgrathergrepresentgthegrecoverygofgpastgexpendituresgovergagfixedgperio
dgofgtime.gExamplegisgthegdepreciationgcharged.
EngineeringgEconomy Pageg3
, • Sunkgcostgisgonegthatghasgoccurredgingthegpastgandghasgnogrelevancegtogesti
matesgofgfuturegcostsgandgrevenuesgrelatedgtogangalternativegcoursegofgactio
n.
• Opportunitygcostgisgincurredgbecausegofgthegusegofglimitedgresourcesg such
thatgthegopportunitygtogusegthosegresourcesgtogmonetarygadvantagegingangalt
g
ernativegusegisgforegone.
• Life-
cyclegcostgrefersgtogagsummationgofgallgthegcosts,gbothgrecurringgandgnonrec
urring,grelatedgtogproduct,gstructuregsystem,gorgservicesgduringgitsg lifegspan.
• Investmentgcostgisgthegcapitalgrequiredgforgmostgofgthegactivitiesgingthegacqu
isitiongphase.
• Workinggcapitalgrefersgtogthegfundsgrequiredgforgcurrentgassetsgthatgaregnee
dedgforgthegstartupgandgsupportgofgoperationalgactivities.
• OperationalgandgMaintenancegcostgincludesgmanygofgthegrecurringgannual
expensegitemsgassociatedgwithgthegoperationgphasegofgtheglifeg cycle.
g
• Disposalgcostgincludesgthosegnonrecurringgcostsgofgshuttinggdowngthegoper
ationgandgthegretirementgandgdisposalgofgassetsgatgthegendgofgtheglifegcycle.gT
hesegcostsgwillgbegoffsetgingsomeginstancesgbygreceiptsgfromgthegsalegofgasse
tsgwithgremaininggvalue.
• Economicglifegcoincidesgwithgthegperiodgofgtimegextendinggfromgthegdategof
acquisitiongtogthegdategofgabandonment,gdemotionginguse,gorgreplacementgfr
omgthegprimarygintendedgservice.
• Ownershipglifeg isgthegperiodgbetweengtheg dategofgacquisitiongandgtheg date
ofgdisposalgbygagspecificgowner.
• Physicalglifegisgthegperiodgbetweengoriginalgacquisitiongandgfinalgdisposalg of
angassetgovergthegsuccessiongofgowner.
g
• Usefulglifegisgthegtimegperiodgthatgangassetgisgkeptgingproductivegserviceg(eith
ergprimarygorgbackup).gItgisgangestimategofghowglonggangassetgisgexpectedgtog
begusedgingagtradegorgbusinessgtogproducegincome.
EngineeringgEconomy Pageg4
Engineeringgisgthegprofessiongingwhichgagknowledgegofgthegmathematicalga
ndgnaturalgscienceggainedgbygstudy,gexperiencegandgpracticegisgappliedgwithgjudge
mentgtogdevelopgwaysgtogutilize,geconomicallygthegmaterialsgandgforcesgofgnaturegf
orgthegbenefitgofgmankind.gIngthisgdefinition,gthegeconomicgaspectsgofgengineeringgar
egemphasized,gasgwellgasgthegphysicalgaspects.gClearly,gitgisgessentialgthatgthegecon
omicgpartgofgengineeringgbegaccomplishedgwell.
Ingmanufacturing,gengineeringgisginvolvedgingeverygdetailgofgagproduct’sgprod
uction,gfromgthegconceptualgdesigngtogthegshipping.gIngfact,gengineeringgdecisionsga
ccountgforgthegmajoritygofgproductgcosts.gEngineersgmustgconsidergthegeffectiveguseg
ofgcapitalgassetsgsuchgasgbuildinggandgmachinery.gOnegofgthegengineer’sgprimarygta
sksgisgtogplangforgthegacquisitiongofgequipmentg(capitalgexpenditure)gthatgwillgenableg
thegfirmgtogdesigngandgproducegproductsgeconomically.
Engineeringgeconomygisgthegdisciplinegconcernedgwithgthegeconomicgaspe
ctgofgengineering.gItginvolvesgthegsystematicgevaluationgwithgthegeconomicgmeritsgof
proposedgsolutionsgtogthegengineeringgproblems.gTogbegeconomicallygacceptableg(i
g
.e.,gaffordable),gsolutionsgtogengineeringgproblemgmustgdemonstrateg agpositivegbal
ancegofglonggtermgbenefitsgoverglonggtermgcost.
Engineeringgeconomicsgisgthegapplicationgofgeconomicgtechniquesgtogthege
valuationgofgdesigngandgengineeringgalternatives.gThegrolegofgengineeringgeconomi
csgisgtogassessgthegappropriatenessgofgaggivengproject,gestimategitsgvalue,gandgjustif
ygitgfromgangengineeringgstandpoint.
ThegGeneralgEconomicgEnvironment
Theregaregnumerousggeneralgeconomicgconceptsgthatgmustgbegtakengintogac
countgingengineeringgstudies.
EngineeringgEconomy Pageg1
, • Consumerggoodsgandgservicesgaregthosegproductsgorgservicesgthatgaregdir
ectlygusedgbygpeoplegtogsatisfygtheirgwants.gExamplesgaregfoods,g clothing,gh
omes,gcars,ghaircutsgandgmedicalgservices.
• Producerggoodsgandgservicesgaregusedgtogproducegconsumerggoodsgandg
servicesgandgothergproducerggoods.gExamplesgaregmachinegtools,gfactorygbu
ildings,gbusesgandgfarmgmachinery.
• Pricegofggoodsgandgservicesgisgdefinedgtogbegthegpresentgamountgofgmone
ygorgitsgequivalentgwhichgisggivengingexchangegforgit.
• Demandgisgagquantitygofgcertaingcommoditygthatgisgboughtgatgagcertaing price
atgaggivengplacegandgtime.
g
• Supplygisgagquantitygofgagcertaingcommoditygthatgisgofferedgforgsalegatgagcerta
ingpricegatgaggivengplacegandgtime.
• Perfectgcompetitiongoccursgingagsituationgingwhichganyggivengproductgisgsup
pliedgbygaglargegnumbergofgvendorsgandgtheregisgnogrestrictiongingadditionalgs
uppliersgenteringgthegmarket.
• Perfectgmonopolygexistsgwhengaguniquegproductgorgservicegisgavailablegfro
mgagsinglegsuppliergandgthatgvendorgcangpreventgthegentrygofgallgothersgintogt
hegmarket.
• Oligopolygoccursgwhengtheregaregfewgsuppliersgandganygactiongtakengbygan
yonegofgthemgwillgdefinitelygaftergthegcoursegofgactiongofgthegothers.
• TotalgRevenuegisgthegproductgofgthegsellinggpricegpergunitgandgthegnumbergof
unitsgsold.
g
• TotalgCostgisgthegsumgofgthegfixedgcostsgandgthegvariablegcosts.
• Profit/gLossgisgthegdifferencegbetweengtotalgrevenuegandgthegtotalgcosts.
CostgTerminology
Costgconsiderationsgandgcomparisonsgaregfundamentalgaspectsgofgengineer
inggpractice.gBeforegthegstudygofgvariousgengineeringgeconomicgdecisionsgproblems
,gthegconceptgofgvariousgcostsgmustgbegunderstand.gAtgtheglevelgofgplantgoperations,g
engineersgmustgmakegdecisionsginvolvinggmaterials,gplantgfacilitiesgandgthegin-
housegcapabilitiesgofgcompanyglevel.
EngineeringgEconomy Pageg2
, • Fixedgcostsgaregthosegunaffectedgbygchangesgingactivityglevelgovergagfeasibl
egrangegofgoperationsgforgthegcapacitygorgcapabilitygavailable.gExamplesgareg
insurancegandgtaxesgongfacilities,ggeneralgmanagementgandgadministrativegs
alaries,glicensegfees,gandginterestgcostsgongborrowedgcapital.
• Variableg costsg areg thoseg associatedg withg ang operationg thatg varyg ing total
withgthegquantitygofgoutputgorgothergmeasuresgofgactivityglevel.gExamplesg are
thegcostsgofgmaterialgandglaborgusedgingagproductgorgservice.
g
• Incrementalg costg isg theg additionalg costg (org revenue)g thatg resultsg from
increasinggthegoutputgofgthegsystemgbygonegorgmoregunits.
• Recurringgcostsgaregthosegthatgaregrepetitivegandgoccurgwhengangorganizati
ongproducesgsimilarggoodsgorgservicesgongagcontinuinggbasis.
• Nonrecurringgcostsgaregthosegwhichgaregnotgrepetitivegevengthoughgthegtot
algexpendituregmaygbecomegcumulativegovergagrelativelygshortgperiodgofgtime
.
• Directgcostsgaregcostsgthatgcangbegreasonablygmeasuredgandgallocatedgtoga
specificgoutputgorgworkgactivity.gExamplesgareglaborgandgmaterialgcosts.
g
• Indirectgcostsgaregthosegthatgaregdifficultgtogattributegorgallocategtogagspecific
outputgorgworkgactivity.gExamplesgaregthegcostsgofgcommongtools,ggeneralgs
g
upplies,gandgequipmentgmaintenance.
• Overheadgcostgconsistsgofgplantgoperatinggcostsgthatgaregnotgdirectglaborg or
directgmaterialgcosts.gExamplesgaregelectricity,ggeneralgrepairs,gpropertygtax
g
esgandgsupervision.
• Standardgcostsgaregrepresentativegcostsgpergunitgofgoutputgthatgaregestablis
hedgingadvancegofgactualgproductiongorgservicegdelivery.
• Cashgcostsgaregthatginvolvesgpaymentgofgcash.
• Noncashgcostsg(bookgcosts)garegcostsgthatgdoesgnotginvolvegagcashgpayme
nt,gbutgrathergrepresentgthegrecoverygofgpastgexpendituresgovergagfixedgperio
dgofgtime.gExamplegisgthegdepreciationgcharged.
EngineeringgEconomy Pageg3
, • Sunkgcostgisgonegthatghasgoccurredgingthegpastgandghasgnogrelevancegtogesti
matesgofgfuturegcostsgandgrevenuesgrelatedgtogangalternativegcoursegofgactio
n.
• Opportunitygcostgisgincurredgbecausegofgthegusegofglimitedgresourcesg such
thatgthegopportunitygtogusegthosegresourcesgtogmonetarygadvantagegingangalt
g
ernativegusegisgforegone.
• Life-
cyclegcostgrefersgtogagsummationgofgallgthegcosts,gbothgrecurringgandgnonrec
urring,grelatedgtogproduct,gstructuregsystem,gorgservicesgduringgitsg lifegspan.
• Investmentgcostgisgthegcapitalgrequiredgforgmostgofgthegactivitiesgingthegacqu
isitiongphase.
• Workinggcapitalgrefersgtogthegfundsgrequiredgforgcurrentgassetsgthatgaregnee
dedgforgthegstartupgandgsupportgofgoperationalgactivities.
• OperationalgandgMaintenancegcostgincludesgmanygofgthegrecurringgannual
expensegitemsgassociatedgwithgthegoperationgphasegofgtheglifeg cycle.
g
• Disposalgcostgincludesgthosegnonrecurringgcostsgofgshuttinggdowngthegoper
ationgandgthegretirementgandgdisposalgofgassetsgatgthegendgofgtheglifegcycle.gT
hesegcostsgwillgbegoffsetgingsomeginstancesgbygreceiptsgfromgthegsalegofgasse
tsgwithgremaininggvalue.
• Economicglifegcoincidesgwithgthegperiodgofgtimegextendinggfromgthegdategof
acquisitiongtogthegdategofgabandonment,gdemotionginguse,gorgreplacementgfr
omgthegprimarygintendedgservice.
• Ownershipglifeg isgthegperiodgbetweengtheg dategofgacquisitiongandgtheg date
ofgdisposalgbygagspecificgowner.
• Physicalglifegisgthegperiodgbetweengoriginalgacquisitiongandgfinalgdisposalg of
angassetgovergthegsuccessiongofgowner.
g
• Usefulglifegisgthegtimegperiodgthatgangassetgisgkeptgingproductivegserviceg(eith
ergprimarygorgbackup).gItgisgangestimategofghowglonggangassetgisgexpectedgtog
begusedgingagtradegorgbusinessgtogproducegincome.
EngineeringgEconomy Pageg4
