Introduction

What is Economics

Economics is the study of how people choose to use resources.

经济学研究的是人如何选择使用资源。

  • Resources include money, land, equipment, time, knowledge, etc.
  • Economics studies how to make the best decision given limited
    resources.
  • Decision making can be hard in practice because different
    alternatives involve trade-offs and there is a lot of uncertainty.
Economics = Make\ choices\ under\ limited\ resources

Different alternatives usually involve trade-offs, and future outcomes are often uncertain. Therefore, economic decision making is essentially about allocating limited resources among competing alternatives.

What is Engineering Economics

Engineering economics is primarily concerned about economic evaluation of real investments; a.k.a. economic decision analysis.

面对一个现实投资决策，用经济角度去分析到底值不值得、选哪个更好。

  • **Real investment：**plant, equipment, physical business assets
  • **Financial investment：**stocks, bonds

Engineering economic analysis focuses mainly on the economic aspects, or the money side, of a decision.

\text{Engineering Economics} = \text{Economic Evaluation of Real Investments}

However, economic analysis is only one part of the final decision. Other relevant aspects, such as flexibility, reliability, and safety, may also need to be considered.

\text{Economic Analysis} \subset \text{Overall Decision Making}

Principles of Engineering Economics

Develop the Alternatives

Before evaluating a decision, identify the feasible alternatives as comprehensively as possible.

Creativity and innovation are important because the best solution may not be obvious. Decision makers should avoid imposing unnecessary constraints and should consider simple solutions when they are effective.

\text{Develop Alternatives} \rightarrow \text{Evaluate Alternatives}

Focus on the Differences

When comparing alternatives, only attributes with different values affect the decision. Attributes with identical values should be eliminated from the comparison.

\text{Relevant Information} = \text{Differences among Alternatives}

For example, if two workstations have the same resale value, resale value does not need to be considered.

Use a Consistent Viewpoint

Use the same viewpoint (perspective) throughout the entire analysis.
The relevant costs, benefits, and risks depend on whose perspective is adopted. The viewpoint of the decision maker is usually used, but the appropriate perspective should reflect whose objective the decision is intended to serve.

\text{Different Perspectives} \rightarrow \text{Different Evaluation}

Example: In the Mr. Rogue case, the firm’s perspective should be used because the decision is made on behalf of the firm.

Use a Common Unit of Measure

Economic outcomes should be expressed in a common monetary unit before alternatives are compared.

For example, if one quotation is in EUR and another is in USD, both should first be converted into the same currency.

\text{Different Units} \rightarrow \text{Common Unit} \rightarrow \text{Comparison}

Consider All Relevant Criteria

A decision should consider all criteria that are relevant to the alternatives and the decision objective.

\text{Good Decision} \neq \text{Decision Based on One Criterion Only}

Make Uncertainty Explicit

Future outcomes are usually uncertain and cannot be predicted with certainty.

Therefore, uncertainty should be explicitly recognized in the decision analysis.

Revisit Your Decisions

After a decision is implemented, compare the predicted outcomes with the actual results.

This feedback helps improve future decision making.

Procedure of Engineering Economic Analysis

  1. Problem recognition and formulation
    Clearly define the decision problem.
  2. Development of feasible alternatives
    Identify realistic options that can be implemented.
  3. Development of outcomes for each alternative
    Identify relevant attributes and estimate their outcomes. Eliminate attributes with identical outcomes and use a consistent viewpoint.
  4. Selection of criteria
    Determine the standards used to evaluate the alternatives.
  5. Analysis and comparison of alternatives
    Evaluate each alternative and compare them under the selected criteria.
  6. Selection of the preferred alternative
    Choose the alternative that best satisfies the criteria.
  7. Performance monitoring and post-evaluation
    Compare actual results with predicted outcomes and improve future decisions.

Cost Classification

Fixed Cost vs Variable Cost

  • A fixed cost remains constant with the quantity of output or service level.
  • A variable cost changes with the quantity of output or service level.

Recurring Cost vs Nonrecurring Cost

  • A recurring cost occurs repeatedly.
  • A nonrecurring cost occurs only once, or does not repeat regularly.

Direct Cost vs Indirect Cost

  • A direct cost can be attributed to a specific activity or output, such as direct labor and materials.
  • An indirect cost, also called an overhead cost, cannot be attributed to a specific activity or output.

Cash Cost vs Book Cost

  • A cash cost involves an actual payment of money.
  • A book cost is recorded in the accounting system as a cost but does not involve a current cash transaction.

A typical example of a book cost is depreciation.

Book costs may still be relevant to economic analysis because they can affect tax payments.

Suck Cost

A sunk cost is a cost that has already occurred in the past and is unrecoverable.

Because a sunk cost cannot be changed by the current decision, it is irrelevant to the current analysis.

Example: A previously paid option fee is a sunk cost and should not affect the current comparison between two buildings.

Opportunity Cost

An opportunity cost is the value of the best rejected opportunity.

It represents the benefit sacrificed when one alternative is chosen instead of another.

Opportunity cost does not necessarily involve an actual cash payment, but it must be considered in economic analysis.