Lecture 1 Engineering Economics Lecture 1.pdf
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The document outlines a course in construction economics and finance, detailing key concepts such as economic goals, factors influencing supply and demand, and the different types of costs in construction. It introduces essential financial concepts like marginal cost, marginal revenue, sunk cost, and opportunity cost, providing definitions and examples for each. Overall, the course aims to equip students with the knowledge to make informed economic decisions that optimize costs and benefits in construction projects.
Lecture 1 Engineering Economics Lecture 1.pdf
- 1. Master of construction Engineering & Management Course: Construction Economics & Finance Semester 3 Lecturer : Eng. AHMED BAASAAY BSc. Civil Engineering | & M.E. Construction Engineering & management | PhD Scholar
- 2. Construction Economics & Finance CHAPTER ONE: INTRODUCTION Lecturer: Eng.Ahmed Baasaay
- 3. 1.1 ECONOMICS is the science that deals with the production and consumption of goods and services and the distribution and rendering of these for human welfare. The following are the economic goals. - Ahigh level of employment - Price stability Efficiency - An equitable distribution of income - Growth Some of the above goals are interdependent. The economic goals are not always complementary; in many cases they are in conflict. For example, any move to have a significant reduction in unemployment will lead to an increase in inflation.
- 4. ▪ The flow of goods, services, resources and money payments in a simple economy are shown in Fig. 1.1. Households and businesses are the two major entities in a simple economy. FLOW IN ECONOMY
- 5. Law of Supply and Demand • In the figure below; it is clear that “when there is a decrease in the price of a product, the demand for the product increases and its supply decreases.” ▪ 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.
- 7. ▪ Factors influencing demand: The shape of the demand curve is influenced by the following factors: - Income of the people - Prices of related goods - Tastes of consumers ▪ Factors influencing Supply: The shape of the supply curve is affected by the following factors: - Cost of the inputs -Technology “If there is an advancement in technology used in the manufacture of the product in the long run, there will be a reduction in the production cost per unit.” -Weather “For example, demand for woolen products will increase during winter” -Prices of related goods: If the price of TV sets is lowered significantly, then its demand would naturally go up.
- 8. 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 is the ratio of the output to input of a physical system. The physical system may be a diesel engine, a machine working in a shop floor, a furnace, etc. ▪ In practice, technical efficiency can never be more than 100%. This is mainly due to frictional loss and incomplete combustion of fuel, which are considered to be unavoidable phenomena in the working of a diesel engine
- 9. • Economic efficiency is the ratio of output to input of a business system. ▪ ‘Worth‟ is the annual revenue generated by way of operating the business and „cost‟ is the total annual expenses incurred in carrying out the business. ▪ For the survival and growth of any business, the economic efficiency should be more than 100%.
- 10. Definition: Construction Economics deals with the methods that enable one to take economic decisions towards minimizing costs and/or maximizing benefits to business organizations. Definition and Scope of Construction Economics
- 11. Scope: The issues that are covered this course are interest formulae, bases for comparing alternatives, present worth method, future worth method, annual equivalent method, rate of return method, replacement analysis, depreciation, evaluation of public alternatives, inflation adjusted investment decisions, make or buy decisions, inventory control, project management, value engineering, and linear programming. Cont..
- 12. ▪ Cost can be broadly classified into variable cost and overhead cost. ▪ Variable cost varies with the volume of production while overhead cost is fixed, irrespective of the production volume. ▪ Variable costs are costs that change as the volume changes. Examples of variable costs are raw materials, piece-rate labor, production supplies, commissions, delivery costs, packaging supplies, and credit card fees 1.3 ELEMENTS OF COSTS
- 13. ▪ Direct material costs are those costs of materials that are used to produce the product. ▪ Direct labour cost is the amount of wages paid to the direct labour involved in the production activities. ▪ Direct expenses are those expenses that vary in relation to the production volume, other than the direct material costs and direct labour costs. 1.3 ELEMENTS OF COSTS
- 14. ▪ Variable cost can be further classified into direct material cost, direct labour cost, and direct expenses. ▪ Overhead cost refers to the ongoing costs to operate a business Examples include rent payable, utilities payable, insurance payable, and salaries payable to office staff, office supplies. ▪ The overhead cost can be classified into factory overhead, administration overhead, selling overhead, and distribution overhead 1.3 ELEMENTS OF COSTS
- 15. ▪ Overhead cost is the aggregate of indirect material costs, indirect labour costs and indirect expenses. ▪ Administration overhead includes all the costs that are incurred in administering the business. Selling overhead is the total expense that is incurred in the promotional activities and the expenses relating to sales force. ▪ Distribution overhead is the total cost of shipping the items from the factory site to the customer sites. 1.3 ELEMENTS OF COSTS
- 16. ▪ The selling price of a product is derived as shown below: (a) Direct material costs + Direct labour 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 ▪ In the above calculations, if the opening finished stock is equal to the closing finished stock, then the cost of production is equal to the cost of goods sold. 1.3 ELEMENTS OF COSTS
- 17. ❑ The following are the costs/revenues other than the costs which are presented in the previous section: - Marginal cost - Marginal revenue - Sunk cost - Opportunity cost 1.4.1 Marginal Cost Marginal cost of a product is the cost of producing an additional unit of that product. Let the cost of producing 20 units of a product be $10 and the cost of producing 21 units of the same product be $10.45. Then the marginal cost of producing the 21st unit is $0.45. 1.4 OTHER COSTS/REVENUES
- 18. 1.4.2 Marginal Revenue Marginal revenue of a product is the incremental revenue of selling an additional unit of that product. Let, the revenue of selling 20 units of a product be $15,000 and the revenue of selling 21 units of the same product be $15,085. Then, the marginal revenue of selling the 21st unit is Rs. 85. 1.4 OTHER COSTS/REVENUES
- 19. 1.4.3 Sunk Cost This is known as the past cost of an equipment/asset. Let us assume that an equipment has been purchased for $100,000 about three years back. If it is considered for replacement, then its present value is not $100,000. Instead, its present market value should be taken as the present value of the equipment for further analysis. So, the purchase value of the equipment in the past is known as its sunk cost. The sunk cost should not be considered for any analysis done from now onwards. 1.4 OTHER COSTS/REVENUES
- 20. 1.4.4 Opportunity Cost In practice, if an alternative (X) is selected from a set of competing alternatives (X,Y), then the corresponding investment in the selected alternative is not available for any other purpose. If the same money is invested in some other alternative (Y), it may fetch some return. Since the money is invested in the selected alternative (X), one has to forego the return from the other alternative (Y). The amount that is foregone by not investing in the other alternative (Y) is known as the opportunity cost of the selected alternative (X). So the opportunity cost of an alternative is the return that will be foregone by not investing the same money in another alternative. Consider that a person has invested a sum of $ 50,000 in shares. Let the expected annual return by this alternative be $7,500. If the same amount is 1.4 OTHER COSTS/REVENUES
- 21. The amount that is foregone by not investing in the other alternative (Y) is known as the opportunity cost of the selected alternative (X). So, the opportunity cost of an alternative is the return that will be foregone by not investing the same money in another alternative. Consider that a person has invested a sum of $ 50,000 in shares. Let the expected annual return by this alternative be $7,500. If the same amount is invested in a fixed deposit, a bank will pay a return of 18%. Then, the corresponding total return per year for the investment in the bank is $9,000. This return is greater than the return from shares. The foregone excess return of $1,500 by way of not investing in the bank is the opportunity cost of investing in shares. 1.4 OTHER COSTS/REVENUES
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