What is Engineering Economy?
ENGINEERING ECONOMY – is the analysis and evaluation of the factors that will affect the economic
success of the engineering projects to the end that a recommendation can be made which will insure
the best use of capital.
In Engineering Economy the following should be noted and define for more understanding on how
to assess engineering projects:
Consumer goods and services – are those products or services that are directly used by people to
satisfy their wants. Food, clothing, cars, refrigerators, TV, shoes, medical services are examples.
Producer goods and services – are used to produce consumer goods or other producer goods.
Machine tools, equipment, factory, buildings, airplanes, buses are examples.
Necessities – are those products or services that are required to support human life and activities
that will be purchased in somewhat the same quantity even though the price considerably.
Luxuries – are those products or services that are desired by human and will be purchased if money
is available after the required necessities have been obtained.
Necessities and luxuries are relative terms, some goods and services are considered as necessity to
one person but luxury to another person.
Demand is the quantity of a certain commodity that is bought at a certain price at a given place and
Elastic Demand – occurs when a decrease in selling price result in a greater than proportionate
increase in sales.
Inelastic Demand – occurs when a decrease in selling price produces a less than proportionate
increase in sales.
Competition, Monopoly, and Oligopoly
Perfect Competition – occurs in a situation where a commodity or service is supplied by a number of
vendors and there is nothing to prevent additional vendors entering the market. Under such
conditions, there is assurance of complete freedom on the part of both buyer and seller.
Monopoly – is the opposite of perfect competition. A perfect monopoly exists when a unique
product or service is available from a single vendor and that vendor can prevent the entry of all
others into the market. Under such conditions, the buyer is at the complete mercy of the vendor as
to the availability and price of the product.
Oligopoly – exists when there are so few suppliers of a product or service that action by one will
almost inevitably result in similar action by the others. Example, if one of the only three oil
companies in the country raises the price of gasoline by 50 cents per liter. The other two
undoubtedly do the same because they could do so and still retain their previous competitive
THE LAW OF SUPPLY AND DEMAND
Supply is the quantity of a certain commodity that is offered for sale at a certain price at a given
place and time. A rice dealer may have 100 cavans of rice in his warehouse but if he only wishes to
sell 70 cavans, then this quantity represents the supply.
The law of supply and demand may be stated as follows:
“Under conditions of perfect competition, the price at which a given product will be supplied and
purchased is the price that will result in the supply and the demand being equal.”
Engineering Economy investigates the economic side of a project. For example, Engineering
economy can be applied to these situations:
•Choosing the best design for a high-efficiency gas furnace.
•Selecting the most suitable robot for a welding operation on an automotive assembly line.
•Making a recommendation about whether jet airplanes for an overnight delivery service should be
purchased or leased.
•Determining the optimal staffing plan for a computer help desk.
Principles of Engineering Economy
1. Develop the Alternatives
2. Focus on the Differences
3. Use a Consistent Viewpoint
4. Use a Common Unit of Measure
5. Consider All Relevant Criteria
6. Make Uncertainty Explicit
7. Revisit Your Decisions
Principles of Engineering Economy
Develop the Alternatives
The final choice (decision) is among alternatives. The alternatives need to be identified and
then defined for subsequent analysis.
Example: The oil company must install antipollution equipment in a new
refinery to meet federal clean-air standards. Four design alternatives
Focus on the Differences
Only the differences in expected future outcomes among the alternatives are relevant to
their comparison and should be considered in the decision.
Example: The outcomes of the Four design alternatives have different capital
investment and annual expenses (i.e., power, labor, maintenance, and
Use a Consistent Viewpoint
The prospective outcomes of the alternatives, economic and other, should be consistently
developed from a defined viewpoint (perspective).
Example: The viewpoint of the oil company (the owner of the refinery who will
pay the cost) should be considered ingenerating the alternatives.
Use a Common Unit of Measure
Using a common unit of measurement to enumerate as many of the prospective outcomes
as possible will make easier the analysis and comparison of alternatives.
Example: The outcomes of the four designs are measured in US Dollars. For
instance, capital investment for design A costs 1,000,000 USD.
Examples of Non-monetary (not economic) Outcomes:
1. Safety to employees and to the public.
2. Meeting or exceeding all environmental requirements.
3. Achieving good public relations.
Consider All Relevant Criteria
Selection of a preferred alternative (decision making) requires the use of a criterion (or
several criteria). The decision process should consider the outcomes enumerated in the monetary
unit and those expressed in some other unit of measurement or made explicit in a descriptive
Example: In order to be economically acceptable, the selection criterion is “Cost”. In
addition, government satisfaction (not economics) is another important
Make Uncertainty Explicit
Uncertainty is inherent in projecting (or estimating) the future outcomes of the alternatives
and should be recognized in their analysis and comparison.
Example: The probability is high that today’s estimates of, for example, future expenses
will not be what eventually occurs.
Revisit Your Decisions
Improved decision making results from an adaptive process; to the extent practicable, the
initial projected outcomes of the selected alternative should be subsequently compared with actual
Engineering Economy and the Design Process
An engineering economy study is accomplished using a structured procedure and
mathematical modeling techniques.
The economic results are then used in a decision situation that involves two or more
alternatives and normally includes other engineering knowledge and input.
MONEY-TIME RELATIONSHIPS AND EQUIVALENCE
Interest plays a major role in our everyday lives. The most basic type of interest is the simple
interest. In fact, your interest – whether you are paying it or earning it - is usually calculated using
different methods. However, simple interest is a good start that gives us a general idea of what a
loan will cause or what an investment will give us.
Interest calculations, whether for a loan or a n investment are exactly the same.
For simple interest, the principal only earns interest. For example, your parents wants you to finish
your college education borrows money from a bank and pays simple interest on that loan. Your
parents, should know how interest is being computed, and it is important to understand how
interest works. Better yet, your bank may be paying you interest on your deposits – and you can
maximize your earnings by knowing more about interest.
Interest – the amount of money paid for the use of borrowed capital or the income produced by
money which has been loaned. I will be the symbol used to denote interest.
Principal – is the amount of money borrowed or invested. P will be the symbol used to denote
principal or capital.
Interest Rate – is the rate or percent, stated on an annual or yearly basis. r will be the symbol to
denote the simple interest rate.
Future Worth – is the increased amount resulting from the increased process. The sum of principal
and interest. Also called as maturity value, accumulated value, or final value and denoted by F.
Time – number of years for the money borrowed or invested. Since interest rates are expressed on
an annual basis, or fractional representation, of time must be used. This is denoted by t.
Simple interest is calculated using the principal only, ignoring any interest that have been accrued in
preceding periods. It is paid on short term loans. This means if we borrow money from someone, we
usually pay a fee. This fee is called “interest.” Simple interest or Flat rate interest. The amount of
simple interest paid each year is a fixed percentage of the amount borrowed or lent a t the start.
I = P r t F = P + I or F = P(1 + r t)
t = time in years
if t is in months,t = t/12
if t is in days, t = t/360 (ordinary simple interest – is computed on the basis pf 12 months of
30 days or 360 days a year.)
t = t/365 (exact simple interest – is computed on the exact number
of days in a year, 365 days for an ordinary year 366 days
for a leap year.
Cash Flow Diagrams
A cash flow diagram is simply a graphical representation of cash flows drawn on a time scale. Cash
Flow Diagram for economic analysis problems is analogous to that of free body diagram for
The use of cash flow (time) is strongly recommended for situations in which the analyst needs to
clarify or visualize what is involve when flows of money occur at various times.
A loan of P100 at simple interest of 10% will become P150 after 5 years.
When you borrow money from a bank, you pay interest. Interest is really a fee charged for
borrowing money, it is a percentage charged on the principal amount for a period of time, usually
If you want to know ho much interest you will earn on long-term investments, in a time deposit for
example, or if you want to know how much you will pay for the cost of the principal amount you
borrowed from a bank after 10 years, you need to understand how compound interest works.
Definition of Compound Interest
Albert Einstein considered compound interest as the “eighth wonder of the world.” Compound
interest works wonder over time because it allows individuals to earn interest not only on the
original amount that they invested, but also they earn interest on the interest they earned from that
Thus compound interest is defined as interest being paid on interest. The accumulated amount at
the end of the period, the original principal and the compounded interest, is called the final amount
or maturity value.
For example, if you deposit P1,000 in the bank for 1 year at 10% interest, then at the end of the year
you would have P1,100 (the original P1,000 + P100 in interest). Now if you left the P1,100 in the
bank for another year, you would now have P1,210 (your P1,100 + P110 in interest). You now have
an additional P10, which is the interest on the interest.
In another year, you would have a total of P1,331 (P1,210 + P121 in interest). Now, you have P31
which is the interest on interest. If this process were allowed to continue for a length of time, the
amount of interest on interest begins to grow exponentially.
𝐅 = 𝐏(𝟏 + 𝐢)𝐧
where: F = maturity value or final amount
P = principal amount
i = rate of interest per conversion period
n = frequency of interest conversion for the whole term
The rate of interest per conversion period is computed as i = r/m, where r is the compound interest
rate and m is the frequency of interest conversion per year. Interest may be compounded annually,
m = 1; semi-annually, m = 2; quarterly, m = 4; and monthly, m = 12. The frequency of conversion for
the whole term is n = mt, where t is the time or term of transaction.
For example, to determine the rate of interest for a period “n”.
1. 6% compounded annually for 5 years
i = 0.06 n = 5
2. 6% compounded semi-annually for 5 years
= 0.03 n = 2(5) = 10
3. 6% compounded quarterly for 5 years
= 0.015 n = 4(5) = 20
4. 6% compounded monthly for 5 years
= 0.005 n = 12(5) = 60
1.) If P100,000 is deposited in a bank that pays interest at 4% compounded quarterly, what is
its maturity value after 3 years?
Given: P = P100,000
r = 4%
m = 4 i =
t = 3 years n = (4)(3) = 12
Solution: F = P(1 + i)n
F = 100,000(1 + 0.01)12
F = P112,682.50 Ans.