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1
Lecture # 1
Engineering Economics (2+0)
Fundamentals of Engineering Economics-2
Instructor:
Prof. Dr. Attaullah Shah
Department of Civil Engineering
City University of Science and IT Peshawar
2
Civil Engineering- Program Educational Outcomes
The graduates of Civil Engineering Program after 4-5 years of
graduation will:
PEO1: Successfully practice Civil Engineering at the highest professional
levels to serve national, and international industries and government
agencies;
PEO2: Have the necessary background and technical skills to work
professionally in one or more of the areas of environmental engineering,
geotechnical engineering, structural engineering, transportation
engineering, water resources engineering and other related fields;
PEO3: Be prepared and commitment to their ethical and social
responsibilities to work for the safety of society, both as individuals and
in team environments;
PEO4: Be motivated for, and capable of pursing continued life-long
learning through further graduate education, or other training programs
in engineering or related fields.
3
×
Life Long
Learning
PLO12
×
Project
management
PLO11
×
Communication
PLO10
Individual and
Team work
PLO9
Ethics
PLO8
Environment and
Sustainability
PLO7
×
Engineer and
Society
PLO6
Be motivated for, and capable of
pursing continued life-long learning
through further graduate education,
or other training programs in
engineering or related fields.
Modern Tools
Usage
PLO5
PEO3: Be prepared and
commitment to their ethical and
social responsibilities to work for the
safety of society, both as individuals
and in team environments;
Investigation
PLO4
PEO2: Have the necessary
background and technical skills to
work professionally in one or more
of the areas of environmental
engineering, geotechnical
engineering, structural engineering,
transportation engineering, water
resources engineering and other
related fields;
×
Design
Development
PLO3
PEO1: Successfully practice Civil
Engineering at the highest
professional levels to serve national,
and international industries and
government agencies;
Problem
Analysis
PLO2
Program
Learning
Objectives
(PLO)
Knowledge
PLO1
Program Educational
Objectives (PEO)
×
×
×
×
× ×
×
×
Engineering Economics
Course Objectives/Outcomes:
At the end of the semester students should be able to:


CLO1: To introduce the fundamentals of
engineering economics.
CLO2: To enable students to perform economic
analysis of different projects.
5
Life Long Learning
PLO12
Project management
PLO11
Communication PLO10
×
Individual and Team
work
PLO9
CLO3: To familiarize the students
with the modern tools of Economic
Analysis
.
×
Ethics
PLO8
CLO2:
To enable students to perform
economic analysis of different
projects.
Environment and
Sustainability PLO7
×
Engineer and Society
PLO6
CLO1:
To introduce the fundamentals of
engineering economics.
Modern Tools Usage
PLO5
Investigation
PLO4
Design Development
PLO3
Problem
Analysis
PLO2
Program
Learning
Outcomes
(PLO)
Knowledge
PLO1
Course Learning
Outcomes (CLO)
Course Outline

Fundamentals of Engineering Economics:

Basic concepts and principles of Economics, Micro-economics theory, the
problems of financial scarcity, Basic concept of Engineering Economy,
Consumer and Producer goods, Goods and services, Price-supply-demandrelationship, Equilibrium, Elasticity of demand & supply, Measures of
economic worth, Non-monitory values, Theory of pricing, Theory of
production and laws of return.
Capital Financing and Allocation:
Funding, funding agencies and planning commission, Capital Budgeting,
Allocation of capital among independent projects, financing with debt
capital, Financing with equity capital, Trading on equity, Financial leveraging
Business Organization and Industrial Relationship: Types of
ownership, types of stocks, partnership and joint companies, Banking and
Specialized credit institution; Labour problems, labour organization,
prevention and settlement of disputes, Markets, competition and monopoly.

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Linear Programming: Mathematical statement of linear
programming problems, Graphic solution Simplex procedure,
Duality problem
Depreciation and Taxes: Depreciation concept. Economic life,
Methods of depreciation, Profit and returns on capital,
productivity of capital, Gain (loss) on the disposal of an asset,
depreciation as a tax shield
election between Alternatives: Time value of money and
financial rate of return, present value, future value and annuities,
Rate of Return Analysis, Incremental Analysis, Cost-Benefit
Analysis, Payback Period, Sensitivity and Breakeven
Analysis, alternatives having different lives, making of buy
decisions and replacement decisions.
Week Topic/Lecture
Lecture
Objectives
Assessment
Learning
Outcomes
Course
1
2
Introduction to
Geology:
The Earth as a
planet, Process of
external and
internal origin
(Volcanic,
Metamorphic,
Sedimentary)
- Introduction to CLO-1
Geology and
Engineering
- Introduction to
various theories
about formation
of earth
- To identify
various layers of
Earth and its
significance of
Engineering
- Significance of
Engineering
Geology
Rocks formation - To introduce CLO-2
and classification: the students and
According to the processes
mode of
involved in the
occurrences and formation of
their compositions different types.
- Occurrence of
Rocks and global
Delivery
(Hours)
Program Lec Tutorial IS
PLO-1
02
01
02
CP
CBA
X
Assessment
( Tools)
TA
X
Assignment/Activity:
Visit website and some videos on the formation of earth.
Team Assignments:
1.
Various theories on the formation of earth
2.
Interior of earth
3.
The role of earth crust in human development
4.
Relation of earth curst with Civil Engineering
5.
Role of Engineering Geology in the Civil Engineering Practice
6.
Branches of Engineering Geology
7.
Various Engineering problems associated with geological
Changes
8.
The challenges in Engineering geology
PLO-1
02
01
02
9
X
X
Class based Test and Assignment covering the Lecture-1 before the start of
topic.
Study the Rock maps of Pakistan and Discuss in the Class, the major rocks,
their occurrence and Engineering uses in KPK covering the following
regions.
North ( Swat Buner and Kohistan)
Central ( Peshawar, Mardan Charsadda etc)
South ( Kohat, Bannu, DIK etc.)
What is Economics?

Scarcity – a basic human dilemma
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Limited resources vs. unlimited wants
The human condition requires making choices
Definitions of Economics

Mankiw’s definition

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Hedrick’s definition
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…is the study of how society manages its scarce resources
…is how society chooses to allocate its scarce resources among competing
demands to improve human welfare
Alternative definitions


… what economists do.
… is the study of choice.
What is Economics?

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“A science that deals with the allocation, or use, of scarce
resources for the purpose of fulfilling society’s needs and wants.”
– Addison-Wesley
Scarcity: A situation in which the amount of something actually
available would not be sufficient to satisfy the desire for it, if it
were provided free of charge.
The Economic Problem

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What goods and services should an economy
produce? – should the emphasis be on agriculture,
manufacturing or services, should it be on sport and
leisure or housing?
How should goods and services be produced? –
labour intensive, land intensive, capital intensive?
Efficiency?
Who should get the goods and services produced?
– even distribution? more for the rich? for those who
work hard?
What is Macroeconomics and Microeconomics?
Macroeconomics is the study of issues that affect the economy as a
whole.
Examples are the effects of inflation, and unemployment on economic
growth and economic well-being.
Macroeconomics examines the aggregate behavior of the economy
(i.e. how the actions of all the individuals and firms in the economy
interact to produce a particular level of economic performance as a
whole).
Ex.:
Overall level of prices in the economy (how high or how low they are
relative to prices last year) rather than the price of a particular good or service.
Microeconomics
focuses on how decisions are made by individuals
and firms and the consequences of those decisions.
Ex.: How much it would cost for a university or college to offer a new course
─ the cost of the instructor’s salary, the classroom facilities, the class materials,
and so on.
Flow in an Economy-Simple Model

Two major entities – Household and – Business organization

Business Organizations need various resources like capital, labor and
land etc from the households and make payments to use these
resources
Households make payments for the goods and services, they
consume.
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Law of Supply and Demand
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Law of Demand: The demand of a product increases with the decrease
of its price and vice versa, provided that other things remain the same.
Demand is affected by:
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•
Income of the people:
Prices of related goods ( Substitute and Complimentary)
Tastes and Habits of consumers:
Law of Supply: The supply of a products/goods increases with the
increase of its price and vice versa, provided that other things remain
the same. Supply is affected by:
Cost of the inputs: With increase of prices
of inputs the cost of production and supply will
reduce.
 Technology: The improvement in technology leads
to reduced production cost and more supply.
 Weather: Demand of woolen products will increase in winter
 Prices of related goods: The decreases in LCD sets would lead to reduction in the
TV prices.

Elasticity of Demand

If price rises by 10% - what happens to demand?
We know demand will fall
 By more than 10%?
 By less than 10%?
 Elasticity measures the extent to which demand will
change
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4 basic types used:
Price elasticity of demand
 Price elasticity of supply
 Income elasticity of demand
 Cross elasticity

Elasticity of demand

Price Elasticity of Demand
The responsiveness of demand
to changes in price
 Where % change in demand is greater than %
change in price – elastic
 Where % change in demand is less than % change in
price – inelastic

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Elasticity
The Formula:
Ped =
% Change in Quantity Demanded
___________________________
% Change in Price
If answer is between 0 and -1: the relationship is inelastic
If the answer is between -1 and infinity: the relationship is elastic
Note: Ped has – sign in front of it; because as price rises
demand falls and vice-versa (inverse relationship between
price and demand)
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Income Elasticity of Demand:
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The responsiveness of demand to changes in incomes
Normal Good – demand rises as income rises and vice versa
Inferior Good – demand falls as income rises and vice versa
Cross Elasticity:
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The responsiveness of demand of one good to changes in the price
of a related good – either a substitute or a complement
Goods which are complements:
Cross Elasticity will have negative sign (inverse relationship between
the two)
Goods which are complements:
 Cross Elasticity will have negative sign (inverse relationship
 Goods which are substitutes:
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
Cross Elasticity will have a positive sign (positive relationship)
Elasticity

Price Elasticity of Supply:
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The responsiveness of supply to changes
in price
If Pes is inelastic - it will be difficult for suppliers to
react swiftly to changes in price
If Pes is elastic – supply can react quickly to changes in
price
Pes =
% Δ Quantity Supplied
____________________
% Δ Price
Determinants of Elasticity
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Time period – the longer the time under consideration
the more elastic a good is likely to be
Number and closeness of substitutes –
the greater the number of substitutes, the more elastic
The proportion of income taken up by the product
– the smaller the proportion the more inelastic
Luxury or Necessity - for example, addictive drugs,
diabetic drugs
Importance of Elasticity

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Relationship between changes
in price and total revenue
Importance in determining
what goods to tax (tax revenue)
Importance in analysing time lags in production
Influences the behaviour of a firm
Types of Efficiency

Efficiency is simply the ratio of output to the input, also called Technical
efficiency.
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Technical efficiency (%) =(Output/ Input) x 100
Technical efficiency (%) = (Heat equivalent of mechanical energy produced/
Heat equivalent of fuel used) x 100
Economic efficiency (%) = (Output/Input)x100 = (Worth/Cost)x100
Economic efficiency is also called ‘productivity’.
There are several ways of improving productivity.
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Increased output for the same input
Decreased input for the same output
By a proportionate increase in the output which is more than the proportionate
increase in the input
By a proportionate decrease in the input which is more than the proportionate
decrease in the output
Through simultaneous increase in the output with decrease in the input.
Elements of Cost
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Two major components: Variable cost and overhead cost
Variable Cost would depend on the volume of production and can
be further divided into direct material cost, direct labor and direct
expenses
 Direct Material Cost: Costs of materials
 Direct Labor; Direct Cost of labor
 Direct expenses: Other direct expenses on production than
material and labor
Overhead Cost: It is fixed irrespective of the production. It can be
further divided into Indirect material cost, Indirect labor cost and
Indirect expenses.
 Overheads such as Administrative, selling and distribution
overheads
Selling Price of a product
a) Direct material costs + Direct labor costs + Direct expenses =
Prime cost
(b) Prime cost + Factory overhead = Factory cost
(c) Factory cost + Office and administrative overhead = Costs of
Production
(d) Cost of production + Opening finished stock – Closing finished
stock = Cost of goods sold
e) Cost of goods sold + Selling and distribution overhead = Cost of
sales
(f) Cost of sales + Profit = Sales
(g) Sales/Quantity sold = Selling price per unit
OTHER COSTS/REVENUES
Marginal cost: The cost of producing an additional unit of that
product.
 Marginal revenue: Marginal revenue of a product is the
incremental revenue of selling an additional unit of that product.
 Sunk cost: This is known as the past cost of an equipment/asset.
The sunk cost should not be considered for any analysis done from
now onwards.
 Opportunity cost
 Opportunity cost of an alternative is the return that will be foregone
by not investing the same money in another alternative.
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Opportunity Cost
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Definition – the cost expressed in terms of the next
best alternative sacrificed
Helps us view the true cost of decision making
Implies valuing different choices
General Steps for Decision Making Processes
1.
2.
3.
4.
5.
6.
7.
Understand the problem – define
objectives
Collect relevant information
Define the set of feasible
alternatives
Identify the criteria for decision
making
Evaluate the alternatives and apply
sensitivity analysis
Select the “best” alternative
Implement the alternative and
monitor results
Making Economic Decisions
The most desirable of the options you pass
up is called the Opportunity Cost
 Rank sleep, studying, and playing video
games 1st, 2nd, and 3rd on a list for what you
value the most

Making Economic Decisions
Options
Benefit
Opportunity Cost
0 hours studying, 3 F on Test
hours sleeping
None
1 hours studying, 2 C on Test
hours sleeping
1 hour of sleep
2 hours studying, 1 B on Test
hour sleeping
2 hours of sleep
3 hours studying
3 hours of sleep
B+ on Test
Making Economic Decisions
There is a point at which you are paying
the same increase in cost, but seeing lower
benefits
 You must make the decision as to whether
the cost is worth it
 This same process is used by businesses
and consumers to make decisions

next..

2. If a person who wants to buy a compact disc
(CD) has just enough money to buy one, and
chooses CD A instead of CD B, then CD B is
the
a.
 b.
 c.
 d.

trade-off
opportunity cost
decision at the margin
opportunity at the margin
Elements of Cost
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Two basic components:
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Fixed Cost( Capital Expenditures-Capex)
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Variable cost:
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One time cost- factory cost, building cost, machinery cost etc.
Direct material cost, Direct labor cost, and direct expenses.
Break Even Analysis (BEA):
The main objective of break-even analysis is to find the cutoff production volume from where a firm will make profit.
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s = selling price per unit, v = variable cost per unit
FC = fixed cost per period, Q = volume of production
The total sales revenue (S) of the firm is given by
 S=s Q
The total cost of the firm =TC = Total variable cost + Fixed cost
 = v Q + FC
 At Break even point Total Cost = Total Revenue
 sQ = vQ+FC or Q = FC/ (s-v)
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The contribution is the difference between the sales and the variable
costs.
Margin of Safety: Sales over and above the break-even sales.
The formulae to compute these values are
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Contribution = Sales – Variable costs
Contribution/unit = (Selling price/unit – Variable cost)/unit
M.S. = Actual sales – Break-even sales = Profit / Contribution x sales
M.S. as a per cent of sales = (M.S./Sales) x 100
Break Even Analysis

Alpha Associates:
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Fixed cost = Rs. 20,00,000 Variable cost per unit = Rs. 100
Selling price per unit = Rs. 200
Find
(a) The break-even sales quantity,
(b) The break-even sales
(ii) margin of safety by all methods.
Solution: Fixed cost (FC) = Rs. 20,00,000 , ariable cost per unit (v) = Rs. 100
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
Selling price per unit (s) = Rs. 200
 Breakeven Quantity = FC/ (s-v) = 20,00,000/ (200-100) = 20,000 units
 Break-even sales = [FC/ (s - v)] s (Rs.) = [20 00 000/200-100] x 200 = 40,00,000
 Contribution = Sales – Variable cost = s*Q – v*Q = 200 (60,000) – 100 (60,000)
= 60,00,000
Margin of Safety: M.S. = Sales – Break-even sales = 60,000 x 200 – 40,00,000
= 1,20,00,000 – 40,00,000 = Rs. 80,00,000
M.S. as a per cent of sales = 80,00,000/1,20,00,000 x 100 = 67%
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PROFIT/VOLUME RATIO (P/V RATIO)
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P/V ratio is a valid ratio which is useful for further analysis. The
different formulae for the P/V ratio are as follows:
P/V ratio = Contribution/Sales= (Sales - Variable costs) /Sales
The relationship between BEP and P/V ratio is as follows:
BEP = Fixed cost / P/V ratio
The following formula helps us find the M.S. using the P/V ratio:
M.S. = Profit/ PV ratio
Example

EXAMPLE 1.2 Consider the following data of a company for the year 1997:
Sales = Rs. 1,20,000, Fixed cost = Rs. 25,000, Variable cost = Rs. 45,000

Find the following: (a) Contribution, (b) Profit, (c) BEP, (d) M.S.

Solution:
(a)
Contribution = Sales – Variable costs =Rs. 1,20,000 – Rs. 45,000 = Rs. 75,000
(b) Profit = Contribution – Fixed cost = Rs. 75,000 – Rs. 25,000 = Rs. 50,000
(c) BEP
 P/V ratio = Contribution/ Sales = (75,000/ 1,20,000) x 100 = 62.50%
Four Factors of Production

Natural Resources (also referred to as “land”)

Labor – effort of a person for which they are paid

Capital – human-made resources used to create other goods

Entrepreneurship – person who takes a risk in combining the
other 3 factors to create a new good
Group Assignments
G1: Explain the subject matter of Economics and its various
fields.
G.2: What is meant by Time Value of Money? Explain with
examples from Engineering point of view
G3: Explain Break Even Analysis and its use.
G4: Describe role of Engineering Economics in decision
making
G5: Explain the concept of efficiency in Economics with
examples.
G6: Explain the factors which influence Demand and Supply
G7: How efficiency can be improved for Engineering
processes?
G8: Explain Decision Making Process.