Engineering Economics Introduction and Elementary Economics Analysis

2. . INTRODUCTION
 ECONOMICS is the study of how people and society choose to
employ scarce resources that could have alternative uses in order
to produce various commodities and to distribute them from
conception, now or in the future.
ENGINEERING ECONOMICS is the application of economic
principles to engineering problems, for example in comparing the
comparative costs of two alternative capital projects or in
determining the optimum engineering course from the cost aspect.
ENGINEERING ECONOMICS is concerned with the allocation
of scarce resources in the engineering processes of producing
certain product.

3. 1.1 Economics
It is the careful management of material resources.
[Dictionary Definition]
 It is the branch of social science that deals with the
production, distribution and consumption of goods and
services with their management.
It is the management of household or private
expenses. [From Greek]

4.  Some of the Economic goals are interdependent. The
economic goals are not always complementary; in many
cases they are in conflict. For example, any move to have
a significant reduction in unemployment will lead to an
increase in inflation.
The following are the economic goals.
 A high level of employment
 Price stability
 Efficiency
 Growth
 An equitable distribution of income
1.1.1 Economic Goals

5.  It’s the flow of goods, service, resource and money payment.
 The two basic entities in the flow of economics are;
1.business
2.household
The two basic entities are highly interdependent and they are
different face of the same coin.
 The process of flow in economics is going to take place mainly
between both business and household.
1.1.2 Flow in an Economy

6.  Business
A. provides goods and service to the consumer.
B. use resources input or raw material
produced by the house hold
 Household
A. consume (use) final goods and services
produced by business and services.
B. Provide raw material or productive input to
the business

7. 1.1.3. Law of Supply and Demand
 When there is a decrease in the price of a product, the demand
for the product increases and its supply decreases
 Lowering of the price of the product makes the producers
restrain from releasing more quantities of the product in the
market. Hence, the supply of the product is decreased.
 The point of intersection of the supply curve and the demand
curve is known as the equilibrium point. At the price
corresponding to this point, the quantity of supply is equal to the
quantity of demand. Hence, this point is called the equilibrium
point.

8. Fig demand and supply curve

9.  Factors influencing Demand
 Income of the people
 Taste and preference of consumer
 Change in Price of related goods
 Number of consumers in the market
 Consumers Expectation
 Factors influencing supply
 Cost of inputs
 Technology
 Weather
 Price of related goods
 Government policies
 Natural conditions
1.1.4 Economic Factors

10.  Science is a field of study where the basic principles of different
physical systems are formulated and tested. Engineering is the
application of science
 Engineering activities are means of satisfying human wants and
requirements
 Because of resource constraints, engineering is closely associated
with economics
 Its essential that an engineering proposal is evaluated in terms of
economics [worth & cost] before it is undertaken
1.2 Concept of Engineering Economics

11. 1.2.1 Types of Efficiency
 Efficiency is the ability to avoid wasting materials, energy, efforts, money, and time in
doing something or in producing a desired result. in a more general sense , it is the
ability to do things well , successfully , and without waste
 The efficiency can be classified into technical efficiency and economic efficiency.
 Technical Efficiency : is the effectiveness with which a given set of inputs is
used to produce an output. A firm is said to be technically efficient if a firm is
producing the maximum output from the minimum quantity of inputs, such as
labor , capital , and technology
 Economic Efficiency : Economic Efficiency is when all goods and factors of
production in an economy are distributed or allocated to their most valuable uses
and waste is eliminated or minimized

12.  Engineering Economics, previously known as engineering
Economy , is a subset of economics concerned with the use
of and application of economic principles in the analysis of
engineering decisions...thus it focuses on the decision making
process, it’s context and environment.
 Scope of Engineering Economics : As discipline, it is
focused on the branch of economics known as
microeconomics in that it studies the behaviour of individuals
and firms in making decisions regarding the allocation of
limited resources.
Definition and Scope of
Engineering Economic

13. 1.3 Elementary Cost
Cost
1.Variable Cost
- Vary with respect to the volume
of the production.
a.Direct material cost
b.Direct labor cost
c.Direct expense
2.OverheadCost
- Fixed irrespective to the volume
production.
a.Factory overhead
b.Administration overhead
c.Selling overhead
d.distribution overhead

14.  The selling price of a product is derived as shown
below :
A. Prime Cost =Direct material costs + Direct labour costs + Direct
expenses
(b) Factory Cost =Prime cost + Factory overhead
(c) Cost of Production= Factory cost + Office and administrative
overhead
D. Cost of goods sold= Cost of production + Opening finished
stock – Closing finished stock
(e) Cost of sales= Cost of goods sold + Selling and distribution
overhead
(f) Sales=Cost of sales + Profit
(g) Sales/Quantity sold = Selling price per unit

15. CHAPTER - TWO
ELEMENTARY ECONOMIC ANALAYSIS

16.  Elementary or simple economic analysis is a method
of managing the number of economic decisions in an
industry or in a business.
 Factors that affect decision of an industry on the raw
material are its;
 Price
 Transportation cost
 Availability
 Quality
2. Elementary Economic Analysis

17.  The following are some examples of simple
economic analysis for a product or a construction;
Material selection
 Design selection
 Building material selection
 Process planning/ Process modification

18.  Raw material cost is most significant in this type of
method. The total cost reduction in any of the
following ways will help to find the suitable raw
material.
- Cheaper in price
- Reduced machining time
- Improved durability of the product
2.1. Material Selection for a Product

19. EXAMPLE - 1
In the design of a jet engine part, the designer has a choice of
specifying either an aluminum alloy casting or a steel casting.
Either material will provide equal service, but the aluminum
casting will weigh 1.5 kg as compared with 2 kg for the steel
casting.
The aluminum can be cast for ETB 100/kg and the steel one for
ETB 50/kg. The cost of machining per unit is ETB 200 for
aluminum and ETB 250 for steel. Every kilogram of excess
weight is associated with a penalty of ETB 1,500 due to
increased fuel consumption.
Which material should be specified and what is the economic
advantage of the selection per unit?

20. SOLUTION
(i) Cost of using aluminum metal for the jet engine part:
• Weight of aluminum casting/unit = 1.5 kg
• Cost of making aluminum casting = ETB 100/kg
• Cost of machining aluminum casting/unit = ETB 200
• Total cost of jet engine part made of Al/unit
= Cost of making Al casting/unit+ Cost of machining Al casting/unit
= ETB 100/kg (1.5 kg) + ETB 200
= ETB 150 + ETB 200
= ETB 350

21. (ii) Cost of jet engine part made of steel/unit:
• Weight of steel casting/unit = 2 kg
• Cost of making steel casting = ETB 50/kg
• Cost of machining steel casting per unit = ETB 250
• Penalty of excess weight of steel casting = ETB 1,500/kg
• Total cost of jet engine part made of steel/unit
= Cost of making steel casting/unit + Cost of machining steel casting/unit
+ Penalty for excess weight of steel casting
= ETB 50/kg(2 kg) + ETB 250 + ETB 1,500/kg(2 kg – 1.5 kg)
= ETB 1100
*Since the total cost/unit of a jet engine part made of aluminum is less than
that for an engine made of steel, aluminum is suggested for making the jet
engine part. The economic advantage of using aluminum over steel/unit is
= ETB 1100 – ETB 350 => ETB 750

22.  Design selection is an important factor which decides
the cost of the product for a specified level of
performance of that product.
 The design modification of a product results in
 Reduced raw material requirements,
 Increased machinability of the materials and
 Reduced labor.
2.2. Design Selection for a Product

23. EXAMPLE – 2
Two alternatives are under consideration for a tapered fastening
pin. Either design will serve the purpose and will involve the
same material and manufacturing cost except for the lathe and
grinder operations.
Design A will require 15 hours of lathe time and 3 hours of
grinder time per 1000 units. Design B will require 5 hours of
lathe time and 10 hours of grinder time per 1000 units. The
operating cost of the lathe including labor is ETB 250 per hour.
The operating cost of the grinder including labor is ETB 200
per hour.
Which design should be adopted if 10,000 units are required
per year and what is the economic advantage of the best
alternative?

24. SOLUTION
• Operating cost of lathe including labor = ETB 250/hr.
• Operating cost of grinder including labor = ETB 200/hr.
(i) Cost of design A
• No. of hours of lathe time per 1,000 units = 15 hr.
• No. of hours of grinder time per 1,000 units = 3 hr.
• Total cost of design A/1,000 units
= Cost of lathe operation/1000 units + Cost of grinder operation/1000 units
= 15 hr. (ETB 250/hr.) + 3 hr. (ETB 200/hr.)
= ETB 4,350
• Total cost of design A/10,000 units = 4,350(10,000/1000)
= ETB 43,500

25. (ii) Cost of design B
• No. of hours of lathe time per 1,000 units = 5 hr.
• No. of hours of grinder time per 1,000 units = 10 hr.
• Total cost of design B/1,000 units
= Cost of lathe operation/1000 units + Cost of grinder operation/1000 units
= 5 hr. (ETB 250/hr.) + 10 hr. (ETB 200/hr.)
= ETB 3,250
• Total cost of design B/10,000 units = 3,250(10,000/1000)
= ETB 32,500
*Since the total cost/1,00,000 units of design B is less than that of design A,
design B is recommended for making the tapered fastening pin.
• Economic advantage of the design B over design A per 10,000 units
= ETB 43,500 – ETB 32,000
= ETB 11,500

26.  Since the cost of any product is significantly
affected by source of the raw material, its price is
location dependent by considering its transportation
cost.
2.3. Building Material Selection

27. EXAMPLE – 3
In the design of buildings to be constructed in Alpha State, the
designer is considering the type of window frame to specify.
Either steel or aluminum window frames will satisfy the design
criteria.
Because of the remote location of the building site and lack of
building materials in Alpha State, the window frames will be
purchased in Beta State and transported for a distance of 1,500
km to the site. The price of window frames of the type required
is ETB 500 each for steel frames and ETB 1,000 each for
aluminum frames.
The weight of steel window frames is 80 kg each and that of
aluminum window frame is 36 kg each. The shipping rate is
ETB 2 per kg per 150 km.
Which design should be specified and what is the economic
advantage of the selection?

28. SOLUTION
• Distance between Alpha State and Beta State = 1,500 km
• Transportation cost = ETB 2/kg/150 km
(i) Steel window frame
• Price of steel window frame/unit = ETB 500
• Weight of steel window frame/unit = 80 kg
• Total cost of steel window frame/unit
= Price of steel window frame/unit +
Transportation cost of steel window frame/unit
= ETB 500 + (80 kg * 1,500 * 2)/150
= ETB 2,100

29. (ii) Aluminum window frame
• Price of aluminum window frame/unit = ETB 1,000
• Weight of aluminum window frame/unit = 36 kg
• Total cost of aluminum window frame/unit
= Price of aluminum window frame/unit
+ Transportation cost of aluminum window frame/unit
= 1,000 + (36 * 1,500 * 2)/150
= ETB 1,720
* Since total cost/unit of aluminum window frame is less than that of steel
window frame, aluminum window frame is recommended.
• The economic advantage/unit of the aluminum window frame over the
steel window frame
= ETB 2,100 – 1,720
= ETB 380

30.  The objective of this process planning method is to identify the most
economical sequence of operations.
The steps in process planning are as follows;
1. Analyze the part drawing to get an overall picture of what is required.
2. Make recommendations to or consult with product engineers on
product design changes.
3. List the basic operations required to produce the part to the drawing or
specifications.
4. Determine the most practical and economical manufacturing method
and the form or tooling required for each operation.
5. Devise the best way to combine the operations and put them in sequence.
6. Specify the gauging required for the process.
2.4. Process Planning/ Process Modification

31. EXAMPLE – 4
The process planning engineer of a firm listed the sequences of operations as shown
below to produce a component.
Sequence Process sequence
1 Turning – Milling – Shaping – Drilling
2 Turning – Milling – Drilling
3 All operations are performed with CNC machine
The details of processing times of the component for various operations and
their machine hour rates are summarized in the table below;
Find the most economical sequence of operations to manufacture the component.
Operations
Machine hr.
Rate(ETB)
Process Sequence
1 2 3
Turning 100 8 7 -
Milling 250 6 20 -
Shaping 200 12 - -
Drilling 150 4 2 -
CNC Machine 1000 - - 15

32. SOLUTION
(i) Cost of component using process sequence 1.
The process sequence 1 of the component is as follows:
Turning – Milling – Shaping – Drilling
Operation
No
Operations
Time Machine
hr. rate
(ETB)
Cost (ETB)
Min Hr.
1 Turning 8 0.133 100 133
2 Milling 6 0.1 250 25
3 Shaping 12 0.2 200 40
4
Drilling
4 0.067 150 10.05
TOTAL = ETB 208.05

33. (ii) Cost of component using process sequence 2
The process sequence 2 of the component is as follows:
Turning – Milling – Drilling
Operation
No
Operations
Time Machine
hr. rate
(ETB)
Cost (ETB)
Min Hr.
1 Turning 7 0.117 100 117
2 Milling 20 0.333 250 83.25
3
Drilling
2 0.033 150 4.95
TOTAL = ETB 205.20

34. (iii) Cost of component using process sequence 3
The process sequence 3 of the component is as follows:
Only CNC operations
=> The process sequence 2 should be selected for manufacturing
the component since it has the least amount of cost.
Operation
No
Operations
Time
Machine hr.
rate (ETB)
Cost (ETB)
Min Hr.
1 CNC Operations 15 0.25 1000 250
TOTAL = ETB 250