ISU CCEE CE 203 CE 203 Chapter 1 Chapter 1 Economics in Economics in Engineering Engineering Decisions Decisions
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ISU CCEE
CE 203CE 203Chapter 1Chapter 1
Economics in Economics in Engineering Engineering
DecisionsDecisions
ISU CCEE
ISU CCEE
The Significance of The Significance of NumbersNumbersThe Significance of The Significance of NumbersNumbers
23 - 3 9/11 911
ISU CCEE
Personal FinancePersonal FinancePersonal FinancePersonal Finance
How much to save each month for an annual trip
Is graduate school a good investment in my future? Will the loss in income be regained by additional earnings?
Is a higher salary better than stock options?
Can you believe an ad for a car of 15y old and having done only 500 miles?
ISU CCEE
Photo of car in front of the Photo of car in front of the househousePhoto of car in front of the Photo of car in front of the househouse
ISU CCEE
Simple – Should I buy a new mechanical pencil?– Should I buy cash or use credit card?
Intermediate – Which backhoe make/model should we buy?– Shall sub out the concrete work? – Shall we do our own wastewater treatment?
Complex (social, political, economic elements)– Shall we build a new lock and dam at…?
Decisions: Classifying by Decisions: Classifying by ComplexityComplexityDecisions: Classifying by Decisions: Classifying by ComplexityComplexity
ISU CCEE
Could the World Trade Could the World Trade Center have withstood the Center have withstood the 9/11 attacks?9/11 attacks?
Could the World Trade Could the World Trade Center have withstood the Center have withstood the 9/11 attacks?9/11 attacks?
Towers did not collapse immediately Fires brought them down Better fire prevention measures? Sturdier fireproofing adds weight
and cost How much should be spend on new
high-rise buildings to prevent this?
ISU CCEE
Technical– What strength steel is required?– How large a settling tank is required?
Economic – Which backhoe make/model should we buy?– What type of foundation is most cost-
effective?
Societal – Is the wetland in the public’s best interest?
Decisions: Classifying by Decisions: Classifying by TypeTypeDecisions: Classifying by Decisions: Classifying by TypeType
ISU CCEE
Problems emphasized in CE Problems emphasized in CE 203203Problems emphasized in CE Problems emphasized in CE 203203
Intermediate complexity, primarily economic
– Important enough to require analysis
– Difficult enough to require organized, rational approach
– Decided largely or entirely on the basis of costs versus benefits (the single criterion of economics)
ISU CCEE
Problems beyond CE 203Problems beyond CE 203 Problems beyond CE 203Problems beyond CE 203
Complex, a mixture of economic, social, and political elements
– Economic aspects of such problems will be discussed in CE 203
– Classic economic theory assumes that the whole economy is in equilibrium (steady state)
ISU CCEE
Rational Decision Making (9 Rational Decision Making (9 steps)steps) Rational Decision Making (9 Rational Decision Making (9 steps)steps)
(1) Recognize the problem (State A)
– Is there a problem that is solvable?– How can the problem be defined?
(2) Define the goal or objective (State B)
– What do we want (or want to know)?– What change do we desire?
ISU CCEE
Rational Decision Making (9 Rational Decision Making (9 steps)steps)Rational Decision Making (9 Rational Decision Making (9 steps)steps)
(3) Identify/develop alternatives– Use/modify existing solutions– Brainstorm (and other techniques) to
expand solution space– Do nothing (does not imply no change)
ISU CCEE
Rational Decision Making (9 Rational Decision Making (9 steps)steps)Rational Decision Making (9 Rational Decision Making (9 steps)steps)
(4) Assemble data –
in 203, primarily economic
– Costs»Materials and supplies» Direct labor» Overhead (facilities, support labor, utilities, etc.)» Extra-market (e.g., employee injuries)
– Benefits» Sales (of products/services)» Extra-market (social, psychological, …)
ISU CCEE
Rational Decision Making (9 steps)Rational Decision Making (9 steps)Rational Decision Making (9 steps)Rational Decision Making (9 steps)
(5) “Real life” definitions for costs and benefits may get complicated– Initial cost per unit?– “Life cycle cost” per unit?– Total cost of satisfying
mission requirements?– “Spread the work around” cost
(DOD work by congress)?– “Accomplish mission regardless” cost?
ISU CCEE
Rational Decision Making (9 Rational Decision Making (9 steps)steps)Rational Decision Making (9 Rational Decision Making (9 steps)steps)
(6) Construct the model(s)– Physical (various kinds)– Virtual (3-D computer model)– Mathematical (typical for economic and
many other types of problems)
(7) Analyze the alternatives– Data processed using model– Results stated in comparable way
ISU CCEE
Rational Decision Making (9 Rational Decision Making (9 steps)steps)Rational Decision Making (9 Rational Decision Making (9 steps)steps)
(8) Select the best alternative– Select highest B:C alternative for
economic problems– Include extra-market and “intangible”
consequences at this point– Present at least two “well-engineered”
solutions for complex problems – Be careful in eliminating alternatives
ISU CCEE
Rational Decision Making (9 Rational Decision Making (9 steps)steps)Rational Decision Making (9 Rational Decision Making (9 steps)steps)
(9) Audit the process and the results
– Were assumptions reasonable?– Were projections accurate?– Are changes in process called for?
ISU CCEE
CE 203 CE 203 Chapter 2 EEAChapter 2 EEA
Engineering Engineering CostsCosts
ISU CCEE
Actual costs may not be known – may mean they must be estimated
Estimating may be difficult but is often critical – good analysis with bad data is worthless
if not disastrous Costs tend to be underestimated
(60% low to 30% high) Benefits tend to be overestimated
(50% high to 20% low)
Costs: what to keep in Costs: what to keep in mindmindCosts: what to keep in Costs: what to keep in mindmind
ISU CCEE
Fixed cost – Constant, unaffected by volume: rent,
insurance, property taxes, interest on borrowed capital, variety of overhead costs
Variable cost– Changes as a function of output: direct
utilities, direct labor, materials, sales commissions, shipping costs, etc.
Costs: some definitionsCosts: some definitionsCosts: some definitionsCosts: some definitions
ISU CCEE
Average cost– Per unit cost =
(Total cost) / (number of units)
Marginal cost– Variable cost for one more unit
Costs: some definitions Costs: some definitions (cont’d)(cont’d)Costs: some definitions Costs: some definitions (cont’d)(cont’d)
ISU CCEE
Sunk cost – Already spent due to past decision– Immaterial to future decisions (though
sometimes this is hard to accept)
(Lost) Opportunity cost– Benefit foregone because resources
(time, money, equipment, etc.) are being used for something else
Costs: some definitions (cont’d)Costs: some definitions (cont’d)Costs: some definitions (cont’d)Costs: some definitions (cont’d)
ISU CCEE
Recurring cost– Known, occurring at regular intervals (and
therefore easy to plan for); e.g., rent, utility bill, full-time labor, etc.
Non-recurring cost – One-of-a-kind, irregular, often unanticipated
(and then difficult to plan for); e.g., start-up costs, unfavorable court verdict, damage due to natural disaster, etc.
Costs: some definitions Costs: some definitions (cont’d)(cont’d)Costs: some definitions Costs: some definitions (cont’d)(cont’d)
ISU CCEE
Incremental cost– Differences between the costs of two
alternatives --- these differences should be the focus of the comparison of the two alternatives
Costs: some definitions Costs: some definitions (cont’d)(cont’d)Costs: some definitions Costs: some definitions (cont’d)(cont’d)
ISU CCEE
Cash cost– Actual transfer of money (“out-of-pocket”)– Basis for engineering economic analysis
Book cost – No transfer of money (usually)– Common example is asset depreciation
(“written off” by the accounting department)
Costs: some definitions Costs: some definitions (cont’d)(cont’d)Costs: some definitions Costs: some definitions (cont’d)(cont’d)
ISU CCEE
Life-cycle cost– Sum of all costs associated with the life-
cycle of a product or service
conception, design, production, testing and quality assurance, maintenance, effects on the environment, disposal, etc.)
– Two concepts:» The later the design change, the higher the cost» The earlier the design decision, the more later
costs are “locked in.”
Costs: some definitions Costs: some definitions (cont’d)(cont’d)Costs: some definitions Costs: some definitions (cont’d)(cont’d)
ISU CCEE
Cash Flow Diagram (CFD)Cash Flow Diagram (CFD)Cash Flow Diagram (CFD)Cash Flow Diagram (CFD)
Graphic tool showing size, sign, and timing of cash flows – helpful for engineering economic analysis (very important initially)
– Horizontal line indicating uniform units of time (days or months or years or …)
– Each cash flow “in” (revenue or benefit) is shown as an arrow up (positive) from time line
– Each cash flow “out” (cost) is shown as an arrow down (negative) from time line
ISU CCEE
Cash Flow Diagram (CFD) Cash Flow Diagram (CFD) samplesampleCash Flow Diagram (CFD) Cash Flow Diagram (CFD) samplesample
$400$40000
$400$40000
$200$20000
$200$20000
$300$30000
$300$30000
$150$15000
$150$15000
$200$20000
$200$20000 $150$150
00$150$150
00
$300$30000
$300$30000
Money Money in (+)in (+)
Money Money in (+)in (+)
Money Money out (-)out (-)Money Money out (-)out (-)
Time “0” or Today
(usually)
Time “0” or Today
(usually)
00 11 22 33 44 55 66
End of period 3 is also
beginning of period 4
End of period 3 is also
beginning of period 4
ISU CCEE
First Cost– Costs of “getting started”
Operations and Maintenance (O&M)– Annual expense (though not necessarily
constant) for fuel, labor, minor repair, etc.)
Salvage value– Revenue received for sale or transfer of
property at end of “project” or useful life
Some Cash Flow Some Cash Flow CategoriesCategoriesSome Cash Flow Some Cash Flow CategoriesCategories
ISU CCEE
Revenue– “Sale” price of goods/services
Overhaul– Major repair or refurbishing
during life of asset
Some Cash Flow Some Cash Flow CategoriesCategoriesSome Cash Flow Some Cash Flow CategoriesCategories
ISU CCEE
In-class example (CFD)In-class example (CFD)In-class example (CFD)In-class example (CFD)
Company A purchased a backhoe for $33,500. The company paid $12,000 immediately and agreed to pay four additional payments of $6,000 each at the end of one, two, three, and four years. Maintenance for the backhoe is expected to be $500 at the end of the first year and $1,000 at the end of each subsequent year. They expect to sell the backhoe for $16,000 at the end of the fifth year (after paying for the needed maintenance).
Draw the cash flow diagram
Company A purchased a backhoe for $33,500. The company paid $12,000 immediately and agreed to pay four additional payments of $6,000 each at the end of one, two, three, and four years. Maintenance for the backhoe is expected to be $500 at the end of the first year and $1,000 at the end of each subsequent year. They expect to sell the backhoe for $16,000 at the end of the fifth year (after paying for the needed maintenance).
Draw the cash flow diagram
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