Engineering Economics Introduction and Elementary Analysis

1. ADAMA SCIENCE AND ENGINERRING
UNIVERSITY
SCHOOL OF CIVIL AND ARCHITECTURAL
ENGINEERING
Introduction of Economics and Elementary analysis
By
Dr. Vijay Singh Rawat
Date 13.12.2019

2. CHAPTER 1
INTRODUCTION
What is Engineering
Engineering is the profession in which knowledge (math and natural sciences gained by study, experience
and practice)is applied with judgment to develop waysto utilize, economically, the materials and forces of
nature for the benefit of mankind.
What is Economics
The word ‘Economics’ was derived from two Greek words, oikos (ahouse) and nemein (to manage) which
would mean ‘managing an household’using the limited funds available, in the most satisfactory manner
possible
Economics is the science that deals with production, exchange and consumption of various commodities in
economic systems. It shows how scarce resources can be used to increase wealth and human welfare. The
central focus of economics is on scarcity of resources and choices among their alternative uses. The
resources or inputs available to produce goods are limited or scarce. This scarcity induces people to make
choices among alternatives, and the knowledge of economics is used to compare the alternatives for choosing
the best among them.

3. Economics deals with how the numerous human wants are to be satisfied with limited resources. Thus, the science
of economics centers on want - effort - satisfaction.
Every society must provide goods and services for the welfare of its citizens. The economy consists of all of the
activities involved in the production and distribution of these goods and services.
The production and distribution of goods and services requires theuse of economic resources called factors of
production. They may be thought of as falling into one of four categories:
 capital
 labor
 land
 Entrepreneurship

4. THE FOUR SECTORS OF THE ECONOMY
Modern complex economies involve the interactions of large numbers of people and organizations. These
economic agents fall into one of three categories: business, households, government, and the rest-of-the-
world.
 Business
The business sector is where production takes place in the economy. The individual agents making up the
business sector are called firms. These are the organizations within which entrepreneurship brings together
land, labor and capital for the production of goods or services. Economies in which firms are generally
owned by private individual srather than by governments are called capitalist or private enterprise economies.
These include almost all the countries in the world today.

5.  HOUSEHOLDS
Those are us, the family units that make up society. We consume the goods and services produced by the
economy. It is for our benefit that the economy exists.
The household sector provides the labor used in production, receiving payment of wages and salaries in
return. Households also provide financial capital to the business sector which includes loans to firms, direct
ownership, or the purchase of shares. Households may invest directly in firms by purchasing their stock or
bonds, but more typically households invest indirectly through financial intermediaries such as pension
funds, insurance companies, banks, and mutual funds. Households own the firms and have claim to all the
income produced by the business sector, including wages, interest, and profits.

6.  GOVERNMENT
We can think of government as having four basic economic functions:
First, it establishes the legal framework within which the economy operates. Economists sometimes refer to
this framework as the rules of the game. A complex body of commercial law clarifies relations between
buyers and sellers, employers and employees, and parties involved in private contracts.
Second, taxes are collected by government from households and firms.
Third, government spends some of these tax revenues to provide goods and services through agencies that
operate much like firms.
Fourth, government also makes transfer payments to those who are entitled to receive them under the law.
 The Rest-of-the-World

7. FLOW IN AN ECONOMY

8. HOUSEHOLDS AND BUSINESSES ARE THE TWO MAJOR ENTITIES IN A SIMPLE ECONOMY.
As you can see clearly from the diagram in a simple economy business organizations have two roles, they
produce goods and provide services by using the different economics resources like land, labor, capital and
with entrepreneurial skills provided by households. In return Business organizations make payment of
money to the households for receiving various resources. The households role in the economic activity is two
things, one they provide the business organization with different resources for them to use in production for
this activity they are paid by the business. Their second role is as users and buyers of the services and goods
provides by the business.
This cycle shows the interdependence between the two major entities in a simple economy.

9. LAW OF SUPPLY AND DEMAND
Demand is defined as the quantity (or amount) of a good or service people are willing and able to
buy at different prices, while supply is defined as how much of a good or service is offered at each
price.

10. when there is a decrease in the price of a product, the demand for the product increases and its supply
decreases. Also, the product is more in demand and hence the demand of the product increases.
At the same time, 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.
To better understand the dynamics involved, suppose that one article of clothing was selling for $30.
Producers would be willing to supply 84 articles of clothing per week, but consumers would only be buying
28 articles per week. As a result, the producers would have excess inventory piling up very quickly. In order
to get their inventory back to the desired level, the suppliers would have to decrease production and reduce
the price. Eventually, the quantity demanded and quantity supplied meet at 57 articles per week at a price of
$15.

12. DEFINITION AND SCOPE OF ENGINEERING ECONOMICS
Definition
Engineering economics deals with the methods that enable one to take economic decisions towards
minimizing costs and/or maximizing benefits to business organizations
Types of Efficiency
Efficiency of a system is generally defined as the ratio of its output to input. The efficiency can be
classified into technical efficiency and economic efficiency.
Technical efficiency
It is the ratio of the output to input of a physical system. The physical system may be a diesel
engine or a machine working in a shop floor.
Technical efficiency (%) = Output × 100
Input
In practice, technical efficiency can never be more than 100%.

13. ECONOMIC EFFICIENCY
Economic efficiency is the ratio of output to input of a business system.
Economic efficiency (%) = Output × 100 or
Input
= Worth × 100
Cost
Worth- is the annual revenue generated by way of operating the business. cost-is the total annual
expenses incurred in carrying out the business.

14. THERE ARE SEVERAL WAYS OF IMPROVING ECONOMIC EFFICIENCY.
• Increased output for the same input
• Decreased input for the same output
• Through simultaneous increase in the output with decrease in the input.
• By a proportionate decrease in the input which is more than the proportionate decrease in
the output
• By a proportionate increase in the output which is more than the proportionate increase in
the input

15. ELEMENTS OF COSTS
What is cost?
In economics cost is defined as the combination losses of any goods that have a value attached to
them by anyone individual. And it is used mainly by economists as means to compare the prudence
of one course of action with that of another.
Types of costs
It can be subdivided broadly as variable and overhead cost.
Variable cost -it is a corporate expense that changes in proportion to product output.it can be further
sub divided to
direct material cost costs are those costs of materials that are used to produce the product
direct labor cost. is the amount of wages paid to the direct labor involved in the production activities.
direct expenses.-is the amount of additional expense to the direct labor.

16. OVERHEAD COST
this are the costs that are not directly related to the manufacture of a product. It refers to all non-
labor expenses required to operate your business. It can also be further subdivided into indirect
material cost, indirect labor cost, indirect expenses
Overhead cost is the aggregate of indirect material costs, indirect labor costs and indirect expenses.
Administration overhead includes all the costs that are incurred in administering the business.

17. 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

18. CHAPTER 2
ELEMENTARY ECONOMIC ANALYSIS
One can manage many of decision problems which occurs in a day to day event on somebody’s
personal life by using simple economic analysis.
For example, we can take industry which can source its raw materials from a nearby place or from
far-off place. In this problem, the following factors will affect the decision
 Price of the raw material
 Transportation cost of the raw material
 Availability of the raw material
 Quality of the raw material

19. Examples of economic analysis
 Material selection for a product
 Design selection for a product
 Design selection for a process industry
 Building material selection for construction activities
 Process planning/ process modification

20. EXAMPLES FOR SIMPLE ECONOMIC ANALYSIS
Material selection for a product
Materials selection is an ordered process by which engineers can systematically eliminate unsuitable
materials and identify the one and small number of materials which are the most suitable.
Each material selection has its own special features . The first requirement in material selection is a broad
understanding of the context. What does the product or component do? Of what system is it a part? In what
environment will it operate? What are the consumers expectations?

21. PRODUCT ANALYSIS
Just what it says – analyse the product!
What does it do?
How does it do it?
Where does it do it?
Who uses it?
What should it cost?
EXAMPLE 2.2 A company manufactures dining tables which mainly consist of a wooden frame and a table
top. The different materials used to manufacture the tables and their costs are given in Table 2.1.

22. In view of the growing awareness towards deforestation and environmental conservation, the company feels
that the use of wood should be minimal. The wooden top therefore could be replaced with a granite top. This
would require additional wood for the frame and legs to take the extra weight of the granite top. The materials
and labour requirements along with cost details to manufacture a table with granite top are given in Table 2.2.
If the cost of the dining table with a granite top works out to be lesser than that of the table with wooden top,
the company is willing to manufacture dining tables with granite tops. Compute the cost of manufacture of the
table under each of the alternatives described above and suggest the best alternative. Also, find the economic
advantage of the best alternative.

24. DESIGN SELECTION FOR A PRODUCT
An engineering activity involving product design, is where the ‘product’ is a complete system to carry out a
function, and usually purchased by a customer for private use. For example, the design of: bicycle, toaster,
television, etc...
For any product Design is an essential factor which decides the cost of the product for a specified level of
performance of that product.
EXAMPLE 2.3 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 18 hours of lathe time and 6.5 hours of grinder time per 1,000
units. Design B will require 8 hours of lathe time and 13 hours of grinder time per 1,000 units. The
operating cost of the lathe including labour is Rs. 250 per hour. The operating cost of the grinder including
labour is Rs. 200 per hour. Which design should be adopted if 1,00,000 units are required per year and what
is the economic advantage of the best alternative?

25. Operating cost of lathe including labour = Rs. 250 per hr Operating cost of grinder including labour = Rs. 200
per hr
(a) Cost of design A
No. of hours of lathe time per 1,000 units = 18 hr
No. of hours of grinder time per 1,000 units = 6.5 hr
Total cost of design A/1,000 units
= Cost of lathe operation per 1,000 units + Cost of grinder operation per 1,000 units = 18* 250 + 6.5*200 = Rs.
5,800
Total cost of design A/1,00,000 units = 5,800 * 1,00,000/1,000
= Rs. 580000
(b) Cost of design B
No. of hours of lathe time per 1,000 units = 8 hr No. of hours of grinder time per 1,000 units = 13 hr
Total cost of design B/1,000 units = Cost of lathe operation/1,000 units + Cost of grinder operation/1,000 units =
8 * 200 + 13 *150 = Rs. 3,550
Total cost of design B/1,00,000 units = 3,550 *1,00,000/1,000
= Rs. 3,55,000

26. DECISION The total cost/1,00,000 units of design B is less than that of design A. Hence, design B is
recommended for making the tapered fastening pin.
Economic advantage of the design B over design A per 1,00,000 units = Rs. 5,80,000 – Rs. 3,55,000 = Rs.
225,000.

27. BUILDING MATERIAL SELECTION FOR CONSTRUCTION
All engineering structures are composed of different building materials like;
 Rock,
 aluminum
 Cement,
Some of them can be found naturally in the form of raw materials which hasn’t been processed in
industries like; clay sand rocks …
These building materials can be found near the construction area or can be far from it.
the cost of these materials mainly depends on the
 ease of transportation
 availability of the materials
 Quality of the raw material

28. When locating the raw material the cost for the transportation must be considered with the price of the material,
because this factors affect the economic decision.
In the design of buildings to be constructed in Alpha State, the designer is considering the type of door frame
to specify. Either steel or aluminum door frames will satisfy the design criteria. Because of the remote location
of the building site and lack of building materials in Alpha State, the door frames will be purchased in Beta
State and transported for a distance of 4000 km to the site. The price of door frames of the type required is
ETB 2000 each for steel frames and ETB 3000 each for aluminium frames. The weight of steel door frames is
80 kg each and that of aluminium window frame is 30 kg each. The shipping rate is ETB 2 per kg per 100 km.
Which design should be specified and what is the economic advantage of the selection?
Distance between alpha state and beta state = 4000 km
Transportation cost = ETB 2/kg/100km
Steel door frame
Price of steel door frame/unit =2000
Weight of steel door frame/unit =80
Total cost of steel door frame/unit= price of steel door frame/unit + transportation cost of steel door frame/unit
= 2000 + (80 x 4000 x 2)/100 = ETB 8400

29. (b) Aluminum door frame
Price of aluminum door frame/unit = 3000
Weight of aluminum door frame/unit = 30 kg
Total cost of aluminum window frame/unit= Price of aluminum door frame/unit + Transportation cost of aluminum
door frame/unit
= 3000 + (30 x 4000 x 2)/100 = ETB 5400
The total cost/unit of the aluminum door frame is less than that of steel window frame. Hence, aluminum door
frame is recommended. The economic advantage/unit of the aluminum door frame over the steel door frame =
ETB 8400 – 5400 = ETB 3000

30. PROCESS PLANNING/PROCESS MODIFICATION
The planning function of management is one of the most crucial ones. It involves setting the goals of the
company and then managing the resources to achieve such goals.
Process planning is planned to renovate design specification into manufacturing instructions and to make
products within the function and quality specification at the least possible costs.
Process planning deals with the selection of the processes and the determination of conditions of the processes.
The least cost of processing must be considered when planning for a new componenet

31. The steps in process planning are as follows:
 Analyze the part drawing to get an overall picture of what is required.
 Make recommendations to or consult with product engineers on product design changes.
 List the basic operations required to produce the part to the drawing or specifications.
 Determine the most practical and economical manufacturing method and the form or tooling required for each
operation.
 Devise the best way to combine the operations and put them in sequence.
 Specify the gauging required for the process.
The process planning engineer of a firm listed the sequences of operations as shown in the below data to
produce a component.
Data for the Example
Sequence Process sequence
1 Turning – Milling – Shaping – Drilling
2 Turning – Milling – Drilling
3 All operations are performed with CNC machine

32. The details of processing times of the component for various operations and their machine hour rates are
summarized below
Machine Hour Rates and Processing Times (minutes)
Operation Machine hour Process sequence
1 2 3
Turning 300 8 8 –
Milling 500 10 16 –
Shaping 450 15 – –
Drilling 400 5 5 –
CNC operations 2,000 – – 10
(a) Cost of component using process sequence 1. The process sequence 1 of the component is as follows:
Turning – Milling – Shaping – Drilling
The calculations for the cost of the above process sequence are summarized below
Workings for Process Sequence 1
Operation Time Machine hour rate Cost
(min) (hr)
Turning 8 0.133 300 39.9
Milling 10 0.167 500 83.5
Shaping 15 0.25 450 112.5
Drilling 5 0.0833 400 33.32
Total: 269.22

33. (b) Cost of component using process sequence 2. The process sequence 2 of the component is as follows:
Turning – Milling – Drilling
The calculations for the cost of the above process sequence are given in
Operation Time Machine hour rate Cost
(min) (hr)
Turning 8 0.133 300 39.9
Milling 16 0.266 500 133
Drilling 5 0.0833 400 33.32
Total: 206.22
(c) Cost of component using process sequence 3. The process sequence 3 of the component is as follows:
Only CNC operations
The calculations for the cost of the above process sequence are summarized below
Operation Time Machine hour rate Cost
(min) (hr)
CNC operations 10 0.167 2000 334
The process sequence 2 has the least cost. Therefore, it should be selected for manufacturing the component.