Republic of the Philippines

CAMARINES NORTE STATE COLLEGE

F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING

MODULE 1: INTRODUCTION TO ECONOMICS

OUTLINE OF LEARNING TOPICS TIME ALLOTMENT: 6 HOURS

1.0 Introduction to Economics
1.1 Introduction
1.2 Principles of Engineering Economics
1.3 Engineering Economics and the Design Process
1.4 Cost Concepts for Decision Making
1.5 Present Economic Studies

INTENDED LEARNING OUTCOMES:

By the end of the module, you will:
• explain the fundamental concepts related to economics;
• describe engineering economy terms
• identify the effect of cost for decision making
• recognize present economy studies

1.1 INTRODUCTION

In this section, we will provide an overview of economics and its relevance to

engineering. We will explore the fundamental concepts of economics that play a crucial role
in decision-making processes.

Definition of Economics:
Economics is the social science that studies how individuals, businesses,
governments, and societies allocate scarce resources to satisfy their unlimited wants and
needs. It examines how people make choices in a world with limited resources, aiming to
maximize their well-being or utility.
Economics is divided into two broad branches: microeconomics, which focuses on
individual economic agents such as households and firms, and macroeconomics, which
studies the overall economy, including factors like inflation, unemployment, and economic
growth.

Scope and Importance of Economics in Engineering:

Economics is an indispensable aspect of engineering, as it guides engineers in
making rational decisions in the design, development, and implementation of projects.
Engineers face numerous choices related to resource allocation, project selection, cost
estimation, and risk assessment, all of which have economic implications. By applying
economic principles, engineers can optimize their decisions to achieve efficiency and
effectiveness in their projects.

Basic Economics Concepts:

1. Scarcity: It refers to the limited availability of resources compared to the infinite
wants and needs of individuals and society. Resources such as raw materials, labor,
and capital are limited, while demands for goods and services are seemingly
insatiable. This scarcity necessitates making choices and trade-offs between various
alternatives.

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING
2. Choice: Is the process of selecting one option or course of action over others.
Because of scarcity, individuals and organizations must make choices to allocate
resources wisely. Engineers must decide on the best use of resources to achieve
project objectives while considering trade-offs between different design options.

3. Opportunity Cost: Is the value of the next best alternative that must be foregone
when a decision is made. In other words, it is the cost of choosing one option over
another. When engineers make choices about project investments or design
alternatives, they must be aware of the opportunity costs associated with their
decisions. Understanding opportunity costs enables engineers to evaluate the
benefits and drawbacks of each choice more accurately.

1.2 PRINCIPLES OF ENGINEERING ECONOMICS

The principles of engineering economics are essential guidelines that help engineers
make informed and effective financial decisions in their projects. Let's elaborate on each
principle:
1. Know the problems and produce alternatives: The first step in engineering
economics is to clearly understand the problems and objectives of the project.
Engineers need to identify potential solutions and alternatives that can address these
problems effectively. Generating multiple alternatives allows for a comprehensive
evaluation of options.

2. Compare each alternatives: Once various alternatives have been identified,

engineers must conduct a thorough comparison of each option. This involves
quantifying and analyzing the costs, benefits, and potential outcomes associated with
each alternative. Comparing alternatives helps in selecting the most economically
viable and optimal solution.

3. Have a specific point of view: Engineers must have a well-defined perspective or

objective when evaluating alternatives. Whether the goal is to maximize profits,
minimize costs, or achieve a certain level of performance, having a clear point of
view ensures consistency and coherence in the decision-making process.

4. Use a universal unit of measure: To compare different alternatives, engineers

should use a universal unit of measure for costs and benefits. Money is often the
most common unit used in engineering economics, as it allows for easy comparison
and aggregation of financial data.

5. Don’t forget the other criteria: While financial factors are critical, engineering
decisions should also consider non-monetary criteria such as social, environmental,
and ethical aspects. These qualitative factors may have significant implications for
the project's success and overall impact.

6. Consider the risk and uncertainties: Most engineering projects involve varying
degrees of risk and uncertainty. Engineers should account for these factors when
evaluating alternatives. Techniques such as sensitivity analysis and probabilistic
modeling can help assess how different levels of uncertainty may influence
outcomes.

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING
7. Review your decisions: Engineering economics is an iterative process. Engineers
should review their decisions periodically; especially as new information becomes
available or circumstances change. Re-evaluating decisions allows for adjustments
and ensures that the chosen alternative remains valid throughout the project's
lifecycle.

1.3 ENGINEERING ECONOMICS AND THE DESIGN PROCESS

Engineering Economic Analysis Procedure

Step 1: Problem recognition, definition and evaluation
Step 2: Development of the feasible alternatives
Step 3: Development of the outcomes and cash flows for each alternatives
Step 4: Selection of a criterion
Step 5: Analysis and comparison of the alternatives
Step 6: Selection of the preferred alternatives
Step 7: Performance monitoring and post evaluation of the result

Engineering Design Process

Activity 1: Problem/need definition
Activity 2: Problem/need formulation and evaluation
Activity 3: Synthesis of possible solutions
Activity 4: Analysis, optimization, and evaluation
Activity 5: Specification of preferred alternatives
Activity 6: Communication

Engineering Economics and the Design Process go hand in hand when making
decisions in engineering projects. Let's align the steps of the Engineering Economic Analysis
Procedure with the activities of the Engineering Design Process:

1. Problem recognition, definition, and evaluation (Activity 1: Problem/need

definition): In this step, engineers identify and define the problem or need that
requires a solution. They evaluate the significance and impact of the problem on the
project or organization.

2. Development of feasible alternatives (Activity 3: Synthesis of possible solutions):

Engineers generate and formulate different feasible alternatives to address the
identified problem. These alternatives are potential solutions that could be
implemented to achieve the project objectives.

3. Development of outcomes and cash flows for each alternative (Activity 4:

Analysis, optimization, and evaluation): For each alternative, engineers analyze and
quantify the outcomes, benefits, and costs associated with its implementation. Cash
flows are estimated over time to understand the financial implications of each
alternative.

4. Selection of a criterion (Activity 2: Problem/need formulation and evaluation): In

engineering economic analysis, a criterion is chosen to evaluate and compare the
alternatives. This criterion could be maximizing profits, minimizing costs, meeting
specific performance targets, or any other relevant factor that aligns with the project
objectives.

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING
5. Analysis and comparison of the alternatives (Activity 4: Analysis, optimization,
and evaluation): Engineers conduct a comprehensive analysis and comparison of the
alternatives based on the selected criterion. This involves using economic evaluation
methods such as net present value (NPV), internal rate of return (IRR), or cost-
benefit analysis.

6. Selection of the preferred alternative (Activity 5: Specification of preferred

alternatives): Based on the results of the economic analysis and considering other
relevant factors, engineers choose the most favorable and economically viable
alternative as the preferred solution.

7. Performance monitoring and post evaluation of the result (Activity 6:

Communication): After implementing the preferred alternative, engineers continually
monitor its performance and assess whether it meets the desired objectives. This
information is communicated to stakeholders and decision-makers.

The Engineering Economic Analysis Procedure complements the Engineering

Design Process by providing a structured approach to assess the financial aspects of
different design alternatives. By integrating economic considerations into the design process,
engineers can make more informed and economically sound decisions that lead to
successful project outcomes.

Study Case: A friend of yours bought a small apartment building for $100,000 in a college
town . She spent $10,000 of her own money for the building and obtained a mortgage from a
local bank for the remaining $90,000. The annual mortgage payment to the bank is $10,500.
Your friend also expects that annual maintenance on the and grounds will be $15,000. There
are four apartments (two bedroom each) in the building that can each be rented for $360 per
month.

Step 1. Problem recognition, definition and evaluation

A lot more money is being spent by your friend each year than is being received.
Expense > Revenue
$ 10,500 + $ 15,000 = $ 25,500 > 4 x $360 x 12 month = $ 17,280
$ 25,500 > $ 17,280 ( variance $ 8,220 )

The problem could be that the monthly rent is too low. She is losing $ 8,220 per year

Step 2. Development of the feasible alternatives

• Option (1). Raise the rent (Will the market bear an increase?)

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING
• Option (2). Lower maintenance expenses (But not so far as to cause safety
problems)
• Option (3). Sell the apartment building. (What about a loss?)
• Option (4). Abandon the building (Bad for your friend’s reputation)

Step 3. Development of the outcomes for each alternative.

Option (1). Raise total monthly rent to $ 1,440 + $ R for the four apartments to cover
monthly expenses of $ 2,125.

Note that the minimum increase in rent would be ($ 2,125 – $ 1,440) / 4 = $ 171,25 per
apartment per month (Almost a 50% increase !).

Option (2) . Lower monthly expenses to $ 2,125 – $C so that these expenses are covered
by the monthly revenue of $ 1,440 per month. This would have to be accomplished
primarily by lowering the maintenance cost.

There’s not much to be done about the annual mortgage costs unless a favorable
refinancing opportunity presents itself.

Monthly maintenance expenses would have to be reduced to ($ 1,440 – $ 10,500) / 12 = $

565. (This represent more than a 50% decrease in maintenance expenses!)

Option (3). Try to sell the apartment building for $ X, which recovers the original $ 10,000
investment and (ideally) recovers the $ 685 per month loss ($ 8,220 / 12) on the venture
during the time it was owned.

Option (4). Walk away from the venture and kiss your investment good-bye. The bank would
likely assume possession through foreclosure and may try to collect fees from your friend.
This option would also very bad for your friend’s credit rating.

Step 4. Selection of a criterion

Criterion that your friend concern is to minimize the expected loss of money and credit
worthiness

Step 5. Analysis and comparison of the alternatives

Minimize the expected loss of money. In this case you might advise your friend to pursue
Option (1) or (3)

Credit worthiness. Option (4) is immediately ruled out and Option (3) could also harm your
friend’s credit rating.

Options (1) and Option (2) may be her only realistic and acceptable alternatives.

Step 6. Selection of the preferred alternative

Your friend should probably do a market analysis of comparable housing in the area to see if
the rent could be raised (Option 1). Maybe a fresh coat of paint and new carpeting would
make the apartments more appealing to prospective renters.

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING
If so, the rent can probably be raised while keeping 100% occupancy of the four apartments.

Step 7. Performance monitoring and post-evaluation of results

In the long run your friend need to see alternatives for lowering maintenance expenses. If
there is opportunity in market selling the apartment building is also good option if capital gain
is bigger than investment cost. All those 4 alternatives should be monitored according
changes in market.

1.4 COST CONCEPTS FOR DECISION MAKING

Cost concepts are essential in decision-making processes as they help engineers

and decision-makers understand and analyze the different cost components involved in a
project or operation.

Fixed Costs vs. Variable Costs:

• Fixed costs are expenses that remain constant regardless of the level of production
or activity. These costs do not vary with changes in output in the short term.
Examples: rent, insurance, salaries of permanent staff, and depreciation of
machinery.

• Variable costs, on the other hand, fluctuate with the level of production or activity.
They increase as production increases and decrease as production decreases.
Examples: raw materials, direct labor, and utilities directly tied to production.

Understanding the distinction between fixed and variable costs is crucial in cost-
volume-profit analysis and helps in determining breakeven points and profitability at different
production levels.

Direct Costs vs. Indirect Costs:

• Direct costs are expenses that can be traced directly and specifically to a particular
product, project, or activity. These costs are incurred for the production of a specific
item. For instance, the cost of raw materials used in manufacturing a product is a
direct cost.

• Indirect costs, also known as overhead costs, are expenses that cannot be directly
attributed to a specific product or activity. Instead, they are incurred to support overall
operations.
Examples: utility costs for the entire facility, administrative salaries, and general
maintenance.

Distinguishing between direct and indirect costs is vital for accurate cost allocation
and helps in understanding the total cost of a project or product.

Marginal Costs and Revenue:

• Marginal Costs: Marginal cost refers to the additional cost incurred when producing
one additional unit of output. It considers the change in total cost resulting from a
change in production quantity. Marginal cost is crucial in making short-term
production decisions, such as determining the optimal production level.

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING

• Marginal Revenue: Marginal revenue is the additional revenue earned from selling
one additional unit of output. It is essential in pricing decisions and helps in
determining the optimal selling quantity to maximize profits.

Analyzing marginal costs and revenues aids in identifying the point where additional
production or sales become less profitable.

Sunk Costs and Incremental Costs:

• Sunk costs are expenses that have already been incurred and cannot be recovered.
They are irrelevant for future decision-making since they are in the past and cannot
be changed. Engineers and decision-makers should ignore sunk costs when
evaluating alternatives.

• Incremental costs are the additional costs incurred when choosing one alternative
over another. It focuses on the difference in costs between two choices. Incremental
costs are essential in making decisions between alternatives, as they provide insight
into the additional expenses associated with a specific option.

Considering incremental costs and disregarding sunk costs ensures that decision-
making is forward-looking and based on relevant information.

Understanding these cost concepts is essential for making well-informed decisions in

engineering and business contexts. By analyzing fixed and variable costs, distinguishing
direct and indirect costs, considering marginal costs and revenue, and accounting for sunk
and incremental costs, engineers can optimize resource allocation, project feasibility, and
overall profitability.

1.5 PRESENT ECONOMICS STUDIES

Present economics studies play a crucial role in various fields, including business,
engineering, and policy-making. These studies provide valuable insights and analysis that
guide decision-makers in making informed choices.

1. Market Analysis and Demand Forecasting:

Market analysis involves the examination and evaluation of market trends,
dynamics, and competitive forces to understand the current state of a market. It helps
businesses and policymakers identify opportunities and threats, assess market
potential, and make strategic decisions.

Demand forecasting is an integral part of market analysis, which involves predicting

the future demand for a product or service. By understanding demand patterns,
businesses can plan production, inventory management, and marketing strategies
more effectively.

2. Feasibility Studies: Feasibility studies are comprehensive assessments conducted

to determine the practicality and viability of a proposed project or initiative. These
studies consider technical, economic, legal, operational, and scheduling factors. By
conducting feasibility studies, decision-makers can identify potential risks, costs, and
benefits associated with a project before committing significant resources.

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING

3. Cost Estimation Techniques: Cost estimation techniques are used to predict the
expenses associated with a project or operation. Accurate cost estimation is crucial
for budgeting and resource allocation. Various techniques, such as parametric
estimating, analogous estimating, and bottom-up estimating, are employed to
determine the project's overall cost.

4. Economic Life and Replacement Analysis:

Economic life analysis involves determining the useful life of an asset or equipment
from an economic perspective. It considers factors such as maintenance costs,
operating expenses, and potential resale value. Economic life analysis helps
decision-makers decide the optimal time for replacement or upgrades, ensuring cost-
effectiveness and efficiency in asset management.

Replacement analysis is a decision-making process that assesses whether to

replace an existing asset with a new one. By comparing the costs and benefits of
continuing to use the current asset versus replacing it, decision-makers can make
sound choices that align with the organization's objectives.

These present economics studies provide valuable information for organizations and
policymakers to make well-informed decisions. Whether it's understanding market trends
and demand patterns, assessing the feasibility of projects, estimating costs accurately, or
optimizing asset management, present economics studies contribute to improved efficiency,
profitability, and sustainable growth.

LEARNING ACTIVITY NO. 1: Conceptual Understanding Test

Instructions: This written test aims to assess your understanding of fundamental economics
concepts, principles of engineering economics, and engineering economy terms. The test
consists of both multiple-choice and short-answer questions. Read each question carefully
and provide your responses to the best of your knowledge.

A. Multiple-Choice Questions
1. Economics is the social science that studies:
a) The history of money
b) How individuals allocate limited resources to satisfy unlimited wants
c) The principles of engineering design
d) The geology of natural resources
2. The time value of money recognizes that:
a) Money has a constant value over time
b) Money is worth less in the future due to inflation
c) Money can be invested to earn interest or returns
d) Money has no impact on decision-making

3. What is the key difference between fixed costs and variable costs?
a) Fixed costs change with production levels, while variable costs remain constant.
b) Fixed costs are incurred for short periods, while variable costs are long-term
expenses.
c) Fixed costs do not vary with production levels, while variable costs fluctuate.

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 Republic of the Philippines
CAMARINES NORTE STATE COLLEGE
F. Pimentel Avenue, Brgy. 2, Daet, Camarines Norte

COLLEGE OF ENGINEERING
d) Fixed costs are associated with labor, while variable costs pertain to raw materials.

B. Short-Answer Questions
1. Define opportunity cost and explain its importance in decision-making.
2. Provide an example of a direct cost and an indirect cost in the context of an
engineering project.
3. Explain the concept of marginal revenue and how it is used in pricing decisions.

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